Role of Banking System in the Economy

A well-developed banking system is a necessary pre-condition for economic

development in a modern economy. It is said to be the financial wheel of an
economic system. The role of the banking system in the economy can be explained
under the following headings.
1. Mobilization of saving: The small or large savings of the people/organization
are mobilized through banking channels. Banks provide attractive interest on
saving and fixed deposits which encourages people to save more.
2. Capital formation: When saving is invested in the production of capital goods, it is called capital formation. Banks promote capital formation by encouraging people to save and by transferring such savings to the hands of
investors for the purpose of producing capital goods.
3. Monetization of economy: The rural areas in the developing countries are
still non-monetized. The banking system helps in the monetization of
the economy by spreading the branches of banks into rural areas.
4. Promotion of employment: Banks help to generate employment
opportunities in a number of ways by directly employing people in their
offices and by providing loans to productive sectors of the economy.
5. Promotion of international trade: Banks facilitate and enhance international
trade exchanging foreign currencies and by opening letter of credit (LC).
6. Increasing living standard: By providing consumer’s credit to their customers,
banks helps to push up the level of consumption and living standard of the
people.

7. Encourage innovations: By providing credit to the entrepreneurs, banks
encourage innovations.