Why are Banks so Important?

Photo by Cory Woodward on Unsplash

Both commercial and central banks hold key parts in society by allowing people to improve their quality of living through funding investment projects and regulating the economy.

Commercial banks provide investments for new businesses, which is extremely important within an economy as it provides new jobs, ultimately boosting the GDP of the economy. A strong economy provides more taxes for the Government, funding important projects such as new roads or hospitals! Investment in new businesses also brings innovation and new technologies, which propel society forward and create efficiency in our lives. The new technologies may cause scientific break-throughs in areas such as medicine, environmental science, or computer science. These scientific break-throughs would have positive spillover effects in the world economy such as decreasing potential exposure to diseases or finding cheaper and less polluting alternatives to fuel cars.

The central bank regulates spending within the economy through interest rate adjustments such as decreasing interest rates through periods of high economic growth to prevent high inflation and increasing them during economic decline to encourage spending. This regulation of interest rates allows stability within the economy, encouraging more investment and expenditure when the confidence in the economy is too low, while discouraging more investment and expenditure when the confidence in the economy is too high. The biggest impact of changing interest rates on people is arguably the mortgage. The low interest rate in a declining money allows people to refinance (reborrow money) at a lower cost and free up funds for us to make new purchases, thereby stimulating the economy. The resulting economic stability enhances a country’s reputation and involvement in international trade, resulting in that country’s currency being more valuable so that the consumers in that country  can spend less on products produced in other countries. This in turn increases available income to spend, giving the opportunity to create wealth in that country’s economy.

Banks also provide a good “storage place” for people to save money. Something to think about: If you didn’t have access to a bank and wanted to save money by storing it in your room, would you trust yourself to not spend it? The ability to save money in a bank has many positive effects on individuals such as protection from financial emergencies, the avoidance of debt, and the ability to make decisions that will increase the quality of life (such as pursuing a degree). Also, more people saving their money in the bank allows banks to have more money to lend out for entrepreneurs and businesses to pursue new projects.

What if the banks fall through? This is a huge problem and can happen if the bank’s assets are worth less than its liabilities, resulting in lower investment and savings, increased unemployment, or even putting the government into more debt. That is why banks are subject to a comprehensive set of regulations such as a proper asset liability ratio.

Overall, Banks have many positive effects on the economy, but they must be regulated and managed well. If not, there will be problems for depositors, creditors, shareholders, employees, and even the government.