Banks that practice narrow banking match the maturity of their investments with the term of the deposits that they collect from the public. In other words, narrow banks take short-maturity deposits and invest in assets that carry a low level of risk and are also of short-term maturity, like short-term government debt.

a. Suppose that all FDIC-insured banks decide to adopt narrow banking. How would narrow banking reduce the level of risk in the banking system?

b. If narrow banking would reduce systemic risk, why does society allow banks to practice maturity transformation?