1.4.1 The role of banks in the economy

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    Banks play a large role in the economy in many ways listed here:

    • Providing mortgages for house purchases (in exchange for interest)
    • Provide loans for businesses to expand (in return for interest)
    • Provide accounts for savers who earn interest and keep their money safe.
    • Invest money (risky) in hopes of making a return on investment (this helps fund money for the interest in savers’ accounts)
    • Give business advice
    • Exchange currency

     

    Banks have been innovative to create ease for customers e.g. ATMs, the development of the online banking system and contactless etc.

     

    Retail banks – A bank that offers services to smaller individuals. They offer current and                            savings accounts, and mortgages as well as other loans.

     

    Investment banks – Serves bigger businesses and lends for major products e.g. Channel                                     tunnel. Make investments for companies, government or themselves.

    • Banks can manipulate the banking system to channel savings into investment rather than keeping them to save.
    • If interest rates are lowered, people will be discouraged from saving as the rewards are low.
    • If the inflation rate is higher than the interest rate, the real value of savings falls, as money is worth less than previously.
    • As the savings lose their spending power, the low interest rates also make loans cheaper so it encourages spending and investment.

     

    The main source of income for banks is through interest which they gain through loans. They create credit by using deposited funds as loans which can be secured against an asset to protect the bank’s funds if the loan is not repaid.

     

    Assumptions in the banking system

    • Banks rely on the fact that not everyone will withdraw their deposits at once.
    • Savers trust banks to act wisely with the risks of lending (so their deposits are safe)

     

    In the UK the Bank of England (B of E) manages the currency, money supply and interest rates as they are the central bank for the country. The Monetary Policy Committee (MPC) meet every month to decide whether the interest rate should be changed and are independent from the government. The B of E sets the base rate which influences interest rates across the country and are used to help meet the government target for price stability.

     

    Collateral – something pledged as security for repayment of a loan, to be forfeited in the                     event of a default.

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