Commercial banks play a very important role in economic development. It is the very rare that an individual has the cash needed to start a business from the bottom up, and it is very rare for existing businesses to expand or recapitalize (in effect, replace old, worn out equipment with...
Commercial banks play a very important role in economic development. It is the very rare that an individual has the cash needed to start a business from the bottom up, and it is very rare for existing businesses to expand or recapitalize (in effect, replace old, worn out equipment with new, more efficient equipment) without having to borrow from a financial institution.
Commercial banks are in the business of moving money. They secure individuals’ and families’ money by providing a physically secure space while paying depositors, those who place their cash with banks for safe keeping, interest for the privilege of having those depositors’ money, which the banks use for other commercial activities. They take the money left with them by depositors and lend it to individuals and businesses, charging interest on the loan, a key way in which the bank makes money for its owners and investors (in the case of publicly owned banks).
Starting up or expanding a business is expensive. It requires, depending upon the size and type of business, tens of thousands of dollars or tens of millions of dollars. The more money a bank takes in through deposits, the more money it has to lend out. The larger the bank, the more capital it has on hand and the larger the loans it can make—loans that, as noted, are repaid with interest. In addition, banks help businesses, depending upon the bank’s assessment of the risk in doing so, that are suffering cash flow problems (i.e., the company in question is suffering from a shortage of customers and is not earning enough to pay its expenses, such as wages for employees, rents, etc.).
Commercial banking is essential for the growth of an economy. When banks suffer, businesses suffer, and vice versa. It is a symbiotic relationship. Banks, however, have a responsibility and a legal requirement to maintain a certain amount of money on hand in case of an emergency that involves depositors needing to withdraw more than usual due to macroeconomic crises. The money the banks are required to have on hand and not lend out may only account for ten percent of their deposits, but it does represent a cushion. Other than those reserves, the bank tries to keep as much of the money it holds moving through loans and investments. All of this is integral to the economic development of an economy.
If banks were to run out of money, the economy would crash, and fear of banks running out money creates a self-fulfilling prophecy wherein rumors of a bank’s difficulties spurs the very bank run that actually devastates the bank. It can be, in other words, what is known as vicious circle. Suffice to say, however, that commercial banking is at the center of economic activity.