Final answer:
Bank regulation ensures depositor protection through deposit insurance and reduces the risk of bank runs. Banks balance the need to maintain liquidity with the necessity to use deposits for profitable lending. The FDIC's deposit insurance program is key to maintaining stability within the financial system.
Step-by-step explanation:
Bank regulation is designed to protect the interests of depositors for several reasons, primarily to maintain public confidence in the financial system. Banks do not keep the majority of deposits on hand because they use these deposits to make loans and investments, which is how they generate profits. A complete reserve system would greatly reduce the bank’s ability to lend and would lower the profitability of banks, which in turn would harm the economy by reducing the credit available to individuals and businesses. However, bank runs can be a risk if too many depositors try to withdraw funds simultaneously.
The risk of bank runs is mitigated through deposit insurance and the lender of last resort. In the United States, the Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000, which covers most individual account holders. This deposit insurance system was put into place to prevent bank runs, which were common during the early 20th century before the FDIC was created.
Banks pay an insurance premium to the FDIC, which is adjusted based on the riskiness of the bank's financial situation. This system protects depositors and helps ensure the stability of the banking system by preventing the panic that would result from a bank failure.