Question

Banks are the major providers of intermediate finance to the household and business sectors of an economy. In carrying out the intermediate process, banks perform a range of important functions. Describe TWO functions of bank and discuss their importance for the financial system. (300 Words).

Answer 1

Banks are playing an important role in the economy as an intermediary between savers and users. They provide a service for the public to deposit their savings as well as offer loans to needy and entrepreneurs who wish to invest it in their business for growth and development. In carrying out the intermediate process, banks perform a range of important functions but here we will explain twoe main functions which are directly associated, in details-

1. Acceptance of deposits from Households-Banks accept deposits from the households who save some money from their earnings against certain interest rates. Banks are considered a secure place to deposit money because we can not keep our saving in our homes safely.so banks insure people for the safety of their savings and households feel that banks are safe places to deposit and keep their money.

2. Providing Loans- The second important function of a bank as an intermediary is lending. A bank can earn by using a part of its deposits to lend to needy borrowers. However, the bank has to keep sufficient liquidity to meet the demands of depositors to withdraw their money. Bank provides various loans to different borrowers at different interest rates. some of them are-

• A personal loan that is unsecured so the interest rate is comparatively more.
• Business loans are loans for entrepreneurs to invest in their business for operations and growth of the business.
• Mortgage loans are special types of loans, which are provided against any valuable security. So the interest rate is comparatively less.
• An overdraft facility is also provided to regular customers of the bank. This allows them to borrow money in the short term. However, the amount allowed is in small quantity and bank charges a very fewer service charge against this facility.

Importance of these two functions for the financial system- The main purpose of the establishment of banks is to provide security and confidence in the financial system. The saving and deposits of households with sustainable use of this money(lending) cause higher growth in per capita capital as well as and per capita income in the transition to the steady-state and also implied that a high saving rate facilitates achieving a higher level of steady-state per capita capital and income of the country as these are properly utilized by borrowers. So increases in saving rate and lending lead to long-term growth rates in the financial system. Finally, there are strong supports for close interlinkages between savings, lending, and economic growth in a cross-country perspective which are backbones for the financial system.

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