Question

Wall Street” fulfills an important role for “main street”. It channels funds from savers to borrowers in the most effective way possible. However, its foundations are fragile by construction; for instance, banks borrow short term funds (including deposits) and lend for long terms investment projects. So they may become illiquid if too many deposits are withdrawn on a short notice. They are also exposed to other risks, such interest rate changes and the risk that loans are not repaid (credit risk). The 2007-08 financial crisis in the US and some other advanced economies vividly shows these perils.

Discuss:

What special functions do the banks and other financial intermediaries perform?

Could an economy do as well without money and banks? Why? Explain.

Should the government regulate commercial banks more or less tightly? Why? Discuss.

Answer 1

1.

Banks and other financial intermediaries perform the function of channelizing funds that are used for production activities and create new jobs. in return, depositors earn interest on their idle money and borrowers can realize their business ideas. The interest rate margin is earned by the banks. Further, the banks and other intermediaries give guarantees to the firms so that they can get the business contract. The third function is to give factoring services that provides liquidity to the smaller firms. So, these are the special function performed by the these institutions.

2.

Economy cannot do well without money and banks, because money helps accelerate economic activities and banks work as a catalyst to channelize the money from one person to another person or entity. Without money, economy will become stagnant and growth will not take place. So, money and banking is essential for the economy.

3.

Government should regulate the commercial banks tightly, because it will help banks deter from speculative activities. Further, it will make the banks to apply prudential norms to issue loans and it will prevent the scope of getting defaults. Further, government regulations will help banks make proper term structure, asset liability management to manage the interest rate risk. So, strict regulations will prevent the bank from failure.