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Unit 2: Role of Banks in the Development of Economy

Notes

Notes The commercial banks should change their policies in favour of granting medium
and long term accommodation to business and industry.

Cheap Money Policy: The commercial banks in an underdeveloped economy should follow
cheap money policy to stimulate economic activity or to meet the threat of business
recession. In fact, cheap money policy is the only policy which can help promote the
economic growth of an underdeveloped country. It is heartening to note that recently the
commercial banks have reduced their lending interest rates considerably.

Need for a Sound Banking System: A sound system of commercial banking is an essential
prerequisite for the economic development of a backward country.

Self Assessment

Fill in the blanks:
1. The commercial banking sector which forms one of the …………………….. of the financial
sector should be well organized and efficient for the growth dynamics of a growing
economy.

2. The rate of saving is generally low in an ………………………….. economy due to the
existence of deep-rooted poverty among the people.
3. Innovations are mostly financed by bank credit in the …………………….. countries.

4. The …………….. business need medium and long term loans for their proper
establishment.

2.2 Role of Banks in Indian Economy

In India, as in many developing countries, the commercial banking sector has been the dominant
element in the country’s financial system. The sector has performed the key functions of providing
liquidity and payment services to the real sector and has accounted for the bulk of the financial
intermediation process. Besides institutionalizing savings, the banking sector has contributed
to the process of economic development by serving as a major source of credit to households,
government, and business and to weaker sectors of the economy like village and small-scale
industries and agriculture. Over the years, over 30-40% of gross household savings has been in
the form of bank deposits and around 60% of the assets of all financial institutions accounted for
by commercial banks. An important landmark in the development of banking sector in recent
years has been the initiation if reforms following the recommendations of the first Narasimham
Committee on Financial System. In reviewing the strengths and weaknesses of these banks, the
Committee suggested several measures to transform the Indian banking sector from a highly
regulated to a more market oriented system and to enable it to compete effectively in an
increasingly globalised environment. Many of the recommendations of the Committee especially
those pertaining to interest rate, an institution of prudential regulation and transparent accounting
norms were in line with banking policy reforms implemented by a host of developing countries
since 1970s.

2.2.1 Role of Banks in a Developing Economy

Banks play a very useful and dynamic role in the economic life of every modern state. A study
of the economic history of western country shows that without the evolution of commercial

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