Banks are very crucial in the economy of every country globally because they are a primary aspect of the financial system. The banks operate in a manner that they help to distribute and allocate funds to borrowers and put money safely for the savers. The banks accept deposits or borrow funds which they, later on, use to provide loans or create purchase securities (McLeay, Radia and Thomas 23). The financial services offered by the banks are the main reason as to why they play a significant role in enhancing the economy.
Every time a bank creates and offers loans for people and businesses they acquire an interest which is charged to both the borrowers and the depositors. The interests obtained contribute to economies of scale through the making of profits which enhances the economy. The process by which banks receive money from the depositors and offers them a loan to the borrowers is called financial intermediation (McLeay, Radia and Thomas 29).
The financial intermediation process allows some assets to be used in the creation of a variety of other assets or even liabilities. For this reason, the procedure will enable people who do not have enough money to carry out a particular business or activity to acquire money from those who have extra money hence facilitating the growth of the economy. Therefore, through financial intermediation, the bank can keep the economy mobile by connecting the deficit economic agents with the surplus economic agents (Gertler and Kiyotaki 34). As mentioned earlier, the benefit that the bank earns from the deposits and loans is the interest, and it facilitates the growth of a variety of businesses by allowing saving plans which can help the companies to save up and acquire enough capital to be able to expand the business.
The banks play a significant role in facilitating mobility of the economy because they allow cash to be easily transferred from one region to another. It will enable businesses and people to make transactions from different places across the globe which facilitates the expansion of not only the internal trade but also the external market. The banks can promote the remittance of money through the provision of credit cards, cheques, real-time gross settlement and drafts that can easily allow the transfer of large amounts of money from one region to another and over long distances (Mirzaei, Moore and Guy Liu 27).
The provision of loans at different periods to different industries in the country and the investments made by the banks to various industrial sectors facilitate agricultural, industrial and commercial consultancy which in turn leads to fast economic development. The banks also promote entrepreneurship which is a significant aspect that encourages economic development. The bank supports entrepreneurship by helping the private sector to take risks and make more investments through the provision of loans at interest rates that are quite friendly.
Banks also provide credit services to its customers. The provision of credit to customers fuels economic growth because it allows the investors to invest beyond the capital that they initially had. Credit provision also enables the government to manage their spending by alleviating the cyclical pattern that occurs as a result of tax revenues and allows it to invest in other projects such as infrastructure projects (Da Silva and Divino 12). Consequently, these activities in the economy tend to facilitate its development.
Banks play a significant role in the provision of liquidity. Liquidity provision allows households and businesses to be protected against cash needs that are unexpected. Banks provide liquidity by providing credit and also demand deposits that people and companies can be able to withdraw at any time they want. Also, the banks sell and buy securities in large volumes at reasonable transaction costs which facilitate liquidity in businesses (Broadbent 17). Through the provision of credit cards, among other methods used to transact significant amounts of money the bank can keep people’s money safe. A bank can manage the risks of thefts in a given economic system and also allows individuals to be able to participate in global foreign exchange without the fear of making losses. The bank, therefore, aids businesses in carrying out most of their activities without any form of risks which facilitates economic growth.
In conclusion, it is evident that banks are necessary to the economy. Banks support the activities of the economy including the making of investments and transactions through the provision of loans and easy ways to transact significant amounts of money such as cheques and credit cards. Consequently, the banks facilitate trade and foreign exchange which are the major components that promote economic growth or development. Banks also make sure that the economy is mobile by accepting deposits from savers and providing this cash as loans to the borrowers to ensure that the economic activities keep going. All these activities prove that banks are crucial in an economy.
- Broadbent, Ben. “Central banks and digital currencies.” Speech at the London School of Economics 2, 2016.
- Da Silva, Marcos Soares, and Jose Angelo Divino. “The role of banking regulation in an economy under credit risk and liquidity shock.” The North American Journal of Economics and Finance 26, 2013, pp. 266-281.
- Gertler, Mark, and Nobuhiro Kiyotaki. “Banking, liquidity, and bank runs in an infinite horizon economy.” American Economic Review 105.7, 2015, pp. 2011-43.
- McLeay, Michael, Amar Radia, and Ryland Thomas. “Money in the modern economy: an introduction.” 2014.
- Ali Mirzaei, Tomoe Moore, and Guy Liu. “Does market structure matter on banks’ profitability and stability? Emerging vs. advanced economies.” Journal of Banking & Finance 37.8, 2013, pp. 2920-2937.