Sound Banking System
A bank plays a critical role in the development of the economy of a country. The banking system integrates several markets in the modern economic world. The savings and collections of depositors get lent to customers in need of money. This process facilitates a flow of funds within the economy from one segment to the other. Therefore, banks facilitate commerce.
Further, a sound banking industry ensures the overall growth of a country by creating capital and managing it effectively.
Features of the sound banking system in economics are –
Adequate Liquidity: One of the essentials of sound banking is to possess a certain degree of liquidity. A bank offers its customer the option to deposit money based on their preferences in several ways, including time deposits, current and savings account deposits and Non-resident ordinary accounts.
Therefore, banks must keep adequate cash in hand with them to satisfy the withdrawal requests of depositors. If a bank fails to do so, the bank is considered insolvent.
Further, the failure to meet the needs of the customers or depositors affects them too. One bank failing makes people lose their trust within the banking industry, and hence they tend to avoid depositing funds with the banks. Banks must have adequate cash to satisfy the withdrawal requests of depositors on a day-to-day basis. Therefore, it is integral for a bank to ensure that it has enough liquidity at all times.
Expansion of Banking: Banking services influence all segments that make up the economy of a country. Therefore, the diffusion of banking services is integral. The services that banks offer should be accessible to each cadre of society. It enables that the flow of funds persists from each section of the society and doesn’t stay concentrated within one segment.
Investment and Loan Policies : A banking industry must have a sound investment policy to assist the bank in achieving its goals. It is integral to keep in mind that if a bank’s loan or investments fail, it can suffer losses or liquidity shortages. Therefore, a prudent bank carefully determines the composition and character of its loans and advances to optimize the earning without putting its safety and solvency in danger. Banks must have a sound investment policy to realize the goals of profitability also as liquidity.
Human Factor: As an industry, banking relies heavily on the standard of individuals working in it. Banking may be a practical affair. Therefore, one cannot rigidly apply the laws of banking because it does not bear fruit. Thus, a sound banking industry depends more on the banking personnel than on banking Laws. Therefore, bankers tend to be highly qualified professionals certifying that those individuals are skilled and adaptive enough to the dynamic needs of the banking industry.
Safety: Another essential of sound banking is that it must be safe. Since banks keep the deposits from their customers, they must ensure the safety of their money and valuables. If the debtors fail to repay the loans in time, banks would lose their credibility and eventually become insolvent. It would also gravely affect the depositors as they would be losing out on their interests and initial investments if the bank were to go insolvent. Therefore, banks should avoid undergoing any risky scenarios unless absolutely needed. Banks must make sure of the safety of their deposits.
Stability: A sound banking industry must be stable. It should operate rationally. If the bank restricts the creation of credit when trade and industry need it the most, it will harm the interests of the businessmen. On the contrary, if it expands credit when the economic conditions do not permit, it will cause a boom and inflation. Therefore, the banking industry should follow a stable lending policy. A nation’s financial institutions can help achieve stability within the banking operations of the commercial banks by a judicious credit control policy.
Elasticity: The steadiness of banking operations should not get interpreted as rigidity. Instead, the banking industry should have sufficient elasticity in its lending operations. It should be in a position to expand and contract the availability of loanable funds with ease following the directions of the country’s leaders.
Profitability: A sound banking industry should be ready to earn sufficient profits. Profits are essential for a bank to be viable and for its growth.
Reserve Management: Reserve management, as the name suggests, requires banks to reserve some money. Adopting reserve management strategies becomes crucial for a bank to hedge any risks or emergencies that might arise in the future. Even though the sum reserved in such reserve accounts is idle and a backup, banks must adhere to specific guidelines to maintain such accounts.
It is evident from the points stated above that banks contribute largely to shape the economy of a country. Therefore, it is that much more important for the banking system to be sound and stable. It not only adds to the economy of a country but also evokes trust in the hearts of a country’s citizens.
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