What is a Bank?
I’m Andy Temte and welcome to the Saturday Morning Muse! Start your weekend with musings that are designed to improve financial literacy around the world. Today is July 5, 2025.
Last week we discussed the history of promissory notes and paper money — building on our lessons focused on the history of money and trade. We found that like early coinage, paper currency represented a debt to be paid and possessed many of the same characteristics—namely that all currency has velocity and flows through an economy. The more times currency is used in transactions, the more economic activity there is, all else the same.
We ended last week’s lesson with an introduction to fiat money — the money we use today — that’s backed solely by trust and confidence in the issuer.
Here in the United States, the issuer of the currency you have in your pocket is the US Government. We learned that prior to 1971, the US dollar was backed by, and was convertible into gold at a predetermined rate. Today, the US dollar is backed only by the “full faith and credit” of the US Government. Put plainly, the currency you hold only has value because of a trust relationship between economic participants (you and me) and the issuer — the US Government.
Your money represents a promise — hence, the link between the first promissory notes and today’s currency.
Now to really understand the evolution of paper currency from promissory notes to the present, we need to introduce the concept of banking. Why? Because historically, paper currency has been backed by promises made between individual traders (e.g., promissory notes), promises made between governments and citizens (e.g., Tang dynasty flying cash from last week), and promises made between individuals, businesses, and banks.
The Definition and Characteristics of a Bank
But what is a bank? A bank, in its most simple form, is defined as:
A financial institution that receives deposits, makes loans, and manages transactions.
Let’s pause to expand on the three main components of this definition:
A deposit is a quantity of money that is placed into an account at a financial institution for safekeeping, investment, or make another financial transaction. In our modern economy, there are many types of deposit accounts - checking, savings, money market, certificates of deposit (CDs), retirement, payroll, sweep, and the list goes on. We will take a deep dive into these account types in later episodes.
A loan is a financial transaction where a financial institution advances a sum of money to a borrower. You can borrow money for a car, house, boat, business, debt consolidation, education, and the list goes on. Again, we’ll take a deep dive into each of these later.
A transaction in a banking context is any kind of deposit, loan, money transfer, payment, or investment. Banks facilitate or manage transactions for a fee. We’ll talk a lot more about how banks make money, but for now, what’s important to know is that the typical bank can earn a significant proportion of their revenue from transaction fees.
So the primary characteristics of a bank and bankers are as follows:
Banks are intermediaries. They connect savers and borrowers.
Banks offer security. They offer a secure environment to store money and other valuables. They also work diligently to identify and prevent fraud.
Banks are facilitators. Remember the velocity of money and how money flows through an economy? This is primarily handled through banking relationships. All modern economies are supported by a healthy banking sector. Banking is ubiquitous today and they’re literally everywhere—both physically and digitally. Bank branch locations are seemingly on every street corner, and you likely have an app on your smartphone that allows you to make banking transactions at any time of the day or night.
Banks are profit seeking. A bank is a business that makes money through transaction fees and the interest it charges on the loans it makes, net of what it pays to depositors (i.e., the interest rate spread). The interest rate spread is the difference between the rate the bank charges/receives for lending money to borrowers and the rate it pays to savers/depositors. Loan rates are almost always higher than deposit rates.
Bankers provide advice to depositors and lenders.
Bankers are risk managers. They continually manage the risk profile of the bank. Banks can get themselves into trouble when they make loans to under-qualified borrowers. If borrowers default on their loans, the bank loses. If depositors want their money back and the bank doesn’t have it, then trust falls, depositors panic, and a bank run can occur. We’ll talk about bank runs in a later episode.
The Modern Lesson
Now next week, as promised, we’re going to introduce a few examples of OG bankers — the Knights Templar, the Medici family, and the Bank of England. But what I want to leave you with today is this modern lesson:
A healthy economy depends on a healthy banking sector.
A wonderful example of this is the Great Recession of 2008. This global economic downturn was caused primarily by the collapse of the U.S. housing market in 2006-2007. In the early-mid 2000s, housing prices increase dramatically, fueled by low interest rates, financial deregulation, and easy credit - meaning that receiving a loan and borrowing was easier, all else the same.
During this period of rapid growth, banks shirked their duty as risk managers and lent money to borrowers who had poor credit and couldn’t afford to repay their loans. When home prices began to fall as the real estate market cooled, these ‘subprime’ borrowers defaulted in large numbers and banks found themselves holding bad loans. A major mortgage lender, Lehman Brothers, declared bankruptcy in September of 2008, which helped exacerbate a global recession that lasted well into 2009.
We’re still feeling the effects of the Great Recession today, primarily in the housing market where the supply of homes is less than the demand. During and after the Great Recession, home builders significantly cut back production of new housing units and we’re still trying to catch up.
Until next week…
Grace. Dignity. Compassion.
