Abstract

Many economists expect that the United States will continue to experience inflation for the foreseeable future. Since the stability of the banking system is a key element in the stability of the economy, it is important to consider some ways in which inflation can affect banking and the regulatory framework in which it is enmeshed. The impact of inflation on both sources and uses of bank funds has created new pitfalls for banks. If the forecast of continuing inflation turns out to be correct, banks will have to change some traditional ways of managing their affairs. Financial hedging techniques can insulate banks against some pressures caused by inflation, but an inflationary environment will put a large premium on innovation in banking. In this connection, various indexing arrangements for both deposits and loans will be discussed, but a detailed analysis of a fully indexed system is beyond the scope of the present article, the principal purpose is to explain the need for banks to innovate and for the regulatory authorities to remove some constraints on bank operations in order to overcome problems raised by inflation. Banks will need to innovate not only to protect their liquidity, solvency and profitability, but also to enable them to perform their important maturity intermediation function in the economy.