Role of Commercial Banks in Economic Development –
The rate of economic development depends on the rate of capital formation. The rate of capital formation depends on the rate of savings, investment and the proper allocation of invisible funds among different sectors and users in the economy.
Role of Banking System –
@ Promotion of Savings –
People save for different reasons. People save for the future needs such as old age, sickness, to own property (house, real estate etc.), to provide education to their children, for their children’s marriage expenses, to fulfill their requirements in periods of unemployment, in future and to purchase durable consumer goods. But to fulfill these requirements, they need assets in the form of which they can keep their savings safe and earn some return as well. Commercial banks promotes savings by providing different types of deposits with various combination of liquidity and rate of interest to match needs and preferences of different savers.
The bank deposits are convenient or easy to hold as a store of value and more safe and liquid (means they can be converted into money or cash easily). They are also easily divisible and very less risky. With all these advantages, they earn different rate of interest depending on the type of deposits. These advantages, encourages households to save more and makes a habit of savings.
@ Mobilization of Savings –
The function of mobilizing savings is of vary importance in the modern economy, because in the monetary economy, the act of saving has been separated from the act of investment. Savings are done by millions of peoples or household and firms or businesses, whose individual savings may be very small, savings of some may be for short term and of others may be for long term.
Banks and other financial intermediaries collects and mobilizes the savings before these can be made available to the producers or investors. Without the banks these savings would not be utilized for productive and investment purposes. Banks mobilize savings of the peoples and firms by providing different types of deposits to fit the needs and preferences of different peoples possessing surplus funds.
If these banks and other financial institutions were not there, those with the surplus funds would have to search for appropriate borrowers and have to make individual bargains with them and bear risks of lending them. The existence of banks makes this process easy and risk free and also enables banks to mobilize more resources for production and investment purposes.
@ Allocation of Funds –
Banks helps in allocation of funds among different sectors, users, producers and investors to make the maximum social return and ensure optimum utilization of savings. The corporate firms can raise resources by the sale of equity shares and debentures, but the non-corporate firms and borrowers depend greatly on the banks to finance their needs of both working capital and fixed capital. Before lending banks take into account the capacity to pay back the loans. So, the banks are in a better position to judge the productivity from the uses for which the funds are given. This helps in maximization of returns from the available financial resources in a socially desirable way.
@ Promotion of Trade, Production and Investment –
By encouraging to save more and mobilizing savings, banks help to increase the aggregate rate of investment in the economy. Banks not only mobilizes the saved funds from the public, but also creates credit which serves as money. The new credit is created by the banks when they lend money to the investors or other borrowers. If this newly created credit is used for productive purposes, enhances production and investment which in turn promotes growth.