The Role of Banks – Principles of Economics

Banks are crucial intermediaries in the payment system, which facilitates the exchange of goods and services for money or financial assets. Those having extra funds that they wish to save can also put their funds in a bank rather than searching for a person who is prepared to borrow them from them and return them later. Those who wish to borrow money might approach a bank directly rather than searching for a lender. The transaction expenses are associated with locating a lender or borrower for this amount of money. Thus, banks reduce transaction costs and serve as financial mediators, bringing together savers and borrowers. In addition to making transactions safer and simpler, banks play a crucial role in the production of currency.

Banks as Financial Intermediaries

A “mediator” is somebody who stands between two other parties. Banks are financial intermediaries, or institutions that function between savers who deposit funds and borrowers who get loans. Financial intermediaries include insurance firms and pension funds, but we will not cover them here since they are not depository institutions, which are organisations that receive deposits and utilise them to issue loans. All the deposited monies are combined into one large pool, which the financial institution subsequently lends out. The figure depicts the role of banks as financial intermediaries, with deposits entering and loans leaving the institution. When banks issue loans to businesses, they will prioritise healthy businesses that have a strong chance of repaying the loans over businesses that are experiencing losses and may be unable to repay. Financial Intermediaries: Banks Because they stand between savers and borrowers, banks operate as financial mediators. Banks accept deposits from savers, who then get interest payments and withdraw their funds. Banks provide borrowers with loans, which are repaid with interest. In turn, banks return funds to depositors in the form of withdrawals, which may include interest payments.

Simple and Complex economy

A system that supplies people with commodities and services and directly or indirectly meets their desires is an economy. This page will provide information about Complex Economy.

Based on their characteristics, economies are categorised as follows:

• Simple or complex economy

• Closed or open economy

• Planned or unplanned economy

• The agricultural or industrial economy

Simple Economy

A simple economy is a system in which individuals generate simple things in modest amounts to satisfy their desires. In this economy, the barter method of commerce predominates. These forms of economies occurred in ancient Indian communities.

Complex Economy

A complex economy is a system in which several types of commodities are manufactured in huge numbers. In these economies, the industrial process is exceedingly complicated and sophisticated. Money is a prevalent medium of trade. This economy emerged during the era after the Industrial Revolution.

Economic Development and Economic Growth

Economic growth is a sustained rise in national income or per capita production. It indicates quantitative growth in the nation. In contrast, economic development is the process through which a country’s real per capita income rises over time alongside a decline in the poverty rate, unemployment, and income inequality.

Capital Markets

The capital markets are where savings and investments are transferred between those who have the capital to lend or invest and those who require it. Typically, banks and investors are money providers, whereas firms, governments, and individuals are capital seekers.

The capital markets consist of both main and secondary markets. The stock market and bond market are the most prevalent financial markets.

The capital markets strive to increase transactional efficiency. These markets provide a venue for the trading of securities between providers and those seeking financing.

Financial Markets

Financial markets refer to any marketplace where securities are traded, including the stock market, bond market, foreign exchange market, and derivatives market. Financial markets are fundamental to the efficient functioning of capitalist economies.

Conclusion

Banks assist the use of money for economic activities since individuals and businesses can use bank accounts when selling or purchasing goods and services, paying workers or getting payment, storing money or obtaining a loan. Banks are financial intermediaries in the financial capital market; they act between savers who contribute financial capital and borrowers who want loans. A balance sheet (also referred to as a T-account) is a financial statement that includes assets in one column and liabilities in another. The liabilities of the bank are its deposits. The bank’s assets consist of its loans, bond holdings, and reserves (which it does not loan out). We determine the net value of a bank by subtracting its liabilities from its assets. If the value of a bank’s assets drops, its net worth might go below zero. The value of assets may decline if there is an unexpectedly high number of loan defaults, or if interest rates rise and the bank experiences an asset-liability time mismatch in which it receives a low-interest rate on its long-term loans but must pay the higher market interest rate to attract depositors. Banks can insulate themselves against these dangers by diversifying their loan portfolios or holding a larger proportion of their assets in bonds and reserves. If banks maintain only a portion of their deposits as reserves, the process of banks lending money, re-depositing those loans in banks, and banks making new loans will stimulate the economy’s money supply.