play a key role in the
monetary system, yet their lending now accounts for less than 20% of
credit market debt in the U.S.
Most of the lending is done by non-bank financial institutions such as
companies, mortgage companies, insurance companies, pension funds, and
investment banks. Non-banks cannot accept demand deposits, and
play no direct role in the payment system.
But they provide a variety of financial products and
compete with banks and
each other for lending opportunities.
intermediaries. They act as a conduit between those with funds to
and those in need of funds. By pooling the funds of investors
they borrow, they can then lend in various amounts and periods.
service they charge a fee, usually in the form of periodic interest
payments. Their borrowing and lending increases the total credit
debt but has no direct effect on the money supply. Non-banks
simply intermediate the transfer of funds from
the bank accounts of the original
investors to the bank accounts of the ultimate borrowers.
short-term at lower rates to lend longer term at higher rates.
a non-bank must be able to roll over its short-term debt at favorable
rates. It must also be able to borrow on short notice to manage
flow problem. For that reason it must maintain an excellent
rating, or it may not be able to borrow at all.
are not ordinary
intermediaries. Like non-banks, they also borrow, but they do not lend
deposits they acquire. They lend by crediting the borrower's
a new deposit, and then if necessary borrowing the funds needed to meet
reserve ratio requirement. The accounts of other depositors
and their deposits fully available for withdrawal. Thus a bank
increases the total of bank deposits, which means an increase in
money supply. When the loan is paid off, the money supply
increase in bank lending
results in a shortage of reserves needed by the banking system, which
Fed can supply. In order to maintain control of the Fed funds
the interest rate on overnight loans between banks, the Fed must
funds as required. It does so by purchasing Treasury securities
lending has no effect on a
bank's own capital. But bank lending is limited by the capital
set by the Fed. If a bank has sufficient capital, it can expand
balance sheet by issuing more loans. However if it is not holding
reserves, it will have to acquire more in order to meet the reserve
requirement. Banks therefore actively seek new deposits. Of
they prefer deposits on which they pay no interest, like ordinary
accounts. They also borrow from savers who open savings accounts
who buy their CDs.