Risk Of Bank Borrowing | Market Rates Of Interest
What is the risk that exists when banks borrow short and lend long? The response to the above question will depend on the market rates of interest. Two of these rates are easily discernible. Short term rates and long and long term rates.
Risk Of Bank Borrowing involves borrowing whenever short term rise in general or advance towards equality with the long term rate, the banks have problems retaining their deposits. To retain these deposits, they must meet the required rates paid on competitive short term securities, and to do this, they must increase the interest rate they pay all depositors.
At the same time the earnings from the assets remain relatively constant, or if the long term rate is also moving in a general upward direction, their earning are increasing only in relation to the new loans they are making at higher rate (and the rate of new existing loans may be rather low). As their profits are squeezed, the intermediaries cannot effectively complete to retain their deposit and this dis-intermediaries process can lead to severe financial and economic distress.
Utility Of Bank And Their Importance (Risk Of Bank Borrowing)
The importance or role of economic development, banks are so to say almost dispensable for a modern community. In fact may be true to say that financial or industrial revolution succeeded in Europe with the assistance of banks hence even among developing countries, mush advancement cannot be hoped to be made in the absence of a sound commercial banking system.
Since the Risk Of Bank Borrowing has become a daring issue, banks as the custodian and distributors of liquid capital form the bedrock of our commercial and industrial activities and upon the prudence of their administration depends on the economic well being of the nation. Their uses could be summarized thus;
- Banks creates purchasing power in the form of bank notes, cheques, bills and drafts and thus economics the use of money proper (metallic money). By creating such purchasing power, they help promote the growth of trade and industry, which depends on the use of money. Money here does not imply coins and notes per say.
- Sectors considered of priority standing rather than wasted in a non essential or non production ventures. Banks usually prefer only those entrepreneurs whose products are in great demand and beneficial to the general public.
- Banks loans in turn enable manufacturers and producers to increase better machinery and equipments, improve working conditions and generally to spend up production and raise national income.
- In managing the Risk Of Bank Borrowing, banks promote balance regional development by opening branches in rural areas or by judiciously and generally spreading their branch networks, banks are able to make credit available where they are not needed for productive purpose. Thus surplus capital can be moved from the regions it is not efficiently employed. In this way, banks bring about a more balanced development that enables backward regions to open up deep and develop.
- Expansion of credit; Fluctuations in bank credit have an important bearing on the level of economic activity. Expansion of bank credit will provide more funds to entrepreneurs and thus will lead to more investment. Under conditions of full employment, expansion of bank credit will exert inflationary pressure on the economy whereas in situations of unemployment, it will push up production in the country. Conversely, a decline in bank credit usually results in decline in production employment, sales and prices. Thus expansion of bank credit by offering more financial resources to the industries enhances the rate of economic development particularly in developing and under-developed economics.
- Banks monetize debt; The creation of bank demands deposits in exchange of the debt of other, in essence short and long term securities is very important service rendered by banks. Commercial banks buy these debts which not generally acceptable as money, either because the debtors are not sufficiently known or because their debts are payable only after a period of time. In return for them they issue demand deposits which are generally accepted as money by these exchanges, banks monetize debt hence banks are recognised not only as traders in money but also as manufacturers of money.
- Banks promote growth with stability; Banks influence government economic activity in another way. Through their influence on the rate of interest in the money market and the supply of funds, they can regulate the rate of investment. By offering fewer accessible fund as it can bring about a string drive which will eventually have an effect upon interest rates. It can also influence the people to hold more of less bank money or more or less of other assets. A cheap more policy with low interest rates will tend to stimulate economic activity, if other conditions are favourable. In this way they promote Risk Of Bank Borrowing, growth and stability.