In a developing country like India, there are many factors that hinder the development of the country. Some of them can be endorsed to the low per capita income and large group of people living below the poverty line. India is an agrarian economy where the country’s potential, neither the human resource nor the natural resources are adequately utilised to the maximum extent which results in low per capita income. Thus the economy is marred with unemployment and underemployment. Since the economy is basically agrarian, disguised unemployment is also unbridled among the farmer community.
Besides the reasons mentioned above, the financial market was in the presence of private moneylenders, landlords, etc. They acted as bankers for centuries and amassed major wealth from the people of India that adversely affected capital formation. Thus the need for a better financial institution and credit infrastructure was felt necessary by the Planning Commission when the Five Year Plans were initiated.
Banks play an important role in the development of a country, because in a modern economy, banks are to be considered not merely as dealers in money but also the traders in development. The banks are not only the stockholders of the country’s wealth but also are the reservoirs of resources necessary for the economic development. Thus, the importance of commercial banks in the process of economic development has been pointed out regularly by economic thinkers and policy makers of the country. Commercial banks played an important role in the Indian economy and considered as the heart of the financial structure.
The success of economic development depends on the extent of mobilization of resources and investment, the operational efficiency, and economic discipline displayed by various segments of the economy. From the economic point of view, the major task of banks and other financial institutions is to act, as intermediaries channelling savings to investment and consumption. Through them, the investment requirements of savers are reconciled with the credit needs of investors and consumers.
The contribution of banking to a country’s economic development can be described as follows:
1. Capital Formation: Capital formation is considered to be the most important determinant of economic development, and banks promote capital formation in following three well-defined stages:
- i) Generation of savings
- ii) Mobilisation of savings.
- iii) Canalisation of savings in a productive way.
Banks play a vital role in all the three stages of capital formation. They motivate savings by providing incentives to the savers like interest on deposits, free and cheap remittances of funds, safe custody of valuables. They, thus, succeed in mobilising the savings generated in the economy. They not only mobilise resources from people who have excess of them but also make the resources so mobilised available to those who have the opportunities of productive investments.
2. Encouraging Entrepreneurial Innovations: In the developing and underdeveloped countries, entrepreneurs generally vacillate to invest in the innovative ventures due to lack of funds. Thus facilities of the bank loans enable the entrepreneurs to start up their investment and innovative businesses and adopt new methods of production and increase productive capacity of the economy.
3. Monetisation of Economy: Monetisation of the economy is important for accelerating trade and economic activity. They, help the process of monetisation in two ways: a) Monetisation of Debts: They buy debts (securities which are not acceptable as money) and in exchange, create demand deposits (which are acceptable as money) and b) By scattering their branches in the rural and backward areas, the banks transfer the non-monetised sector of the economy into monetised sector.
4. Implementation of Monetary policy: An appropriate monetary policy is needed for economic development. But for the effective implementation of the monetary policy a well-developed banking system is necessary prerequisite. Control and regulation of credit by monetary authority is possible with .the active co-operation of the banking system in the country. Banks directly influence economic activity and thus, influence the place of economic development through:
a) Variation in Interest rates: An increase in the interest rates discourages investment and economic activity. Conversely, a reduction in the interest rates makes the investment more profitable and stimulates economic activity. Thus, to overcome a deflationary situation, banks can follow cheap interest rates, and to control inflation, they can adopt dear money policy with high interest rates.
b) Variability of credit: Banks can influence economic activity by the availability of credit also. Credit creation is a vital function of banks and the major portion of money supply is formed by banks credit. Thus, the banks increase the supply of purchasing’ power through their credit creation activity and hence the aggregate demand. This result in increases in investment, production and trade in the economy
5. Promotion of Trade and Industry: Economic progress in the industrially advanced countries, during the last two hundred years has become possible only with the development of banking system. The use of bank cheque, the bank draft, and the bill of exchange have accelerated the pace of industrialisation.
6. Encouragement to right type of Industry: The banks, by granting loans, (particularly medium-term and long-term) provide financial resources to the right type of industries to procure necessary material, machines, etc. The banks should formulate their loan policies in accordance with the broad objectives and strategy of industrialisation as adopted in the plan.
7. Balanced Regional Development: For achieving balanced development in different regions of the economy, banks play an important role. They transfer surplus capital from the developed regions to the underdeveloped regions where it is scarce and most needed. This reallocation of funds between regions will promote economic development in the under developed areas of the economy.
8. Development of Agriculture and other neglected Sectors: Underdeveloped economies are basically the agricultural economies in the rural areas. Hence the economic development in these economies requires the development of agriculture and small-scale industries in rural areas. So far, in underdeveloped countries, banks have been concentrating on trade and commerce and have almost neglected agriculture and industry. Therefore necessary structural and functional reforms in the banking system of the underdeveloped countries should be made in order to encourage the banks to play developmental role in these economies. The banks must diversify their activities not only to extend credit to trade but also to provide medium term loans to industry and agriculture.1
9. Stabilization of prices: The inconsistent behaviour of prices is not helpful for the steady and rapid rate of economic growth. It demands stability in prices of goods and services. Commercial banking system plays an important role in stabilizing prices through their decisions to provide or not to provide credit; the impact of credit on stabilisation of prices is different for the credit which stimulates production and the credit which raised the level of consumption. Even the credit, which goes to production purposes, can have different repercussions depending on the time lag between the increase in demand and the increase in supply which the credit generates. If too much credit goes to longer gestations, it can have an adverse effect on the price level. Cheap and timely availability of credit with adequate availability of other things, helps the manufacturer to produce things at lower cost, which is one of the important considerations for fixing up the prices, in addition to this, banks also help in balancing demand and supply conditions, and its absence causes disequilibrium in these conditions, there by, causing price fluctuations. A growing economy requires increasing supply of money which should be elastic to the extent that geared to the seasonal demands of business; otherwise, it would have adverse effects on the general price line.
10. Support to the government: The government motive force for economic development is facilitated by commercial banks. Through .subscribing the public debt and investing money in various government securities, banks provide and help in arranging finance to the government agencies. This process of credit supply enables the government to implement various schemes of development. To achieve targets through their working in co-ordination with the commission, .the banks help the Planning Commission. For balancing the economic development and thus, decentralizing its activities, banks provide credit to the needy in the rural areas. The working of banks indirectly helps the Government of India to solve many problems in development such as shortage of savings, price rises, unemployment, unbalanced development, lack of entrepreneurial skills, etc. They help the government in minimising the social cost of supplying currency to the public. Thus the banking industry has been playing multiple roles in transformation of the development process of the economy, viz, branch expansion, deposit mobilization, priority sector lending, etc.
For citing this article use:
- Vemula, H. (2012). A study on Indian consumers service quality perception and satisfactions in retail banking with special reference to Hyderabad.
