What role do banks play in the economy?
Banks primarily act to help control the supply of money in circulation. Economically, the amount of liquid capital in the country is important to determining the strength of an economy. Banks use a federally accepted interest rate to give out loans and infuse capital into the economy, which increases spending, and they can bolster the economy and help to improve cash flow around the nation.
Banks can, additionally, buy and sell money to the Federal Reserve through federal bonds. By doing this, they, along with the Federal Reserve, can either increase or decrease the total supply of money in the economy. This money is then—through loans, interest and incentives—distributed through the economy or, conversely, stored in the Reserve to prevent inflation from getting out of control.
By doing these actions, banks play an important and stabilizing role in the economy.
Banks play two major, closely related roles in the economy. They serve to provide the loans that allow a great deal of consumption and investment to occur and they increase the supply of money.
Lending money is a tremendously important activity for the economy. People tend to need to borrow money to buy big items like cars and homes. Banks lend the money that allows them to do this, thus allowing much more economic activity than would occur if people had to simply wait until they had enough cash on hand to buy such things. Businesses generally need to borrow money to expand or upgrade their capacity. Banks lend money to allow them to do this. If banks did not do this, businesses would not be able to grow as much and the economy would suffer.
By lending, banks are also expanding the money supply. They are able to take deposits and, in essence, lend them out over and over. This means that a given amount of money, deposited in a bank, can turn into much more money (as much as 10 times more) than was deposited. By lending, banks create more money that, as described above, allows more economic activity to occur.