The characteristics of Banks tell us their importance. Justify.
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Answer:
Purpose of Banks
A bank is a financial institution which is involved in borrowing and lending money. Banks take customer deposits in return for paying customers an annual interest payment. The bank then uses the majority of these deposits to lend to other customers for a variety of loans. The difference between the two interest rates is effectively the profit margin for banks. Banks play an important role in the economy for offering a service for people wishing to save. Banks also play an important role in offering finance to businesses who wish to invest and expand. These loans and business investment are important for enabling economic growth.
purpose-of-banks
Main purpose of banks
Keep money safe for customers
Offer customers interest on deposits, helping to protect against money losing value against inflation.
Lending money to firms, customers and homebuyers.
Offering financial advice and related financial services, such as insurance
1. Safety of deposits
Banks are seen as a secure place to deposit money. It would be impractical and risky to keep all your savings as cash under your bed. In medieval times, people would often pay early banks (e.g. Knights Templar) to keep their money and assets safe. It also saves people worrying about money. In the UK, commercial banks are guaranteed by the Bank of England as a lender of last resort. Therefore, consumers see them as safe places to deposit money.
2. Interest on deposits
Commercial banks pay interest on deposits. For current accounts, this may be very low, but for saving accounts, the interest rate can be significant. In a period of inflation, interest rates on deposits are very important for maintaining the real value of your savings. For example, if inflation is 4% then keeping cash will see the value of savings decrease in value. However, if the bank is paying an interest rate of 6%, then the real value of your savings will increase. For some customers, such as pensioners, interest payments on their bank savings can be an important source of income.
Different types of Bank accounts
Current account (checking account in the US) This bank account enables easy and quick access to money. A customer can withdraw the money at a moment’s notice and will have features, such as debit card and cash points. The interest rate on current account tends to be very low because the bank needs to keep sufficient liquidity to meet the demand of customers to withdraw.
Savings account (time deposit account) Savings accounts typically have limits on the amount of money that can be withdrawn at once. Often banks require a certain notice of (e.g. seven days) to pay money requested. This enables banks to pay a higher interest rate as the bank needs less liquidity.
3. Loans
A bank can become more profitable by using a percentage of its deposits to lend to other customers. If a bank pays 2% on bank deposits but lends money to firms and consumers at 6%, then it can make a bigger profit on its deposits. A bank just needs to keep sufficient liquidity to meet the demands of customers to withdraw money.