The difference between a bank and a non-bank is that a bank has a reserve account at the Fed:
Ultimately, the Govt creates all reserves, so why not just have the Govt make loans directly? Because we do not want the Government to make credit decisions, they are too likely to dole out money to politically connected constituencies, while starving worthwhile, but unconnected borrowers. You can see this today, as banks and unions get Billions, while shop keepers, dry cleaners, manufacturers, and restauranteurs shutter their businesses and go on the dole. An institution that makes loans it knows will not be paid back is not making loans at all, it is making gifts, and the operational bankruptcy of the FHA is a great example of this in action. Many adjectives come to mind: corrupt, wasteful, abominable, unfair, fraudulent, etc. This is the opposite of Responsible Governance. Barry, we really expected more.So, to keep responsible lending, we put private capital infront of public capital and ask that private capital take the first loss on loans it makes which turn out to be bad. Ultimately, taxpayer money is there as backup, but it should not be directing investment. We call this institutional arrangement a “bank”.
This simple sensible construct is utterly lost on policy makers and the commentariat alike. For banking to do the job it is meant to do (ie. make loans that will be paid back), a bank should be required to keep all loans it makes on its books until maturity.
(Hat tip to Arnold Kling.)