Bank Role in a Nations Economy - Research Paper Example

Bank Role in a Nation’s Economy Banks are one of the oldest institutions in the world. In fact, some sources even consider the existence of banks some 2500 years ago. Banks then were actually storehouses for grains or crops often stored by farmers. In the ancient world, buildings such as temples became repository of important crops, grains, metals, gemstones and anything that has value in it. Later on, banks were established since commerce was greatly expanding. However, the most important concept about banks is when banks work effectively it affects macroeconomic stability since it is an integral part of a country’s financial system. It must be understood that banks work for itself, for the customers and for the economy . It is then important to understand how banks work, the purposes it serves in the economy and the significant role it plays in enhancing macroeconomic stability. Nevertheless, a discussion of a short history of banking would provide a good background on the role of this financial institution two centuries ago. As mentioned before, storehouses were considered banks Nevertheless, even when barter was replaced by currency, the existence of a bank as a financial institution was not yet fully established. In fact , Hildreth ( 1837) wrote that the first bank in Genoa, Venice came into being only after the Republic ended. Hildreth recounts : “The Republic being engaged in war, and falling short of funds, had recourse to a forced loan. The contributors to that loan, were allowed an annual interest of four per cent on the sums they had been obliged to lend; certain branches of the public revenue were assigned for the payment of that interest; and a corporation, entitled the CHAMBER of LOANS , was created for the express purpose of looking after this business, managing those branches of the revenue assigned to the lenders ; and attending to, and securing the punctual payment of the interest, as it fell due”( Hildreth, 1837,p.5) The Chamber fulfilled some of the roles that modern day banks do such as : selling and exchange, lending money, circulating money, and accepting deposits. Later the Chamber was known as the Bank of Venice. From then, banks sprouted into different cities such as Genoa and Barcelona since they engaged in so much trade too. In our current time, banks have played roles not much differently from the Bank of Venice. Only, the banking industry has become more complicated as international trade became dynamic and currency exchange from different countries have grown. Also, the banking system nowadays has integrated technology which has made it more convenient for its millions of customers, here and abroad. How Banks Work Banks work for itself to earn money. Normally, banks work by accepting deposit from people who have opened an account. These people put their money on the bank in the hope that it would be safe there so trust and confidence is crucial to a banking system. According to an article in 2009 by aol.com titled How Do Banks Make Money Anyway? banks earn through lending out the deposits that they have gained. A more specific illustration by Gordon states: “It’s all about the spread. Your bank may be charging you, say, an annual rate of 7 percent on a car loan while it borrows at the fed funds rate — what banks charge each other for overnight loans — of 0.25 percent.” ( Gordon , 2009) If the bank has made sound and prudent decisions about its capacity to release loans, then it earns money from the interest rates. But if it miscalculated the loans and incurred bad debts , then it is headed for trouble as what happened in the recent financial crisis. When investment banks invested in high-risk securities, the investment collapsed and had the domino effect on the whole financial system. The bank runs in 2008 were devastating as more banks closed similar to that of the Depression Era. Banks work for people by encouraging them to save. In studying macroeconomics, it can be learned that personal savings have over-all effect on the economy. This was apparent in the case study that we studied in class regarding the saving habit integrated in the Japanese culture. In the case of America, PSAVERT ( Personal Savings Rate) gives us an idea of what percentage of the of the disposable income do Americans use to save money. I couldn’t agree any further with Cramer in his article when he said that: “Increased personal savings, whether it’s due to a genuine change in attitude or forced upon by tighter credit, is a good thing. This is because savings enable investments which develops the economy, and lays the foundation for future savings and consumption.” ( Cramer, 2007, p.1) Unfortunately, most economists urge us to spend rather than save thereby aggravating the situation. Lastly, banks work also for the economy although this is not the main purpose why banks exist. Banks affect the economy mainly through credit. Usually, the Federal Reserve sets the interest rate of banks when they lend money to their customers. A bank maybe required to keep 10% of their money in reserve so they use this for lending. Sadly, some loans were not repaid by institutions through home mortgages and this caused great problem for the whole economy. Banks needed a bail-out for it to survive which is a very unpleasant scenario. As mentioned before, this contributed to the economic crisis in 2008 from which America is still trying to recover from. In conclusion, banks have played a major role in contributing to trade since 18th century. However, the manner in which a bank operates for itself, for the people and indirectly for the economy has effect on the macroeconomic stability of a country. Because of this, it is important that government play a crucial role in regulating the monetary policy of a country. Also, people must be encouraged to save more since their savings translate to higher capital for a country. Indeed, these changes would be a long-shot, but if accomplished well, a country can get on its feet again. References: Cramer, J. (2007, October 2). What Does the Personal Savings Rate Tell Us About the Economy? -- Seeking Alpha. Stock Market News, Opinion & Analysis, Investing Ideas -- Seeking Alpha. Retrieved February 14, 2010, from http://seekingalpha.com/article/48742-what-does-the-personal-savings-rate-tell-us-about-the-economy Gordon, M. " How Do Banks Make Money, Anyway? - AOL Money & Finance." Money - AOL Money & Finance. N.p., 4 Apr. 2009. Web. 14 Feb. 2010. Read More