Essay on the Role of Banks in Economic Development

The role of banks in economic development is to remove the deficiency of capital by stimulating savings and investment.

A sound banking system mobilizes the small and scattered savings of the community, and makes them available for investment in productive enterprises.

In any plan of economic development, capital occupies a position of strategic importance. No economic development of sizable magnitude is possible unless there is an adequate degree of capital formation. A very important characteristic of an under-developed economy is deficiency of capital which is the result of insufficient savings made by the community. Backward economies hardly save 5% of the national income, whereas they should save and invest at least 15%.

In 1950, Colin Clark, estimating the capital needs of China, India and Pakistan, pointed out that they must save 12.5% of the national income to absorb the increasing labour force and maintain the past rate of increase in productivity.

In the under-developed countries, not only is the capital stock extremely small but, as pointed out above, the current rate of capital formation is also very low. The serious capital deficiency in under-developed countries is reflected in the small amount of capital equipment per worker and in limited knowledge, training and scientific advance.

These are serious handicaps in economic development and here the banks can play a useful role:

The role of banks in economic development is to remove the deficiency of capital by stimulating savings and investment. A sound banking system mobilizes the small and scattered savings of the community, and makes them available for investment in productive enterprises.

In this connection, the banks perform two important functions:

(a) They mobilize deposits by offering attractive rates of interest, thus converting savings,, which otherwise would have remained inert, into active capital.

(b) They distribute these savings through loans among enterprises which are connected with economic development. In this way, they promote the development of agriculture, trade and industry.

It is difficult to see how, in the absence of banks, could small savings be stimulated or even made possible. It is also difficult to see who would distribute these savings among entrepreneurs. It is through the agency of the banks that the community’s savings automatically flow into channels which are productive.

The banks exercise a degree of discrimination which not only ensures their own safety but which makes for optimum utilization of the financial resources of the community. We see that in India the period of economic development has coincided with a phenomenal increase in bank deposits—and bank offices.

Thus, the banks have come to play a dominant and useful role in promoting economic development by- mobilising the financial resources of the community and by making them flow into the desired channels. The Indian banks are now playing a very active role in fostering economic development of the country.