BUS614 Study Guide

Unit 2: Banking

2a. Outline the history of banking from the 17th century to today

  • How did banking evolve throughout history?

In the early 1600s, merchants began to use banknotes as a means to settle financial obligations. This new form of settling debt was used to support lending, and as a result, it helped create the first bank in the UK, not to mention the use of cheques, which started in the mid-1600s.

However, in the late 1600s, a new function was introduced to banking. Bank clerks regularly met to set off cash movements of each cheque against others, arranging for the balance to be paid between banks only. This is what is known as clearinghouses. In addition, during the late 1600s, a group of goldsmiths formed the Bank of England to raise funds for the war against France. At the same time, the Bank of Scotland was also created, which is credited for the "overdraft" service commercial banks offer today.

In the late 1700s, London started emerging as a financial center of the world. As a result of the strength of the British sterling, British banks offered trade financing and investment banking. After the dominance of British banks, US banks gained momentum after the First World War when European capital landed in New York, establishing the city as an international financial center.

To review, see The Origins and Evolution of Global Banking and Timeline of Financial Services.


2b. Describe the differences between commercial banking and investment banking 

  • What are the services offered by Investment Banks?
  • What are the services offered by Commercial Banks?

Investment Banks

Investment banks are financial institutions that assist corporations in accessing capital markets by raising funds. They additionally assist in corporate mergers. As such, they act as intermediaries in complex financial transactions.

Investment banks thus provide their services to corporations and high-net-worth individuals exclusively. These services include IPO underwriting, financial advisory, mergers and acquisitions (M&A) support, securities sales and trading, and asset management. Unlike commercial banks, investment banks do not accept deposits or provide loans.

Commercial Banks 

Commercial banks offer their services to depositors, including accepting deposits, offering loans, discounting bills of exchange, funds transfer, and foreign currency exchange, among other services. These for-profit financial institutions mainly use depositors' money to provide loans.

Commercial banks make a profit through the difference between the interest the banks earn on loans and the interest these banks pay on deposits, plus fees banks earn from other financial services they provide.

In the US, commercial banks can be either National or State banks. National Banks receive their bank charter from the US Treasury Department through the Comptroller of the Currency. On the other hand, State Banks receive their bank charter from the state where they operate.

To review, see Institutions and Markets and US Financial Institutions.


2c. Analyze the role of central banks and their effects on financial markets 

  • What role do Central Banks play?
  • How do Central Banks affect the functions of the financial markets?

The Role of Central Banks

Generally, Central Banks control the money supply, provide price stability, attain economic output and employment goals, regulate commercial banks, stabilize the macroeconomy, and provide a payment system. These institutions act as bankers for governments and are regarded as lenders of last resort.

Central Banks and Financial Markets 

Central banks, through their role as regulatory authorities, use their actions to steer financial markets and economies. The central bank is responsible for the country's monetary policy and is entrusted with maintaining steady GDP growth and ensuring low inflation levels.

To review, see Central Bank Form and Foundation and Regulation.


Unit 2 Vocabulary

This vocabulary list includes the terms that you will need to know to successfully complete the final exam.

  • Investment Bank
    • An investment bank is a financial institution that assists organizations in raising capital.
  • Commercial Bank
    • A commercial bank is a financial institution that accepts deposits from depositors and offers loans.
  • Clearing Houses
    • Clearinghouses are financial institutions that facilitate the exchange of securities, transactions, and payments.
  • Thrift Institutions
    • Financial institutions that encourage personal savings and home-buying and obtain their funds from the public.
  • Depository Institutions
    • Financial institutions that obtain funds through accepting deposits.
  • Credit Unions
    • These not-for-profit, tax-exempt financial institutions are member-owned and pool assets, funds, and loans. They offer other services to their members, including favorable interest rates on deposits.
  • Brokerage Firms
    • These financial institutions buy and sell securities for their clients and provide them with related advice.
  • Non-depository Institutions
    • These organizations enter into contractual agreements and invest in securities that appeal to investors.
  • Central Banks
    • A financial institution controls the production and distribution of money and credit in a particular country.
  • The Federal Reserve
    • The Fed is the US Central Bank, comprising a central governmental agency and 12 regional Federal Reserve Banks. It is entrusted with regulating the monetary and financial systems of the US.