Page 23 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice

Notes banks in the 18th and 19th centuries, the industrial revolution would not have taken place in
Europe. The economic importance of commercial banks to the developing countries may be
viewed thus:
1. Promoting capital formation
2. Encouraging innovation
3. Monetization

4. Influence economic activity
5. Facilitator of monetary policy
Above all view we can see in briefly, which is given below:

Promoting Capital Formation: A developing economy needs a high rate of capital
formation to accelerate the tempo of economic development, but the rate of capital
formation depends upon the rate of saving. Unfortunately, in underdeveloped countries,
saving is very low. Banks afford facilities for saving and thus encourage the habits of thrift
and industry in the community.

Did u know? Banks mobilize the ideal and dormant capital of the country and make it
available for productive purposes.
The significance of Development Finance Institutions or DFIs lies in their making available
the means to utilize savings generated in the economy, thus helping in capital formation.
Capital formation implies the diversion of the productive capacity of the economy to the
making of capital goods which increases future productive capacity. The process of Capital
formation involves three distinct but interdependent activities, viz., saving financial
intermediation and investment. However, poor country/economy may be, there will be
a need for institutions which allow such savings, as are currently forthcoming, to be
invested conveniently and safely and which ensure that they are channelled into the most
useful purposes. A well-developed financial structure will therefore aid in the collections
and disbursements of investable funds and thereby contribute to the capital formation of
the economy. Indian capital market although still considered to be underdeveloped has
been recording impressive progress during the post-interdependence period.
Encouraging Innovation: Innovation is another factor responsible for economic
development. The entrepreneur in innovation is largely dependent on the manner in
which bank credit is allocated and utilized in the process of economic growth. Bank credit
enables entrepreneurs to innovate and invest, and thus uplift economic activity and
progress.
Monetization: Banks are the manufactures of money and they allow many to play its role
freely in the economy. Banks monetize debts and also assist the backward subsistence
sector of the rural economy by extending their branches in to the rural areas. They must be
replaced by the modern commercial bank’s branches.
Influence Economic Activity: Banks are in a position to influence economic activity in a
country by their influence on the rate interest. They can influence the rate of interest in the
money market through its supply of funds. Banks may follow a cheap money policy with
low interest rates which will tend to stimulate economic activity.

Facilitator of Monetary Policy: Thus monetary policy of a country should be conductive
to economic development. But a well-developed banking system is on essential

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