Solving the Enigma of Banking and Money

Abstract

To solve the enigma of why banks exist, and to understand their role in the economy properly, it is necessary to find out what makes them special and why others, for instance brokers or non-bank intermediaries, cannot easily perform the same functions. Fama (1980) argues that one of the two main functions of banks is the provision of transactions and accounting services. Together with the central bank, they serve as the settlement system of non-cash transactions in the economy. This has long been recognized, such as by Schumpeter (1912, 1917/18), who describes the banking system as the 'central settlement bureau, a kind of clearing house or bookkeeping center for the economic system' (1934, p. 124). Thus to him banks and the central bank perform the function of a 'social accounting and clearing system' of the economy. 1 This feature must indeed be important, since non-cash transactions constitute the majority of all transactions in the economy. It is also what banking systems have usually had in common over the past 5000 years. In Japan, transactions amounting to about 70% of annual GDP are settled through the banking system (and thus through the central bank) every single day. 2 Thus the volume of annual transactions in Japan amounts to over ¥100,000 trillion. Notes and coins amount to an average outstanding balance of ¥62.1 trillion. 3 This means that less than 5%, most likely between 1% and 2%, of all transactions takes place in cash. 4 The rest is settled as non-cash transfers. Since even non-bank financial institutions, such as credit card companies, ultimately settle their accounts through the banking system, virtually all non-cash payments are settled in the accounts of banks (and the central bank). 5 The accounting and settlement feature alone is not sufficient, however, to explain the pivotal role banks have been playing in economic systems-after all, there are specialized accounting firms, and bookkeepers, or scribes, have existed outside the banking system for thousands of years. As Fama (1980), suggests, this first feature is likely to become important due to its interaction with a second feature, so that together a unique combination comes about. What is this second feature? 161 12