Absent a satisfactory understanding of what it is—or was—that
makes banks special in a functional sense, it is very difficult, with
any degree of consistency, to answer questions about the separation
of banking from other lines of business, the scope of banking powers,
the ownership and control of banks, and banking structure more generally.
This essay seeks to shed light on these issues by stepping back from
current institutional, regulatory and legal arrangements and attempting
to identify the essential functions of banks.
The essay suggests that banks perform three essential functions: (1)
they issue transaction accounts (i. e., they hold liabilities that are
payable on demand at par and that are readily transferable to third parties);
(2) they are the backup source of liquidity to all other institutions,
financial and nonfinancial; and (3) they are the transmission belt for
On close inspection, it becomes evident that these essential functions
are highly interdependent and that banks' ability to perform such functions
dictates the need for a high degree of public confidence in the overall
financial condition of banks—and especially the quality of banks'
This dictate has been reinforced by a public safety net—deposit
insurance and access to the lender of last resort—which is uniquely
available to “banks.” The presence of that public safety net
implies unique public responsibilities on the part of banks and would
further seem to imply that if we are no longer willing or able to segregate
essential banking functions into an identifiable class of institutions,
then the public safety net should be made universally available to any
institution that provides a banking function, or it should be eliminated
Against this background, the essay goes on to suggest a definition of
a bank. The definition is deceptively simple: a bank is any institution
that is eligible to issue transaction accounts. If an institution meets
this definition, it would (1) be eligible for government deposit insurance;
(2) have direct access to the discount window; (3) be subject to reserve
requirements; and (4) have direct access to Federal Reserve payment services,
particularly the wire transfer system.
Four important implications emerge from the essay's analysis of essential
bank functions and the associated definition of a bank.
First, if preserving essential bank functions really does matter it
follows that banks must be competitively viable.
Second, there is room for broader bank powers. The expansion of those
powers must, however take place within a context that guards against excessive
risk-taking by banks and insures the impartiality of the credit decision
Third, once agreement has been reached on appropriate banking powers,
questions about bank ownership and control become easier to answer. Certainly
logic would suggest that particular powers be vested in banks only to
the extent that there is a willingness to permit another institution engaging
in those same activities to own banks. By the same token, nonbanking organizations
would be permitted to own banks only insofar as their activities match
permitted banking activities. And if they own a bank, they would become
a bank holding company.
Fourth, while there is a powerful case for placing some subsidiary banking
activities into affiliates of bank holding companies on the grounds of
segregating capital and providing greater protection against self-dealing,
the bank holding company is not a substitute for prudent management nor
is it a fail-safe device for containing risk.
Complete text of “Are Banks Special?”
Comments in response to this essay or regarding similar issues can
be found in the following:
Interview with Carter H. Golembe, The Region, June 1998
Interview with E. Gerald Corrigan, The Region, November 1990
Safeguards to the U.S. Banking
System Should Not Be Dismantled,
The Region, June 1990