The concept of money depositing and lending is the fundamental principle that differentiates banks from other kinds of financial institutions. The money deposited by banks’ clients is paid to them on demand or after the expiry of the time for which the money is deposited. Deposits basically work as liabilities of the banks and hence a bank is supposed to manage them to maximize its profit in the same manner as it manages its assets which are created by lending. Therefore the fundamental activity of a bank is to act as an intermediary between a borrower and depositor. There exist other financial institutions also which act as intermediaries between the buyers and sellers, such as stockbrokers, stock exchanges, pooled investment funds, etc. But the thing which differentiates a bank from other financial institutions is accepting deposits and granting of loans (Heffernan, 2005).
The bank has more knowledge about borrowers as compared to any other individual lender as all borrowers have accounts with their respective banks. This helps a bank to decide regarding lending money to any borrower by reviewing past records of the account holder. Banks use this information to increase the size of their lending activities. Thus, it can be said that banks have fewer risks in lending money as compared to individual lenders (Heffernan, 2005).
Most of the highly rated corporations have been getting loans at a much cheaper rate by issuing bonds for public subscription as compared to the bank rates, but then they also prefer borrowing from banks as it shows their creditworthiness to the financial markets and suppliers. If a bank provides them with loans at a cheaper rate, then automatically, the demand for its services will increase (Stiglitz and Weiss, 1988).
The second most important activity of banks is offering liquidity to their clients. Depositors and borrowers have altogether different preferences about liquidity such as withdrawing money from their respective accounts at any point in time. Many enterprises take loans from banks and repay them as per the return they expect on their investments.
The liquidity choices have changed over time considering demand due to some unexpected events. If any customer makes a fixed (term) deposit with their bank, then he expects that he can easily withdraw the money in case of an emergency by paying some amount as penalty towards that premature withdrawal. In the same manner, a borrower also expects from a bank that he/she may be allowed to repay a loan to the bank before the due date and thus save the amount of interest. Banks have to pool a huge number of savers and borrowers of funds to meet the demands of both the parties. Therefore, liquidity is considered one of the important services that banks offer customers and thus it differentiates a bank from other financial companies which offer similar or other financial products like real estate services, unit trusts, and insurance. It is the only reason that the services of banks are considered as ‘public good’ (Heffernan, 2005).
For citing this article, use:
- Shamshad, M. (2018). Sustainable Banking in India Issues and Challenges.