The Role of the Banks to Individuals and Companies

 

The Role of the Banks to Individuals and Companies

Introduction

Banks are financial institutions that are licensed to accept deposits from members of the public and companies and lend them loans. Banks play a vital role in the economy and the financial system both locally and internationally. They ensure that there is an efficient flow of money by allocating funds obtained from savers to borrowers. Banks also offer financial services and advice in regards to investment and savings and this reduces the public’s cost of obtaining financial advice from other private firms about borrowing activities and savings. These services contribute to the efficiency of the economy. Due to the important role that the banks play to the economy, they are highly regulated by the states to ensure the stability of the economy. The aim of this paper is to examine the role that banks play to individual members of the public and companies. The activities that banks undertake include personal banking, investment banking, corporate banking, transaction banking, private banking, insurance, foreign exchange trading, commodity trading, consumer finance, and many others. Banks enhance and improve the lives of individuals and companies by lending them fund for personal and business and offering a variety of convenient saving services.

How banks work

Banks operate by accepting deposits from individuals and companies or borrowing funds from other markets. They can borrow from individuals, financial institutions, governments, and business. They then use the borrowed funds and deposits to purchase securities or make loans. They then lend loan to business, individuals, government or other financial institutions. They lend a higher interest than they borrowed to gain profit. Through the process borrowing, taking deposits, lending and responding to signals of interest rates, the banking system controls the movement of funds from borrowers to savers resulting in the efficient flow of funds in the economy. Savers range from individuals who deposit their monthly or daily savings to corporations who deposit millions of dollars. When customers deposit money, they gain savings interests to protect their funds from inflation. However, lending customers pay higher interests than the interest earned by saving customers. This is where the bank gets most of its profit from. Customers deposit money into the banks and allow them to lend the money because banks can place the funds more effectively than individuals (Perelman 159).  Banks promise the depositors fixed returns and the permission to withdraw the funds at will.

Banks can lend money to borrowers for years and sometimes even decades. Even in cases where borrowers fail to repay their loan, the banks still have the obligation to allow the depositors to withdraw funds. However, banks lower the risks associated with long-term lending by giving short-term loans. Short term loans give the bank more profit that can be used to cover the money lost through long term lending. Additionally, banks enjoy economies of scale through pooling together large amounts of money. As a result, of large economies of scale banks are not affected much by risks of lending and borrowing.  Furthermore, banks have superior knowledge about lending that enables them to calculate the risk and creditworthiness of customers to minimize lending risks. They do so by gathering all the information about customers and using the information to determine their creditworthiness (Perelman, 149). Depositors prefer to deposit their money in banks to avoid the risks of lending directly.

Fig1

FDIC

Insurance/ safety guarantee

 

Commercial banks

Insurance/regulation             deposits/withdrawal

loans

 

Efficient flow of fund

 

Lending

Banks play a vital role in the lives of individuals and companies through lending them money which they use to improve their lives. One of the main purposes of commercial banks is to lend money to customers either for short term or long term. Companies and individuals borrow fund from banks for various reasons which include start-up capital for new business, assert financing, mortgages, credit card financing, and unsecured loans. These services help individuals and companies to finance their personal needs and business needs, and enjoy a better life without financial difficulties. However, companies and individuals who borrow from commercial banks repay the fund with an interest. Interest rate refers to the price paid by a borrower to the lender in return the funds (Pilbeam68). As Pilbeam explains the interest rate is a vital eco variable that affects consumptions, investment, and savings in an economy (Pilbeam68). Interest rates are also important formulas for pricing financial assets such as future, forwards, swaps and options. Commercial banks determine the interest rates according to the prevailing conditions in the market. Borrowers, on the other hand, prefer banks with low interests and most of them wait until interests are low for them to borrow.  In all countries, there are many banks that offer lending services, and individuals and company often choose the banks with the best interest rates and terms of payment. Thus, banks play the role of the lending fund to individuals and companies for various purposes.

Mortgages

A mortgage is a loan offered by commercial banks or other lending institutions to facilitate the purchase of real estate or home. Individuals and companies acquire a loan from banks for which they pay later over a given amount of time. Banks give loan to customers who meet the credit score required by the banks or if the income level and the ability to repay the loan (USA GOV 1). The bank can also obtain the property for which a mortgage was taken if an individual fails to repay the loan and the interest accrued. Banks also offer reverse mortgage where people do not have to pay for the loan as long as they are occupying the home. The loan is repaid only when a person dies, sells the home or move way permanently (USA GOV 1). A reverse mortgage allows older people over 62 years to convert their equity into cash without selling their home. As a result, people are able to own properties even without cash.

Mortgages have benefited a lot of people by helping them to acquire properties that they would not have obtained on their own without the assistance of the bank. Before 1930, only a small percentage of Americans owned a home. Only a few people had the money required to purchase a house. At that time there were no bank loans that were specifically designed to buy a home. However, today most Americans can acquire homes even without large amounts of money because of bank mortgages. According to the report released by the government on Quarterly Residential Vacancies and Homeownership in 2019, 64% of Americans now own a home (Census Gov 1). Banks, therefore, facilitate property ownership for both companies and individuals. In a mortgage loan, the banks lend an individual or a company a large amount of money usually 80% to purchase a home which acts as collateral for the mortgages. Some banks offer a single fixation period for the mortgaged while others split the mortgage into portions with different fixation period and mortgage rates (Basten, et al. 3). However, when homeowners fail to repay their loan, the bank can take the house through a process referred to as foreclosure. During a crisis the issues of foreclosure were common but most banks now offer families mortgage with less down payment and longer repayment period to reduce the risk of foreclosure during the market crisis (Quinn 142). Overall, banks have improved the lives of Americans through a mortgage that allows individuals and business owners to acquire homes and real estate without a large amount of money.

Business expansion

Banks also play a vital role in lending individuals funds to start a small business. Most Americans rely on bank loans to set up a business to sustain themselves and their families. The loans are expected to be paid within a particular period of time plus interest. Individuals obtain loans from the bank for their business either in the name of the business or in the name of the business owner. According to Cole and Sokolyk, start-up businesses prefer business debt from banks to personal debts (Cole and Sokolyk 2). The authors also assert that young entrepreneurs who start their business using business loans outperform businesses that do not use loans as start-up and working capital (Cole and Sokolyk 2). Banks readily offer a loan for business if the creditworthiness of the business owner meets the standards of the banks. Most business owners and companies prefer borrowing from banks because their interests and repayment period are reasonable. Bank loans have helped many entrepreneurs in the United States to start small firms and to finance them during hard economic times. Consequently, the standard of living of people who borrow to start a business improve greatly. Without business loans, it would be hard for business owners to raise the funds required for daily business activities. Banks provide business owners with enough working capital to cover the expenses without strain to make a profit. The bank also provides a reasonable amount of time for business owners to repay their time. This ensures that the businesses have already break-even and they can sustain themselves while still servicing the business debt. This also contributes to the growth of the economy. Therefore, banks play a significant role in improving the lives of people by offering business loans as well as personal loans.

Savings

Banks provide deposit services to individuals, household, small business, companies, institutions and groups throughout the world.  They provide a safe place where people can store their money and withdraw it at will. As of 2015, the number of FDIC insured banks were 6, 400, and the number of assets and deposits in 2014 were 415,650,361 and $11826,573 respectively (FDIC 1). According to the FDIC survey in 2017, only 6.5 % of households in America were not banked (FDIC par 2). Additionally, 18.7 % of the households had savings accounts but they obtained financial services outside the bank. The report by the FDIC shows that a large percentage of Americans have savings accounts that they use to obtain services and products. More than 50% of Americans benefit from the services offered by the banks that include deposits, withdraws, cheques, credit card services among others. These people store their money in banks because they believe that the bank has the ability to keep their money safe and to put it into good use. The money that individuals deposit in savings are lent to other customers who borrow from a bank and this maintains the flow of funds and stability of the economy. Additionally, saving services enables people to save the money for future needs that include retirement plans, emergencies, school fees and investment and many others. It is difficult to save money to achieve a certain goal without a bank account. Thus, banks savings minimize the risk of overspending money and experiencing future financial difficulties.

Additionally, banks make the lives of Americans easy by offering convenient ways to save and withdraw funds. Depositors can access their money in any bank branch across the nation. Banks also use automated teller machines that serve customers quickly and conveniently. The banks also have a variety of savings plan that is customized to fit the needs of the customers. These savings plans include regular saving account, checking account, online saving account, money market deposit account, certificate of deposits and automatic saving plan. Most banks offer regular savings accounts where people sign up either in person or online. Saving accounts have a six-month limit of withdrawals or other transaction and may also have a minimum balance requirement. Most people use regular savings account for their daily transaction. This account is easily accessible and convenient for miscellaneous transactions. The savings account are also easy to open and maintain, and it can be linked to checking account directly.

Individuals and company benefit from the online banking system because they do not have to go to the bank physically to make withdrawals. An online account is different from a regular account because members transact exclusively through the internet and phone. Online transactions. As Tarhin et al explains, the emergence of the internet has changed the way banking was done into an online-based banking system that is fast and convenient (1). Most people use online banking because it does not require an elaborate process. Online banking has been enhanced by online business that requires online transactions. Banks in the United States that offers online banking services include Ally Bank, Charles Schab. Axos and Discover. Most banks, however, combines different savings services for the customers to choose the most convenient for them. Interests rates earned by deposits vary depending on the type of savings account. Thus, banks make the lives of people easier by offering convenient options for saving and withdrawing funds.

Minimizes saving risks

Banks eliminates the risk of borrowing and saving money. Firstly, banks offer lower interest rates for loans than other private lending institutions. Due to the competition that exists in the industry, banks have to maintain a reasonable interest to attract new customers to retain existing ones. Additionally, banks are highly regulated by the government under the FDCI and this ensures that banks engage only in practices that protect the public funds. The Federal Deposit Insurance Corporation was created under the Glass-Steagall Act (1993). The corporation provides deposit insurance that ensures that the deposits of banks are safe. Therefore, the safety of depositor’s funds is guaranteed. FDIC insures $250,000 per depositor and per bank. FDIC also examines financial institutions insured under it for soundness and safety, performs consumer-protection functions as well as managing banks in receivership. The corporation was founded in January 1934 and since then, no bank depositors have lost their funds due to bank failure.  Depositors who are members of the insured banks have the assurance that even if the bank fails, they will receive up to $250,000 of their money. Therefore, banks guarantee safety to the money deposited by individuals and the company.

The following tables the number of commercial banks insured by FDCI in 2018. FDCI (2018)

  Commercial banks
Number of insured institutions by the FDCI 4,715
Number of FDCI-supervised 31,140
Total assets 16728
Total loan 9460
Real estate loans 0.02%
C&I loan 0.32%
Loan to individual 2.25%

 

In conclusion, banks improve the lives of people by offering loans that are used to increase people’s income and providing safe and convenient saving services. The primary purpose of banks is to receive deposits and lend funds to individuals and companies. The process of receiving deposits and lending maintains an efficient flow of money that contribute to the stability of the economy. Banks play a vital role in the economy and for this reason, they are under the supervision of the FDCI. FDCI monitors the safety and progress of banks and insures them against any risk. People all over the world use banks for daily transactions, to obtain a loan, and for financial advice. Thus, banks are important tools in the lives of people and business that enables them to access vital life process.


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