Okay, continuing in Unit 8, Lesson 2, we're going to discuss what banks do,  okay? So financial markets, that is banks and other financial institutions, provide the link between savings and investment in the economy. A bank is a profit making entity that takes in deposits from households and firms and makes loans to firms, households, and the government. Banks can be fragile institutions. 

They're very, you know, they, when the economy is overall volatile, banks  become volatile because people aren't borrowing money, you know, they are  going to hold on to their cash, they're not going to invest it, so then that  becomes a very turbulent time for banks because they make their money off of  interest that they make on loans and deposits, okay? So, you know, they, so  when the economy goes bad, banks can be in a bad situation because, you  know, they're not bringing in deposits, they're not able to make loans, they're not investing money, they're not, you know, able to raise their revenues, right? So  then when the economy goes bad, it's really, sometimes can be really fragile for  these banks, right? They must ensure that their depositors are not worried the  bank might go out of business taking their money with them. All right, banks do  many things to ensure that their customers have confidence in them, though.  

Perhaps the most important is that they keep a certain amount of assets in a  very liquid form such as cash, right? This means that if a depositor comes in to  withdraw his or her money, the bank will be able to meet that obligation. 

These liquid deposits are called reserves of the bank, cash reserves. Most  banks in the United States are members of the Federal Reserve System. This  membership comes with the responsibility to hold some fraction of deposits on  reserve. 

Remember in lesson one in the first video of unit eight, we talked about the  reserve requirement. This is what we're bringing up again. The reserve  requirement limits the amount of deposits that banks are able to loan out to firms and households. 

So let's look at this example. Suppose a bank has $1,000 on deposit and the  reserve requirement is 10%, then the bank must hold at least $100 on reserve  and can loan out at most $900. We say at least 100 since the bank is free to  hold more than 10% on reserve. 

In uncertain times when a bank is unsure how many depositors are likely to  want to withdraw their money, the bank may choose to keep reserves above and beyond the level required by the Fed, which is a smart move by banks because  they want to ensure that if there is a time of uncertainty, that if there are a lot of 

depositors that want their money back, that they have reserves above the  required amount and therefore they'll be able to provide the depositors their  cash back. What does a bank do if it finds itself with insufficient reserves on a  given day to meet its reserve requirements? The answer to that is it borrows  from either other banks or from the Federal Reserve itself. Because the Federal  Reserve can influence the interest rates at which banks borrow, it can influence  the behavior of the banks. 



Last modified: Monday, October 5, 2026, 9:09 AM