02 March 2012 Written by  Fasil Alemayehu and Merhatbeb Teklemedhin

Economic Significance of Banks

The existence of a strong and effective banking system is very important for the economic development of a country.
  • Banks through acceptance of deposit of money from persons who do not need it at the present and lending it to persons who want it for investment, serve as financial intermediaries thereby providing ideal source of fund for investment that is crucial in increasing production, exports, creation of jobs and foreign exchange earnings of the country.

  • Similarly bank lending to customers who need the money for consummation, purchase of various goods  and services, construction of houses,  and education increases demand for those goods and services, thereby encouraging producers and service  providers to expand their undertakings and increase production. Expansion and increase in production requires employment of additional workers, thereby creating new jobs, encourage producers and suppliers of raw materials to increase their production and supply.

  • Banks also play a positive role in encouraging savings by providing an incentive to save through payment of interest on deposits/savings and providing safety and security. Saving is also an important source of future investment and the improvement of the living standards of the society.

  • The power of the national bank in fixing interest rates is particularly crucial in both investment and saving. If the rate of interest fixed by the bank on deposits /i.e. the interest banks pay on money deposited on saving and other accounts / is attractive, it will encourage people to save their money rather than spend it. However, such interest should not discourage people from investment and productive activities and turn them to rent collection /potential investors may decide to deposit their money and collect interest/. If the rate of interest charged by banks on money given on loan to borrowers is lower, it may encourage potential borrowers and investors to borrow and invest, thereby contributing their part in the expansion and increase of production of goods and services, creation of employment opportunities, increase in exports and foreign exchange earnings of the country.

  • The existence of a network of banks covering all parts of a country facilities business transactions in the country by making payments easier, safer and cheaper. Payment through banks also avoids the risk of loss or theft of money.
Last modified on Wednesday, 02 May 2012 13:05