A bank's function

• What they are
• Interested parties
• Strengths and drawbacks
• Expenses
• Underlying rules
• Pitfalls

What they are

Banks are undertakings whose activity consists in the collection of savings from the general public and the granting of credit: they collect money and lend it to households and firms.

Banks raise funds in the form of deposits of money made by the public and through bond issues. Bonds consist in the promise to repay the sums received, at a certain date and offering a certain periodic interest. Banks maintain a share of the funds collected in cash to satisfy requests for cash from customers, and invest the remainder in the form of loans and by purchasing securities.

In addition to granting loans to firms and households, banks carry out various financial activities: for example, they hold securities, carry out interbank transactions and grant loans to other financial intermediaries.

What sets banks apart from other financial intermediaries is the particular nature of their liabilities, i.e. the funds that they must pay back to depositors; customers can use the sums deposited in current accounts to carry out transactions (i.e. payments) using instruments such as cheques, credit transfers or payment cards.

Interested parties

The intermediation activities carried out by banks can be in favour of households, firms, or other banking or financial intermediaries. More generally speaking, the role of banks as intermediaries helps the economy to function properly.

What a bank does is what we call the transformation of maturities, i.e. it raises funds in the form of deposits from the public, which are typically reimbursed on demand, i.e. at the request of depositors, and transforms them into financial assets that are usually less liquid, such as loans, which normally have a duration of over one year. Since not all depositors withdraw their funds simultaneously, a bank is able to use part of the funds to finance longer-term financial activities, such as loans to firms and mortgages to households.

Strengths and drawbacks

Banks play an important economic role that consists in transferring financial resources (i.e. money) from persons who have such resources to those who lack them, acting as the counterparty for each transaction. In an economy without financial intermediaries, companies that require funding for an investment project would have no alternative but to raise financial resources from a large number of individual investors, which would mean high costs for the company.

Banks are companies and pursue profit. Customers must constantly monitor the supply of banking services on the market to opt for the best value based on their needs at any given point in time. Portability has enabled customers to change banks in 12 days.

Banks have gradually increased their presence in sectors other than the traditional ones of collecting deposits and supplying loans. They currently offer intermediation services linked to the financial markets, for example the placement and trading of securities and asset management. The expansion of banking activities into new markets together with financial innovation increase the opportunities for customers to access new products but also augment the risks and complexity of the financial system.

Expenses

The products and services provided by banks have a cost that may vary from bank to bank.

Underlying rules

Banks are subject to special regulations that safeguard sound and prudent management. The primary banking legislation is in the Consolidated Law on Banking (Legislative Decree 385/93 and subsequent amendments).

In Europe, the Bank of Italy is the national competent authority for banking supervision as part of the Single Supervisory Mechanism (SSM).

The regulatory framework for supervision is divided according to its sources: international, EU, and primary and secondary national legislation, and is available on the Bank of Italy's website in the Legal framework section.

There are a number of instruments in modern day banking systems that protect their stability, such as deposit insurance or recourse to the central bank as 'lender of last resort' (this means that, in the event of a lack of liquidity, banks can access loans from the central bank).

Italian banks adhere to the Interbank Deposit Protection Fund (FITD), or if they are Banche di Credito Cooperativo (cooperative credit banks - BCCs), they adhere to the Depositor’s Guarantee Fund. Deposit insurance is one of the key components underpinning the safeguards in place and ensuring the stability of the banking system. In this way, the social function of savings and the monetary function of banking intermediation are recognized and protected, whilst preventing traumatic repercussions for depositors in the event of bank failures.

The purpose of the deposit guarantee scheme is to provide protection for inexperienced savers, who do not have the instruments to properly assess the degree of risk of the parties to whom they entrust their savings.

The maximum amount covered is €100,000 for each depositor and per bank.

Pitfalls

People tend to use intuitive rules to resolve complex decision-making problems. The use of mental shortcuts may lead to oversimplification of the decision. In choosing a bank or banking service, people may simplify their decisions and simply opt for the nearest bank.

To avoid making this kind of mistake, don't just make a superficial and instinctive judgment. Take the time to think about what you know in order to make your decision, and give yourself the time you need to reflect on the available options. Don't think in stereotypes: every decision should be assessed on its own merits and according to your needs.

To find out more, watch our videos on behavioural traps.