Question

Write essays on how do the banking system works

Answer 1

Banking system is a system that handles cash, credit and other financial credit in an economy. Banks are controlled by the Central Bank of a country. Banks are the safe place where people deposits their excess cash. Basic function of the bank is depositing and lending money. It is a channel between the depositors and borrowers. People deposit their excess cash and savings in the banks on which they get interest from the banks. The money that is deposited by a people is further lend out by the bank to the borrowers as a loan, on which bank charges an interest. By doing so banks create money supply in the economy by providing liquidity to the households for consumption and businesses for investment. The profit of the bank is the difference between the interest they recieve on loans and interest paid by them on deposits.

There is a percentage of deposit that banks had to set aside as reserves, as per the guidelines of Central banks. Money supply in the economy is controlled as central banks using this reserve ratio and interest rate. when money supply is required to increase, reserve ratio and interest rates are reduced and banks lend more and money supply is required to decrease, Interest rate and reserve ratio is kept high, so banks could lend less.