Introduction to Finance

Small Business Practice

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52
C H A PT E R 3 Banks and Other Financial Institutions
issues check-writing accounts to facilitate purchases and paying bills, and makes loans to indi-
viduals and businesses. This defi nition of a bank is consistent with the Webster’s dictionary 
defi nition cited at the beginning of the chapter. In contrast, an 
investment bank
helps busi-
nesses sell their new debt and equity securities to raise fi nancial capital.
Figure 3.3
depicts these two types of indirect transfers from savers to a business fi rm. 
You should be able to recall a similarity between this fi gure and Figure 2.2 in Chapter 
2, which also included direct transfers between individuals and business fi rms whereby 
no fi nancial institution performs an intermediary role by bringing individual investors 
together with business fi rms desiring to sell securities. Direct investments are relatively 
rare occurrences. The top portion of Figure 3.3 shows the traditional role of the commer-
cial bank as a fi nancial institution that accepts the deposits of savers in exchange for the 
bank’s securities (e.g., certifi cates of deposit, or CDs). The bank then lends money to 
the business fi rm in exchange for the fi rm’s promise (e.g., a note) to repay the loan. The 
bottom portion of Figure 3.3 shows that the investment bank markets the business fi rm’s 
securities (e.g., a bond) to savers. This can be done either by fi rst purchasing the securities 
from the fi rm and then reselling the securities (a practice called “underwriting,” as we 
will see in Chapter 11) or by just marketing the securities on behalf of the issuing fi rm to 
savers.
In the midst of the Great Depression, Congress passed the 
Banking Act
of 1933
. This 
legislation, commonly known as the