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Banking Theory and Practice

Notes From the different macroeconomic models, banks have been found to be a part of the supply
side of the economy. However, over time banks have transformed from merely money generating
organizations to a multi tasking entity.

2.1 Role of Banks

A proper financial sector is of special importance for the economic growth of developing and
underdeveloped countries. The commercial banking sector which forms one of the backbones of
the financial sector should be well organized and efficient for the growth dynamics of a growing
economy.

!
Caution No underdeveloped country can progress without first setting up a sound system
of commercial banking.

The importance of a sound system of commercial banking for a developing country may be
depicted as follows:

Capital Formation: The rate of saving is generally low in an underdeveloped economy
due to the existence of deep-rooted poverty among the people. Even the potential savings
of the country cannot be realized due to lack of adequate banking facilities in the country.
To mobilize dormant savings and to make them available to the entrepreneurs for
productive purposes, the development of a sound system of commercial banking is essential
for a developing economy.
Monetization: An underdeveloped economy is characterized by the existence of a large
no monetized sector, particularly, in the backward and inaccessible areas of the country.

Notes The existence of a non monetized sector is a hindrance in the economic development
of the country.

The banks, by opening branches in rural and backward areas, can promote the process of
monetization in the economy.

Innovations: Innovations are an essential prerequisite for economic progress. These
innovations are mostly financed by bank credit in the developed countries. But the
entrepreneurs in underdeveloped countries cannot bring about these innovations for lack
of bank credit in an adequate measure. The banks should, therefore, pay special attention
to the financing of business innovations by providing adequate and cheap credit to
entrepreneurs.
Finance for Priority Sectors: The commercial banks in underdeveloped countries generally
hesitate in extending financial accommodation to such sectors as agriculture and small
scale industries, on account of the risks involved there in. They mostly extend credit to
trade and commerce where the risk involved is far less. But for the development of these
countries it is essential that the banks take risk in extending credit facilities to the priority
sectors, such as agriculture and small scale industries.

Provision for Medium and Long-term Finance: The commercial banks in underdeveloped
countries invariably give loans and advances for a short period of time. They generally
hesitate to extend medium and long term loans to businessmen. As is well known, the
new business need medium and long term loans for their proper establishment.

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