Introduction to Finance

investment bank 
a bank that helps 
businesses sell their new debt and 
equity securities to raise fi nancial 
capital
Glass-Steagall Act of 1933 
provided for separation of 
commercial banking and investment 
banking activities in the United 
States
Gramm-Leach-Bliley Act of 1999 
repealed the separation of 
commercial banking and investment 
banking provided for in the Glass-
Steagall Act
universal bank 
bank that engages 
in both commercial banking and 
investment banking activities
Savers
Business Firm
Money
Money
Savers
Business Firm
Investment
Bank
Commerical
Bank
Indirect Transfers: Commercial Bank
Indirect Transfers: Investment Bank
Money
Money
Commercial
Bank’s CDs
Firm’s
Note
Firm’s
Bond
Firm’s
Bond
FIGURE 3.3
 Commercial 
Banking and Investment 
Banking Intermediation 
Activities

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3.3 Overview of the Banking System
53
Functions of Banks and the Banking System
Depository institutions accept deposits, make loans, and issue checkable deposit accounts. Like 
commercial banks, savings and loan associations (also called savings and loans or S&Ls), savings 
banks, and credit unions perform these activities. The U.S. 
banking system 
includes commercial 
banks, savings and loans, savings banks, and credit unions. It is common practice today to refer to 
all depository institutions as banks. Banks and the banking system perform fi ve functions:
(1) accepting deposits 
(2) granting loans 
(3) issuing checkable deposit accounts 
(4) clearing checks 
(5) creating deposit money
To the extent that commercial banks also perform investment banking operations (i.e., are 
universal banks), they perform an additional function: 
(6) raising fi nancial capital for businesses
In accepting deposits, banks provide a safe place for the public to keep money for future 
use. Individuals and businesses seldom wish to spend their money as it becomes available; 
without depository facilities such funds may lie idle. The banking system puts the accumu-
lated deposits to use through loans to persons and businesses that have an immediate use for 
them. This, of course, is the fi nancial intermediation activity of depository institutions in the 
savings-investment process.
Banks play an important role in the payments process or mechanism in place in the U.S. 
fi nancial system by creating deposit money. By writing checks against demand and other 
checkable deposits, it is easier for individuals and businesses to make purchases and to pay 
bills or debts. Of course, it is not enough just to permit check writing; there must also be 
an effi
cient mechanism for processing the checks so they can be presented to the bank that 
authorized the check for payment.
Let’s take a brief look at how checks are “cleared” or processed in the United States. Let’s 
assume that you owe $100 for the purchase of a product on credit from the ABC fi rm. You 
write a $100 check against your checkable deposit account, held at First Bank, payable to ABC 
and mail the check to ABC. An ABC employee opens the envelope containing your check and 
deposits the check in ABC’s deposit account held at Last Bank.
There are three basic ways to clear a check through the U.S. banking system:
• Bank to bank
• Through a bank clearinghouse
• Through a Federal Reserve Bank