Banking Modern Banking Has Its Thesis

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Banks can provide credit to help a consumer smooth out his or her cash flows. These functions allow consumers to make large purchases they otherwise would not be able to make. The benefit to this is that it improves the standard of living for most consumers to be able to protect their savings and make these purchases.

For business, banks are a valuable resource. While most businesses have some form of current account that they can use to safeguard small amounts of capital, access to credit is a far more important consideration for business. For most businesses, expansion cannot be incremental, but in leaps and bounds. Such expansions are based on expectations of future cash flows, not present cash flows. This means that the business would not be able to expand without financing from the bank.

Banks also provide significant liquidity to the stock markets, in turn allowing for industry to acquire capital. Banks are among the largest institutional investors in the world, owning stocks in their own portfolios, in portfolios of their clients and in portfolios of investment funds. The liquidity that the banks provide makes capital markets more efficient, resulting in easier access to capital for most companies. This again spurs economic growth. It should be noted that banks do not exercise direct ownership in the way that they do in many other countries. They are invested in the markets but do not exert significant control over these companies and do not consider any non-financial firm to be a subsidiary; they are merely investments.

The government therefore also relies on the banks. Because of the credit they provide, banks facilitate economic expansion.

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In the United States, banks play a less direct role in economic growth than they do in other nations where the government-bank relationship in economic growth is built into the structure of the banking system (i.e. Canada, Japan). However, the government still relies on the banks to fulfill their role in order to keep the economy moving forward. The recent credit crunch is an example of a time when the banks have become unwilling to lend, and this has hindered the government's ability to bring about a restoration of economic growth.

The government does, however, rely on the banks to control the money supply. The Federal Reserve -- an arm of the government but not directly linked to the White House -- uses interest rates to compel the banks to lend. This function is also governed by the reserve requirement. This is the percentage of deposits that banks are allowed to lend. By adjusting the amount of money that the banks are allowed to lend, the government can either put money into the economy or take money out of the economy (Schwartz, 2009). This is the main lever by which government controls the inflation rate and the economic growth rate. Banks are used for this function because of their tradition role as holders of capital. If the government input money into the economy directly, that would devalue the dollar. It is therefore more effective to use the banks for this purpose, because the money already exists; it merely needs to be allowed to enter the system.

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