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The banking sector is the section of the economy devoted to the holding of financial assets for others, investing those financial assets as leverage to create more wealth and the regulation of those activities by government agencies.
Holding of Financial Assets
This is the core of all banking, and where it began—though it has expanded far beyond the days of holding gold coins for Holy Land pilgrims in exchange for promissory notes.
A bank holds assets for its clients, with a promise the money may be withdrawn if the individual or business needs said assets back. Avoiding devastating bank runs that could destroy the sector as a whole is why banks are required to maintain at least 8% of their book values as actual money.
Key Takeaways
- The banking industry is an economic sector at the forefront of the U.S. economy.
- Banks only have to keep 10% of each deposit made to them and can use the remaining money for loans.
- Banks must adhere to specific government regulations.
- During the 2008 financial crisis, some big banks, such as Citigroup and Wells Fargo, had to be bailed out by the federal government.
Using Assets as Leverage
Traditionally, banks leverage the money in their vaults as loans, earning money from the interest rates charged on those loans. The great contradiction of banking is that almost all of a bank’s actual money is nowhere near its vaults, meaning that its true value is only paper, yet that paper value is what grows the economy.
The banking sector has always attempted to diversify its risks by investing as widely as possible; this prevents an unexpected loan default from sinking the entire bank. However, this can cause other problems.
The regulation of the banking sector is key to maintaining the public’s trust.
If a bank had invested in the aluminum futures market and had a vested interest in increasing its value, it could simply prevent the aluminum from being sold to industry and drive up that value. This could have a knock-back effect on industry and disrupt the economy, which the banking sector should avoid at all costs.
This is not a random example. Goldman Sachs did exactly that from 2010-2013, and it avoided regulation to prevent this sort of market manipulation by moving the aluminum from warehouse to warehouse within the regulatory limit. It also owned the warehouses, located in Chicago. (For related reading, see: The Evolution of Goldman Sachs.)
Regulation of Banking Activities
Because banks are the underpinning of a modern economy, governments naturally have laws in place to prevent banks from engaging in dangerous activity that threatens the economy.
These laws are often enacted after hard financial lessons, such as the creation of the Federal Deposit Insurance Corporation (FDIC) in 1933 after the bank panics of the previous 50 years. However, such laws are campaigned against by banks and are sometimes removed, and this has led to history repeating itself.
The financial crisis of 2008 was created, in part, by several U.S. banks over-investing in subprime mortgages. Prior to 2000, there were laws that limited the amount of subprime mortgages available, but deregulation efforts removed this limitation and permitted the crisis to happen. It was not the only cause, but it was the tipping point that destroyed worldwide trust in the banking sector.
The banking sector’s core is trust. Without it, no one would deposit money, and it would be unable to use that money to give loans, invest and drive economic growth, and regulation is used to create that trust.
Popular Companies in the Banking Sector
Wells Fargo (WFC) is one of the largest U.S. financial services and bank holding company by market capitalization. It operates in more than 30 countries worldwide and is one of the 100 largest companies in the United States. The company provides consumer and commercial financing, as well as banking, insurance, and investment services.
JP Morgan Chase (JPM), like Wells Fargo, is a true American banking institution and one of the largest investment banks in the world. In addition to regular consumer and commercial banking, JP Morgan offers a wide variety of investment banking services, including raising capital in debt and equity markets, advising on corporate strategies, market making in derivatives, and brokerage and investment research services.
HSBC Holdings (HSBC), headquartered in the United Kingdom, is a global banking and financial services firm that particularly appeals to income investors. The company is segmented into four divisions through which it offers a wide range of consumer and commercial banking services—retail banking and wealth management, global banking and markets, commercial banking, and private banking.
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