The Traditional Theory of Banking

The Traditional Theory of Banking

In this paper author review the traditional theory of banking and

attempt to examine the theoretical reasons for why banks exist. As a

financial intermediation, the natures of the banks are to provide

financial services and conduct the intermediary functions in the whole

financial system by accepting deposits and making loans. The question

raised here are how they conduct these roles and why the borrowers and

lenders do not come together without the banks for the saving of

intermediation costs, why both of the two parties are ready to pay for

their services and what’s the value added by the banks?

The paper proceeds as follows. Section 2 offers a traditional view of

banks and describes the nature of them. By analyzing how the banks

conduct their traditional function, there rises a question of why the

borrowers and lenders do not choose direct deal with each other? Which

leads to the consideration of the theoretical rational for the

existence of banks. This analysis is presented in section 3, which

have an intensive expatiation in the theories.

In section 4, what are the problems if the direct deals between the

borrowers and lenders happen, and how can banks solve those problems

are presented therefore answer the question why individuals are

willing to pay the intermediation costs. This is followed in section 5

by an analysis of the recent changes in the banking industry. With the

development of the financial system, declining entry barriers and the

deregulation of the banking industry make banks no longer the monopoly

suppliers of banking services and reduce their comparative advantages

which they usually hold in the past. Whether the reasons give rise to

the existence of banks are still powerful will be examined here, while

section 6 offers a way of considering whether banks are declining by

looking at the value added by the banks. When the value added by banks

is examined, banks are not a financial intermediation, which not only

conduct the traditional services but also provide more diversified