Role of Banks in the Economy (1.4.1)

Channeling savings towards investment

1. Commercial banks act as middleman, taking money that people have saved, and giving it out as loans to businesses

2. This system collapses if everyone asked for their money back from the banks

Financial intermediation

1. Process where banks act as a middleman

2. Between savers (surplus funds) and borrowers (shortage of funds)

How does commercial banks create credit

1. By making loans

2. Credits borrowers account with money that didn’t exist before.

Main source of income for commercial banks

1. Interest charged on loans

2. This charged interest is higher than the interest they pay out to savers

Collateral

1. An asset preserved as a security measure

2. So that if a borrower fails to pay back, the bank can take their asset away

3. Banks have the right to sell this asset to recover their financial losses

Why secured loans (mortgages) have lower interest rates than unsecured loans

1. Secured loans carry lower risk, as the borrower can be seized off their assets to recover financial losses

Monetary stability

1. Adjusting interest rates and money supply

2. To influence aggregate demand

Main responsibilities of a central bank (Bank of England)

1. Managing currency and cash supply

2. Setting the base interest rates

3. Implementing monetary policy to maintain price stability

Base rate

1. Interest set by central bank

2. Which influences all other interest rates (loans mortgages and savings), charged by commercial banks across entire economy

Liquidity & Profitability Conflict

1. Liquidity is holding cash to meet daily customer withdrawals, earns no interest

2. Profitability comes from lending money out long term for high interest. Which reduces cash reserves (how much bank currently has)

3. Banks must carefully balance both so they can make money without running out of cash