It is the ability of the commercial banks to create money in the form of demand deposits by making loans and investments that distinguishes commercial banks from other financial institutions. While some thrift institutions have acquired demand deposit authority, their participation in money creation is limited relative to banks which hold nearly all business demand deposits and the majority of individual and government demand deposits. The banking system can build up deposits by increasing loans and investments so long as banks keep enough currency and reserves to meet the requirement imposed on them by regulation and to redeem whatever amounts the holders of deposits want to convert to currency. This is a unique attribute that is often difficult for the layman to understand and that occasionally even baffles bankers. As contrasted with the banking system as a whole, however, an individual bank cannot expect that the deposits it creates will remain with it. The money it can lend and invest, at any moment, is its excess of cash and bank balances over required reserves and minimum cash requirements. The individual bank must stand ready to pay out the deposits it creates when it makes new loans and to pay for the securities it buys upon delivery.
In practice, out of the vast aggregate of financial transactions, the individual bank gains and loses funds in the course of each day's business. From its net gains the bank can increase its loans and investments. If the bank has net losses it must collect loans or sell investments. As one of the theoretical aggregate of all banks, it competes for its share of the deposits that the banking system as a whole may create when additional reserves are supplied by the Central Bank.
A bank does not create credit in a vacuum; it creates credit in order to supply the funds that are needed by the community it serves and the nation of which it is a part. Bank loans and investments may finance production, distribution, investment, consumption, and the needs of government. Credit enables goods to move through the channels of trade, people to acquire homes, factories to be built, workers to buy automobiles, the nation to finance its defense, and many other useful or profitable purposes. Without credit, business as we know it would be almost impossibly impeded, and our standard of living would never have been attained.
Bank credit supplies money where and when it is needed, and the repayment of bank credit removes money from circulation when the specific need for it has passed. When the economist speaks of a "balanced" economy he envisions an overall balance between production and consumption. With respect to both the businessman and the individual, however, such a balance usually involves a time lag. The farmer invests seed, fertilizer, and six months' effort into a crop before he can harvest and sell it . The manufacturer must assemble, pay for, and put to use plant, materials, and labor before he can produce a salable product. The individual who wants to buy a car or must meet unexpected medical expenses may not have the money on hand but is able to make his purchase or pay his bills out of future income. In supplying credit to farmers, manufacturers, and individuals, the commercial bank bridges the time lag between production and consumption and thus helps to bring the financial affairs of the economy into balance.
This is another way of saying that commercial banks supply liquidity to the economy. Through their ability to lend and invest, they can provide money immediately in consideration of assets or efforts that have a future money value. Commercial banks use many different means and organizational forms to supply this liquidity. Seasonal selfliquidating business loans, consumer home-mortgage loans, tax anticipation notes, business term loans, bank credit cards, and many other forms are used. In larger banks, separate departments are generally established to specialize in certain forms of lending. The foreign deparments of some large banks, for example, are almost separate institutions in themselves. In smaller banks, one or a small number of bank officers is generally responsible for bank loans and investments; however, farm lending or consumer credit is frequently departmentalized. The important aspect is not the particular means or organizational form, but the bank's active effort to supply the funds that are needed in the community that it serves.
