There are many definitions of banking, but it can generally be defined as a system concerned with safeguarding deposits and making funds available to borrowers. Hoggson (1926) asserts that a deposit is a safe place where excess cash can be stored. Banking can be dated back to the middle ages. It developed due to the rising need for credit in commerce. Banks basically do make their own money through charging higher interest rates on loans. They play a very crucial role in the economic life of a nation. When the banking system is of a nation is sound, the health of its economy is also sound. Banks are effective partners in economic development because their borrowing and lending activities aid in the process of production, distribution, exchange and consumption of wealth. In the contemporary world, banks facilitate the utilization of a country's resources through mobilizing people's savings for investment purposes. As such, a great fraction of the capital of any given country would remain inactive in the absence of banking. Japan is a very good example; its economy grew within a very short time because it had a very good banking structure. On the other hand, banks in Bangladesh helped in bringing the poverty level down; the micro-finance sector boosted their economy which in turn changed the lives and the living standards of its people.
According to Boland (2009), modern Banks play a very significant role in the economies of both underdeveloped and developed economies. They usually offer investment services, lending services, borrowing, advice and brokerage services. With the availability of suitable banking services, modern trade and commerce have also become a possibility. Banks promote savings; people from all walks of life, from laborers to businessmen can keep their money safely in the banks and various saving centers.
Banks also promote investment in a very significant manner. With ease, banks can invest the money they get in industry, agriculture or trade, either directly or through giving out loans to other possible investors. Foreign trade is mostly carried through banks. Money is transferred from one country to another through banks, whether it is export or importation of goods and services. The regular ways that banks use to transfer money are through the use of bills of exchange and letters of credit.
According to Allman (2006), banks also play a significant role in supplying liquidity to the economy. On the asset side, they do this by loaning out money to help businesses grow and allow consumers to buy cars, homes and other consumer products. Small business owners find banks important because they can borrow from it; they usually find funding through public markets impossible due to their small size. Banks also build relationships with their customers thus giving them important information about their operations. The bank-customer relationship aids small businesses to access loans because the banks get special information about them. As such, during economic recession, businesses with strong relationships with banks are able to obtain funds to sustain themselves. On the liabilities side, banks do accept deposits and in turn give out transaction services. Both borrowers and lenders have different preferences concerning liquidity. As a result of this, banks put funds together and have to rely on the law of averages so as to offer liquidity to their customers.
Boland (2009) asserts that banks help in reducing transaction costs. They do this through: giving standardized products, providing convenient venues of business and offering less costly expertise by using tested procedures. As such, customers are freed from the weight of gathering information and monitoring banks by supervisory bodies which regulate and supervise banks to ensure that they conform to acceptable codes of behavior. Banks are very important because they help small savers in reducing costs such as those incurred when monitoring, negotiating, or contacting other financial institutions (Hoggson, 1926). They achieve economies of scale and scope that lie in the cost of transaction. Thanks to banks', costs of transaction related to saving and deposits are falling. Banks also enjoy information on economies of scope in lending due to the fact that they have access to information about the borrowers who have accounts with them.
According to Allman (2006), banks also play the critical role of a monitoring unit. Depositors have delegated banks to monitor borrowers' behavior because borrowers have to be monitored so as to guarantee the highest probability that loans will be repaid. Secondly, lending contracts are not complete unless the behavior of the borrower after the loan has been issued is determined. In addition, payment and settlement systems are very vital to an economy. Banks come in handy because they administer the payment systems which are important to the economy. By managing payment systems, banks carry out customers' payment instructions through the transfer of funds between their accounts. Secondly, customers receive payment or make payments through cheques, orders, and credit or debit cards. Thirdly, funds flow between individuals and retail and wholesale markets quickly and safely. By doing all this, banks act as the transition belt for Monetary Policy Corrigan.
It is now very clear that the banking sector is a key driver of any given economy. Even the UN has its own bank; the World Bank. It is a big deposit for all the member countries. They can also borrow from it according to their various needs. However, unwise borrowing and uneconomical spending by countries may lead to huge debts and distress to the economy. As such, it is advisable to have a simple banking system for any progress to be felt. According to Hoggson (1926), banks have an upper hand over other financial institutions. For instance, both banks and other financial institutions can act as intermediaries, but the fact that banks take deposits and grant loans singles them out from the institutions. Banks act as intermediaries because they mobilize savings from savers (surplus units) to borrowers (shortage units) so as to finance productive economic activities. In addition, they have an influence on the level of cash stocks because they are able to create deposit liabilities. Arguably, banks will continue to play a big role towards economic growth.