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Modern banks provide many services


Bank is a financial firm that accepts people’s deposits and uses them to make loans and investments. People keep their savings in banks for several reasons. Funds are generally safer in a bank than elsewhere. A debit card or an account that permits online banking provides a convenient way to pay bills. Also, funds deposited in most bank accounts earn interest income for the depositor. People who deposit money in a bank are actually lending it to the bank. The bank typically pays interest for the use of the funds.

Banks help promote economic growth. Manufacturers borrow from banks to buy new equipment and build new factories. People who do not have enough savings to pay immediately the full price of a home or an automobile also borrow from banks. In these ways, banks help promote the production and sale of goods and services. As a result, banks help create jobs.


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Brokers at a bank

Like all businesses, banks try to earn profits. They have traditionally done so by accepting deposits at one rate of interest and then lending and investing those funds at a higher rate. But large banks also earn fees from other activities. These activities include brokerage (buying and selling securities for other investors) or selling insurance.

Banking is nearly as old as civilization. The ancient Romans developed an advanced banking system, The Roman banking system served the Romans’ vast trade network. This network extended throughout Europe, Asia, and much of Africa.

Modern banking began to develop during the 1200’s in Italy. The word bank comes from the Italian word banco, meaning bench. Early Italian bankers conducted their business on benches in the street. Large banking firms were established in Florence, Rome, Venice, and other Italian cities. Banking activities slowly spread throughout Europe. By the 1600’s, London bankers had developed many of the features of modern banking. They paid interest to attract deposits. They also loaned out a portion of their deposits to earn interest themselves. By the same date, individuals and businesses in England began to make payments with written drafts on their bank balances. Those drafts resembled modern checks.

Bank services

Safeguarding deposits. Deposits in a bank are safe. Banks keep cash and other liquid assets available to meet withdrawals. Liquid assets include securities that can be readily converted to cash. Banks are also insured against losses from robberies. But the most important safeguard is the fact that in most countries, governments have established deposit insurance programs. The insurance protects people from losing their deposits if a bank fails.

A bank not only keeps savings safe but also helps them grow. Funds deposited in a savings account earn interest at a specified annual rate. Many banks also offer a special account for which they issue a document called a certificate of deposit (CD). Most CD accounts pay a higher rate of interest than regular savings accounts. However, the money must remain in the account for a certain period, such as one or two years. Banks also offer money market accounts. These accounts pay an interest rate based on the prevailing rates for short-term corporate and government securities.

Providing a means of payment. People who have funds in a bank checking account can pay bills by simply writing a check and mailing it. Written checks, however, are not as frequently used to pay bills as they once were. Electronic forms of banking have become more common. For example, customers may request that their bank automatically pay recurring bills, such as telephone and mortgage payments. This process is called automatic deduction. Banks also allow people to pay bills electronically by telephone or through the Internet.

Many banks offer credit cards. People can use the cards to pay for their purchases at stores and other businesses. The bank then pays the businesses directly and sends the customer a monthly bill for the amount charged. The cardholder can usually choose to pay only part of the bill immediately. If so, he or she must pay a finance charge on the unpaid balance.

Banks may also issue debit cards, which resemble credit cards. When a cardholder uses a debit card, the amount of the purchase is deducted directly from the cardholder’s checking account. Some cards can be used as either credit or debit cards.

Making loans. Banks receive funds from people who do not need them at the moment and lend them to those who do. For example, a couple may want to buy a house but have only part of the purchase price saved. If one or both of them have a good job and seem likely to repay a loan, a bank may lend them the additional money they need. To make the loan, the bank uses funds other people have deposited.

A major obligation of a bank is to permit depositors to withdraw their funds upon demand. But no bank has enough cash readily available to satisfy its depositors if all were to demand their funds at the same time. Banks know from experience, however, that such a demand—called a run—rarely occurs. If people are confident they can withdraw their funds at any time, they will leave them on deposit until needed. As a result, banks can loan and invest a large percentage of the funds deposited with them. In most countries, the government limits the percentage of a bank’s funds that can be used for loans and investment. The government also sets a minimum percentage that must be kept on reserve for meeting withdrawals.

Other services. During the late 1900’s, banks began to offer a wide range of financial services. For example, a large number of banks offer mutual funds. Mutual funds are investments in which money from many investors is pooled and used to buy stocks and other securities. Some banks offer financial instruments called derivatives. Derivatives make payments to investors based on price changes in certain financial markets, such as the stock market or foreign exchange.

Electronic banking. A system called electronic funds transfer (EFT) moves funds from one account to another without the use of checks. EFT includes five types of facilities and systems—automated teller machines, telephone-banking systems, computer-banking systems, automated clearinghouses, and point-of-sale terminals.


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Automated teller machine

Automated teller machines (ATM’s) are computer terminals at banks, airports, shopping centers, and many other locations. They are also called cash machines or cash dispensers. A customer inserts a special ATM card into the machine and uses a keypad (set of buttons or keys) to enter a personal identification number (PIN). People use automated teller machines primarily to make deposits, transfer funds between accounts, and withdraw limited amounts of cash. ATM’s enable people to do their banking at many locations any hour of the day or night, seven days a week.

Telephone-banking systems enable customers to pay bills and transfer funds from one account to another by calling a special telephone number. Typically, the customer requests a transaction by pressing a sequence of buttons on the telephone in response to recorded messages. In this way, the customer gives instructions to a bank computer, which carries out the transaction.

Computer-banking systems also allow people to pay bills and transfer funds from one account to another at any time. Many banks offer online banking through the Internet. People simply visit their banks’ websites to do their banking.

Automated clearinghouses are computer centers for the automatic deposit and the automatic payment of many bills. An employer or the government, for example, instead of issuing paychecks or social security checks, directs the computer to credit a person’s account with the person’s pay. People can also arrange for insurance premiums, mortgage installments, and other regular payments to be transferred from their bank accounts to the billers’ accounts.

Point-of-sale (POS) terminals are computer terminals in retail stores. To pay for a purchase, a customer presents a debit card. In seconds, the system transfers the amount of the purchase from the customer’s bank account to the store’s bank account.

In France and other countries, smart cards are widely used for purchases. These cards have one or more embedded computer chips that store information about the user’s bank balance and purchases. Smart cards store more data than magnetic-stripe cards do. But they cost more to issue and require special terminals.

During the 1990’s, many banks in Europe began to use electronic money, also called e-money or e-cash. To make purchases in stores or over computer networks, users simply present proof of stored money value. In one e-money system, banks electronically transfer the customer’s stored value onto his or her smart card or other device.

Kinds of banks

Banks differ in the services they provide and in their form of ownership. Financial experts sometimes use the word bank to refer only to a commercial bank. Other institutions do not perform all the functions of commercial banks or are more restricted in performing them. These institutions include savings banks, savings and loan associations, and credit unions. They are often called thrift institutions, or simply thrifts, because a chief purpose is to encourage saving. Some countries simply divide banks into deposit-taking institutions and credit institutions.

Most countries also have agencies called central banks. Although they are called banks, they do not accept deposits or lend money to the public. Other kinds of banks include investment banks and multilateral development banks.

Commercial banks are the most important banks in terms of assets. They offer a wide range of services, including checking and savings accounts, loans, and individual retirement accounts (IRA’s). IRA’s accumulate interest tax free until funds are withdrawn. Commercial banks traditionally served businesses, but they now meet the financial needs of individuals as well.

A commercial bank is owned by stockholders who buy shares in it. In return for acquiring a bank’s stock, stockholders expect the bank to pay them cash dividends from its profits. .

Savings and loan associations are another important type of deposit-taking institution. Savings and loans are often called building societies or S & L’s. Savings and loans were established to help people purchase homes. For a long time, they were the chief source of home mortgages. Today, S & L’s have become more varied. They offer a variety of services, including checking accounts, IRA’s, money market accounts, and consumer and business loans. Several large building societies in the United Kingdom, for example, have expanded into other types of banking or converted to commercial banks.

In the past, almost all savings and loans were owned and operated by their depositors. But today those owned by stockholders are far more important than those owned by depositors.

Savings banks were created in the United States in the early 1800’s. Originally, they were charitable institutions to provide a safe place for poor working people to save for retirement. Originally, almost all savings banks were mutual savings banks. Mutual savings banks are operated by a board of trustees who elect their own successors. Since the mid-1980’s, many savings banks have become stock savings banks. These banks are operated by a board of directors who are elected by shareholders.

Savings banks offer savings and checking accounts and IRA’s. They also make personal and business loans.

Credit unions are formed by people with a common bond. For example, they may work for the same company or belong to the same church. The members pool their savings. When one of them needs funds, he or she may borrow from the credit union. A credit union often charges a lower rate of interest than another financial institution would, because credit unions are exempt from most taxes. A credit union distributes its profits to members as dividends on their accounts. Credit unions are important in the United States and Canada. Federal, state, and provincial laws limit credit unions to meeting the needs of their members. They do not typically lend to businesses.

Investment banks purchase newly issued stocks and bonds from corporations and governments. They then resell the securities to investors in smaller quantities. An investment bank makes a profit by selling securities at a higher price than it pays for them. The first investment banks were formed by British merchants in the 1800’s. In the 1930’s, the U.S. government prohibited mixing commercial and investment banking. But in the 1980’s, the government began to permit large commercial banks to buy and sell securities within limits. In 1999, it removed the barriers separating investment banking from commercial banking. The banking system made up of investment banks and other less regulated banks is sometimes called the shadow banking system.

Central banks, which in most countries are government agencies, perform financial services for national governments. Their chief responsibility is to help stabilize interest rates, prices, and overall economic activity. Central banks do so by influencing the money supply. The money supply is the total quantity of money in a country, including cash and bank deposits.

Central banks also perform a variety of services for other banks. For example, they serve as a lender of last resort. That means they make emergency loans to banks that need cash for unexpected deposit withdrawals. Central banks also handle the clearing of checks. Clearing is the process by which banks settle claims against one another that result from the use of checks.

The functions of central banks differ from country to country. In the United States, the Federal Reserve System, often called simply the Fed, is the central bank. It was established in 1913. The Fed helps regulate and supervise commercial banks.

Multilateral development banks are international financial institutions owned by and funded by member nations. The purpose of these institutions is to provide funds to developing countries for projects that promote economic and social progress. Although most of the banks channel funds to public projects, some funding is also provided for private ventures.

There are dozens of development banks worldwide. The World Bank is the largest development bank. Other important banks are the African Development Bank; the Asian Development Bank; the European Bank for Reconstruction and Development; and the Inter-American Development Bank. Every year, these banks commit billions of dollars to projects in developing countries. The multilateral development banks also provide grants, technical cooperation, capital investment, and other types of assistance.

Banks throughout the world

The world’s largest private banks have headquarters in Germany, Japan, Switzerland, the United Kingdom, and the United States. These banks are multinational corporations, operating in many countries throughout the world. In 1988, banking leaders in these and several other countries agreed to establish international standards for the minimum amount of capital relative to assets that a bank must have. A bank’s capital is its net worth after all its financial liabilities, such as deposits, are deducted from its assets. These international standards are known as the Basel Accords, named for the city in Switzerland where the agreements were created.

Africa. Kenya, Nigeria, and South Africa have well-developed banking systems with large numbers of both commercial and merchant banks. In most other African countries, large multinational banks with headquarters abroad carry out much of the banking. Some countries, including Algeria and Ethiopia, have nationalized their banks—that is, put them under government control. Egypt nationalized its banks in 1961 but restored privately owned banks in 1974. Tanzania nationalized its banks in 1967 but legalized private banking again in 1993.

African countries with large Muslim populations, such as Egypt and Senegal, have special Islamic banks. Islamic banks operate according to Islamic rules. Islam forbids the charging of interest, so Islamic banks make special arrangements with the clients to whom they lend money. For example, the client may pay a commission on the loan, or the bank may receive a share of ownership in the client’s business.

Asia and the Middle East. Hong Kong, Singapore, and Tokyo are the largest banking centers in Asia. Many of the world’s richest banks have their headquarters in those three metropolitan areas. In Japan, large financial institutions called city banks serve the banking needs of major industrial firms. Leading city banks include the Bank of Tokyo-Mitsubishi UFJ and Sumitomo Mitsui Banking Corporation. Smaller regional banks serve local businesses and smaller firms.

Many Asian countries have both government-owned and private banks. For example, the government of India owns the country’s largest commercial banks. India also has hundreds of smaller private banks. Several other Asian countries, including Iraq, Laos, Myanmar, and Pakistan, ended government ownership of banks in the late 1980’s or early 1990’s.

For many years, Beirut, Lebanon, was the banking center of the Middle East. In the 1970’s, however, a civil war broke out between Lebanese Christians and Muslims. This fighting left Beirut’s banking industry in ruins. Bahrain later became the financial hub of the Middle East. Bahrain has encouraged the establishment of offshore banking units. Offshore banking units may not provide local banking service but do accept deposits from governments and foreign businesses. Singapore is another Asian country with offshore banking units.

Iran nationalized all banks in 1979 and established an Islamic banking system. Many other Asian and Middle Eastern countries, including Bahrain, Malaysia, and the United Arab Emirates, also have Islamic banks.

Australia and New Zealand. Four large commercial banks, usually called trading banks, dominate banking in Australia and New Zealand. The four are the Australia and New Zealand Banking Group (ANZ), the Commonwealth Bank of Australia, the National Australia Bank, and Westpac Banking Corporation. In New Zealand, almost the entire banking system is foreign-owned.


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Early bankers in Italy

Europe. The banking system in many European countries is dominated by a few large banks, each with many branches. In the United Kingdom, for example, several large clearing banks handle most checking and credit transactions. These banks are Barclays, HSBC, Lloyds Banking Group, and the Royal Bank of Scotland. Banking in Germany is dominated by Commerzbank, Deutsche Bank, and HypoVereinsbank. Swiss banking was long concentrated in three institutions, Credit Suisse Group, Swiss Bank Corporation, and Union Bank of Switzerland. The number was reduced to two in 1998, when Swiss Bank and Union Bank merged to form UBS. Banks in Switzerland attract deposits from many countries because of their reputation for safety and secrecy.

Banks in many European countries offer a wider range of services than banks in other countries do. For example, many German banks are universal banks that conduct customary banking plus a wide range of securities and insurance activities.

During the late 1980’s, Communist rule ended in much of Eastern Europe. The Soviet Union dissolved in 1991. Many Eastern European countries and former Soviet republics began sweeping reforms of their banking systems. Many new private banks sprang up.

Latin America. Such countries as Argentina, Bolivia, Brazil, and Chile have both government-owned and private banks. Many foreign-owned banks also operate in those countries. Cuba nationalized all its banks in 1960. Colombia, El Salvador, Mexico, and Nicaragua nationalized many banks in the late 1970’s and early 1980’s. But those countries began to return their banks to private ownership in the late 1980’s and early 1990’s.

Canada. The Canadian banking system consists of a small number of commercial banks that control almost all the country’s total banking assets. They have thousands of branches throughout the country. In Canada, commercial banks are federally chartered and regulated. The biggest banks may own securities firms, trust companies, and insurance companies.

Canada also has loan companies. The loan companies handle deposits and invest primarily in mortgage loans. Hundreds of credit unions provide consumer credit. Trust companies and loan companies may be regulated by the national or the provincial government. Credit unions are supervised by the provinces.

Regulation of U.S. banks

Commercial banks in the United States must have a state or federal charter. A bank charter is a document granting government permission to operate a bank. The type of charter determines whether federal or state officials are the bank’s main regulators and supervisors.

Federally chartered banks are called national banks. State banks are, on average, smaller than national banks. But a few large banks have state charters.

Regulation of a state-chartered bank is directed mainly by a state official. A state bank may decide voluntarily to join the Federal Reserve System to gain access to the Fed’s check-clearing and emergency lending services. The Fed regulates and supervises its member banks. It also regulates all bank holding companies (companies that own and control just banks) and financial holding companies (companies that own and control banks, securities firms, and insurance companies). Regulation and supervision of national banks is performed by the Office of the Comptroller of the Currency, an agency of the U.S. Department of the Treasury. All national banks must belong to the Federal Reserve System.

A government corporation called the Federal Deposit Insurance Corporation (FDIC) insures deposits in nearly all the commercial and savings banks in the United States. The FDIC insures each account for a maximum of $250,000. If an insured bank cannot pay its depositors their funds, the FDIC will pay them up to the limit. The FDIC also helps regulate banks. Most S & L’s are federally chartered and regulated by the Office of the Comptroller of the Currency. The FDIC insures deposits in S & L accounts up to $250,000.

Federally chartered credit unions are regulated by the National Credit Union Administration. It administers the National Credit Union Share Insurance Fund, which insures accounts at both federally and state chartered credit unions up to $250,000.

The Consumer Financial Protection Bureau, a federal agency, guards consumers against deceptive practices involving mortgages, credit cards, and other forms of lending.

History of U.S. banking

After winning the war of independence in 1783, the United States struggled to establish its own economic and financial system. Most of the people in the new nation lived on farms. The only cities were small compared with those in Europe. Industry and trade were undeveloped. Americans had little experience with banks, and they disagreed about what kind of banking system should be established. One group, led by Secretary of the Treasury Alexander Hamilton, wanted to develop an industrial economy. This group believed large banks were essential. Another group, led by Secretary of State Thomas Jefferson, thought the nation should remain mostly agricultural. Jefferson’s group opposed the establishment of large banks.

Hamilton and his followers also wanted a strong federal government that had the exclusive authority to charter and supervise banks. Jefferson and his supporters favored states’ rights and strict limits on the power of the central government. They insisted that only states should charter and supervise banks.

The First Bank of the United States was established by the federal government in 1791. The First Bank had a 20-year charter that expired in 1811. The bank functioned as both a commercial bank and a central bank. It made loans and purchased securities and safeguarded deposits. It also issued currency and performed a variety of services for the government. In addition, the First Bank regulated the lending practices of state banks and the issuing of bank notes. At that time, most of the paper money consisted of bank notes, which were issued by banks rather than governments. The issuing bank promised to exchange its notes for gold or silver coins on demand.

The First Bank was not only the largest bank of its day but also the largest corporation in the country. The federal government provided a fifth of the bank’s capital. Private investors supplied the rest.

Many state banks, business firms, and individuals believed that by setting up the First Bank, the federal government had given itself too much power at the expense of the states. The bank functioned well, but Congress refused to renew its charter in 1811.

After the First Bank ceased to exist, the number of state banks grew rapidly. Most of them issued their own bank notes, which people used as currency. Many banks did not have enough gold and silver coins on hand to exchange for the notes. As a result, much currency was worth less than the value printed on it. To resolve this problem, Congress established the Second Bank of the United States in 1816. The Second Bank also had a 20-year charter.

The Second Bank of the United States resembled the First Bank in its organization and functions. It regulated state banks and limited them from issuing too much paper money and from making loans without enough security. However, President Andrew Jackson and many other Americans viewed the Second Bank as a dangerous monopoly. In 1832, Jackson vetoed the renewal of its charter, which expired in 1836. The United States did not have another federally chartered bank until 1863 or another central bank until 1913.


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Bank notes

The Wildcat Period, from the early 1800’s to 1863, was a time of widespread problems in U.S. banking. One of the worst problems was a fluctuating money supply. State banks sometimes issued large amounts of bank notes and lent funds freely. At other times, they tightened the money supply and made few loans. These fluctuations led to wide swings in prices and levels of economic activity. Also, many banks had too little capital to support the risky loans they made. As a result, institutions failed, and depositors lost their savings. Counterfeiting was another problem during the Wildcat Period. Because hundreds of banks issued notes of their own design, counterfeiters could easily fool people by inventing fake currencies.

In spite of its many problems, the Wildcat Period probably benefited the economy in some ways. Banks made risky loans that contributed to the nation’s economic growth and development. The loans financed new factories, railroads, and other industrial projects.


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Making paper for bank notes

The national banking system. In 1863 and 1864, Congress passed the National Bank Acts. The acts allowed for privately owned banks to be chartered by the federal government. The new banks, called national banks, issued uniform notes backed by U.S. government bonds. The issuance of these bank notes was strictly controlled by the government. The government drove state bank notes out of circulation by imposing a tax on their use.

The new national banking system gave the nation a safe, uniform currency. But it did not provide a way to increase the money supply steadily to meet the needs of the growing economy. Periodic shortages of cash, together with inadequate bank reserve requirements, caused a series of financial panics. Panics struck in 1873, 1884, 1893, and 1907. During each panic, many banks closed temporarily because they did not have enough readily available cash for their depositors. Some of those banks never reopened, and the economy suffered.


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Banking in the United States

To prevent new financial panics, Congress passed the Federal Reserve Act of 1913. By creating the Federal Reserve System, this act enabled the federal government to control bank reserves. It could thus influence the money supply to meet the nation’s needs. Many people still worried about the concentration of financial power, however. To ease those concerns, Congress did not create a “single” central bank. Instead, it divided the country into 12 districts, each with its own reserve bank. A seven-member board of governors in Washington, D.C., supervises the system and coordinates the policies of the 12 banks.

The crisis of 1933. The Great Depression hit the United States—and the world—in 1929. Business firms failed. Workers lost their jobs. Farmers lost their farms. Banks had made loans to thousands of people who could not repay what they owed. The Depression also forced many depositors to withdraw their savings. Banks had great difficulty meeting the withdrawals. The withdrawals came at a time when banks were unable to collect on many loans. Furthermore, the collateral for the loans had lost value due to the Depression. Collateral is something of value that a borrower pledges to the lender in case the loan is not repaid as promised.

In February 1933, banks in Detroit failed. The blow to public confidence was so great that depositors throughout the country attempted to withdraw cash from their banks. These runs ruined many banks. To stop the panic, President Franklin D. Roosevelt declared a bank holiday on March 6, 1933. All banks closed until federal officials examined the books of each one. Only banks found to be in good condition were allowed to reopen. Many never reopened. Roosevelt’s action was designed to help restore public confidence in U.S. banks and put an end to the crisis.

The Banking Act of 1933 also strengthened people’s faith in banks. It created the FDIC to insure bank deposits. The act also prohibited commercial banks from engaging in investment banking activity. This law is often called the Glass-Steagall Act because it was sponsored by Senator Carter Glass of Virginia and Representative Henry B. Steagall of Alabama.

Changes in banking laws. From the 1930’s to the 1960’s, bank regulation centered on ensuring financial stability. During the 1960’s and 1970’s, however, the focus of regulation broadened to include consumer issues, such as fairness in lending. In 1968, Congress passed the Consumer Credit Protection Act. This law is often called the Truth in Lending Act. It requires banks and other lenders to state clearly the actual annual interest on loans. The Equal Credit Opportunity Act of 1974 prohibits banks from discriminating on the basis of sex or marital status in making loans. Amendments to the act passed in 1976 forbid discrimination on the basis of race, color, religion, national origin, or age. The Community Reinvestment Act of 1977 encourages banks to meet the credit needs of their communities.

A boom in money market funds. During the early 1970’s, many private investment companies began to offer money market funds. These funds paid interest rates that exceeded the rates offered by banks and thrifts. As a result, many people withdrew their savings from lower-yielding bank and thrift accounts and deposited them in more attractive money market funds. To help banks and thrifts keep their depositors, the Depository Institutions Deregulation and Monetary Control Act of 1980 gradually raised the federal ceilings on bank interest rates. The act removed interest-rate caps completely by 1986. In addition, it authorized all banks and thrifts to offer interest-bearing checking accounts called negotiable order of withdrawal (NOW) accounts.

The Garn-St Germain Depository Institutions Act of 1982 let banks and thrifts compete directly with money market funds. This act was named for its sponsors, Senator Edwin J. (Jake) Garn of Utah and Representative Fernand J. St Germain of Rhode Island. It authorized banks to offer federally insured accounts that would pay market interest rates and permit withdrawals on demand. It also allowed banks to sell shares in mutual funds.

The savings and loan crisis. In the 1980’s and early 1990’s, the savings and loan industry experienced its worst financial crisis since the Great Depression. More than 1,000 institutions failed. Hundreds more were acquired by stronger institutions. Factors contributing to the crisis included lax regulation and supervision, mismanagement and fraud in the industry, and extensive competition from other types of financial firms. The crisis also resulted from the failure of customers to repay their loans. Many customers could not repay because of a recession in agriculture and the petroleum industry and because of a sharp decline in U.S. real estate prices.

The widespread failure of S & L’s bankrupted the Federal Savings and Loan Insurance Corporation (FSLIC). The FSLIC had insured deposits in such institutions since the 1930’s. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 dissolved the FSLIC and gave responsibility for insuring savings and loans to the FDIC. Such regulation was formerly the job of the Federal Home Loan Bank Board. In addition, the act created the Resolution Trust Corporation to sell the assets of all remaining failed savings and loans. The corporation finished its work in 1995 and was dissolved that same year. To help prevent future problems, Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1991. It requires federal regulators to intervene whenever a bank’s capital falls below a specified level.

Diversification and mergers. During the 1990’s, banking began to transform itself into a new industry called financial services. Large banks offered a wide variety of services, such as insurance and brokerage. In 1998, the insurance firm Travelers Group Inc. merged with Citicorp bank to become Citigroup. Citigroup is a giant financial services company that operates in dozens of countries.

At the same time, a wave of bank mergers transformed the banking system in the United States and throughout the world. More than 2,000 commercial bank mergers took place in the United States during the 1990’s. In 1999, Congress passed the Financial Services Modernization Act. This law allowed banks, insurance companies, and securities firms to combine within a financial-services holding company. These varying types of financial institutions could be owned by one parent company, providing each institution operated independently. The act lifted restrictions imposed by the Glass-Steagall Act of 1933, which had separated commercial banking from investment banking. It also ended limits created by the Bank Holding Company Act of 1956, which had separated banking from insurance. The consolidation trend strengthened after the passage of the law. In 2004, for instance, J. P. Morgan Chase & Co. and Bank One Corporation merged to form JPMorgan Chase. JPMorgan Chase ranks as one of the largest financial services companies in the United States. Some experts believe, however, that allowing banks and insurance companies to trade in complex investments helped contribute to the financial crisis that began in 2007.

Crisis in finance. The 2007 crisis started with mortgage loans and investments connected to those loans. Investments tied to mortgages became more and more profitable in the early 2000’s. Because of this, some banks began giving mortgage loans to borrowers without carefully checking into the borrowers’ ability to repay. By 2006, the number of people who were not repaying their mortgage loans began to rapidly increase. Further, prices for houses began to drop. Investments based upon mortgages became less and less valuable.

Several banks and other financial institutions suffered large losses. For example, the investment bank Bear Stearns, near bankruptcy, was taken over by JPMorgan Chase in 2008. Other institutions were also severely hit by the crisis and then taken over. They included Countrywide, one of the largest mortgage lenders in the United States and the investment firm Merrill Lynch, both taken over by Bank of America. Washington Mutual, a huge lender in mortgage banking, was taken over by JPMorgan Chase. The investment bank Lehman Brothers filed for bankruptcy.

The United States government and, particularly, the Federal Reserve, took steps to ease the crisis for banks. In an unusual move, the Fed invoked a law dating back to the Great Depression that allowed it to guarantee billions of dollars in losses that JPMorgan Chase could suffer from the Bear Stearns purchase. In September 2008, the U.S. government took over two huge mortgage finance companies, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). In October, the U.S. Congress passed a $700-billion bailout plan meant in large part to aid the troubled financial industry. More than 500 banks received federal bailout money. They included Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. The government also agreed to bail out a huge insurance company that had been active in insuring investors against various types of losses, American International Group (AIG). In addition to selling insurance to individuals and businesses, AIG provided insurance on risks for financial institutions. The government feared that allowing the company to fail could lead to a disaster for the already troubled financial system. By March 2009, the amount of the AIG bailout had reached $150 billion. The government had promised an additional $30 billion to try to stabilize the company. By 2010, banks had repaid most of the bailout money they had received from the federal government.

The problems with home mortgages grew as the economic crisis continued. United States banks foreclosed (took property back because the borrower had not kept up payments) on a record number of homes in 2009 and 2010. In late 2010, judges began to discover that banks had kept faulty records on many mortgage loans. The attorneys general of all 50 states launched an investigation into home foreclosures. Some banks suspended mortgage foreclosures for a time in an attempt to correct the problems with their procedures.

The banking crisis also affected banks outside the United States. In 2008, European leaders united behind a rescue package for banks in Europe. The rescue could eventually total around $2 trillion, as the credit crisis spread to the international banking system. Some banks in Europe had to be nationalized (purchased by their government) to remain able to pay debts. Governments took these actions to try to restore confidence in the banking system. Despite these actions, some European Union (EU) nations faced severe banking crises by 2012. The nations that were hardest hit were Greece, Spain, Italy, and Ireland.

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