The role of banks in the economic system: functions, developments and challenges

In the complex world of business, banks are in a central position. They are not only simple money brokers, but also play a complex role in the management of economic processes. Understanding their functions, their development over time and the challenges they face is essential to the mechanisms of the financial world and theirto recognize influence on society. This article provides a detailed view of the banks, their tasks, their changes over time and the risks associated with their activities.

What is a bank? The basic definition

The question of the importance of a bank is quite easy to answer at first glance. The term comes from Italian and is “Banco” or “Banca”, which literally means “table”. This term refers to the original place where money changers did their business, namely at a table where coins and bills were exchanged. with itIt becomes clear that banks have always been active in their basic function in the area of money business, i.e. in exchange, administration and rental activities with money. Your task is to organize flows of money, control and secure the flow of money within an economy. They act as intermediaries between savers and investors, between borrowers and donors, andare the lynch points in the financial system.

The economic importance of the banks

From an economic perspective, banks take on a variety of essential tasks that ensure the smooth functioning of an economy. One of their most important contributions is to balance the many small deposits of savers and the demand for large, often long-term loans from companies, public institutions orto create the state. This process is called the so-called conurbation function because the banks pool the large number of small assets and convert them into larger credit volumes. In addition, they coordinate different interests with regard to the terms of the maturity. The wishes of those who want to invest their money in the short term with the needs of those whowant to make investments, to reconcile. This process is called a deadline transformation function and is one of the most crucial tasks of the banks in a market economy. They ensure that capital is distributed efficiently, investments are possible and the economy as a whole remains in motion. The trust of people in the banks is oneBasic requirement, because most investors trust that their deposits are secure and that they will be returned if necessary. This trust forms the basis for the so-called trust function of the banks, which enables them to reliably fulfill their tasks in lending and payment transactions. When lending, banks must have the creditworthiness of theCheck the borrower and observe the principle of risk diversification. This means you should not invest exclusively in individual companies or industries, but make a wide range of dispersion to minimize the risk of losses.

The loss of trust and the crisis of the banking system

However, the experience of the last few decades has shown that trust in the banks is not a matter of course. Numerous monetary and financial crises have revealed how far banks have moved away from their original trust function. These crises are the result of complex connections and cannot simply be explained by legal regulations alone. The centralRulebook for banks, the Banking Act, which is also referred to as the “Basic Law” of the banking system, only briefly describes in § 1 that banks are companies that conduct banking. It lists the main activities, such as accepting deposits, granting loans or custody of securities. This simple definition was once sufficient, but theRapid development of the financial world has long since exceeded the limits of this classification. Since the turn of the millennium, the financial industry has expanded into ever new business areas and areas of activity. The law has been repeatedly adapted to the new realities, but the complexity of financial products has increased considerably as a result. Especially since 1998, the definitions have been veryBecome extensive, with multiple pages full of lists of various financial companies, products and structures. This development has led to the classic banking business being a small niche, while the modern financial business is in a opaque, nested and highly complex network of products and structures. For laypeople it is increasingDifficult to keep track, let alone recognize all risks. The products are designed in such a way that they are hardly understandable for the average citizen, even though they are offered for sale. Regulation has also become more intensified in this context, but the diverse and difficult-to-understand structures make effective control more difficult. The result isAn opaque market that can only be penetrated by experts, while the general public is increasingly losing trust.

The Bad Bank and the management of toxic securities

In recent years, a special form of banking has established itself, the so-called “bad banks”. These institutions are used to collect the toxic securities and bad loans that arose in the course of financial crises. This is a kind of waste heap for problematic assets that the actual banks no longer want to have in their balance sheets, to theirto maintain stability. The sums bundled in these special institutions are enormous: More than 1,000 billion euros were transferred to these waste heaps throughout Europe. The central question is how high the actual value losses will be when it turns out that many of these papers no longer have any real value. Often the papers taken over areso-called “unsecurities”, the value of which could later turn out to be zero or close to zero. This resolution is intended to ensure the stability of the financial system, but the actual effectiveness depends on the extent to which banks are willing to accept significant impairments. If the substance of the economy as a whole is still intact, individual assets could stillhave a residual value. However, if the building fabric was severely damaged by the crisis, the entire system threatens to collapse. The Bad Banks are therefore a kind of lifeline, but they only work if the causes of the crisis are actually corrected. Otherwise, there is a risk that new crises will always occur because the underlying problems are unresolved.stay As long as the causes are not addressed, the risks in the bank balance sheets will arise again and again, which endangers the stability of the entire system.

Banks’ balance sheet: focus on assets and liabilities

In order to better understand the way the banks work, it is worth taking a closer look at their balance sheets. The example of Markus, who has built a small company with his fries frites specialties, is helpful. When he was founded, he had saved 17,000 euros and his house bank granted him a loan of 28,000 euros. With that he could take a food truck with himBuy full equipment for a total of 45,000 euros. The balance sheet of his company shows the comparison of assets and liabilities. The liabilities side describes where the capital came from: Markus has brought in 17,000 euros in equity, and the bank granted him a loan of 28,000 euros. The assets side shows which assets the money was invested in: the food truck includedinventory. The liabilities are reflected in the total of the bank assets in Germany, which amounts to around 8,400 billion euros. A large proportion, around 35 percent, comes from deposits from customers to checking, fixed-term deposit or savings accounts. In addition, capital flows from other banks and the European Central Bank into the system. The equity of the banks is comparatively low and makesonly about 5 percent of the balance sheet total, which increases the risk. The usage side shows that around 40 percent of the total is invested in loans and securities at domestic and foreign banks. This illustrates the close interdependence of the international financial world. Another high proportion, about 45 percent, is used in the non-bank sector by providing loans toprivate individuals, companies or the state. The question arises as to how much of this means actually flows into the real economy in order to promote productivity and employment there. In Germany, the proportion of loans that flow directly into production and retail is around 40 percent. The rest is invested in speculative assets, which is the danger ofblistering increased. It is particularly problematic when banks invest in risky securities that lose value in the event of a crisis. The 2007 financial crisis has shown how speculative engagements can pull entire economies into the abyss. The enormous losses in value of bank assets, especially for bonds from crisis countries such as Greece or Italy, havedanger, which is in the networking of the financial world. The risks must therefore be better controlled and made more transparent in order to prevent another catastrophe.

The gross domestic product: The measure of economic performance

Let’s imagine someone discovering a large, fallen tree trunk after a storm in the forest. For the moment, this tree trunk is a free commodity because no one else claims to do so. The finder breaks down the trunk into boards, which he sells for 50 euros. With these boards, a carpenter builds a shelf that he sells for 200 euros. The carpenter pays hisJourneyman who receives 60 euros in wages. The dealer who sells the shelf receives 300 euros for delivery and assembly, minus 40 euros in wages for his helper, he has a 60 euro profit. This simple example illustrates how value is created on several levels and ultimately combined in a country’s gross domestic product. The gross domestic product corresponds in this casethe final price of the shelf, i.e. 300 euros. It is the sum of all goods and services produced in a country within a certain period of time, whether they were made in the private household, in companies or in the public sector. In Germany, gross domestic product in 2012 was around 2,650 billion euros, in the USA it was around 3,400billion dollars. The European Union achieved an economic output of over $16,600 billion in the same year, which illustrates the enormous economic power of this community. GDP is thus an important indicator of a country’s performance, with the distribution of this value among the various players being as significant as the levelof the whole value. It is the basis for prosperity and social development, whereby the distribution within society also plays a decisive role. The growth rate of the gross domestic product is often used as a benchmark for the progress of an economy, although this view is also criticized as it only provides social and ecological aspectsinsufficiently considered.

The financial sector’s share of gross domestic product and its importance

The financial sector contributes about five percent to the gross domestic product in Germany. In international comparison, this proportion is different. In countries with a particularly pronounced banking and financial sector, such as Liechtenstein, this value is almost a third. In recent decades, the value added in the financial sector has increased significantly, which is due to achanges in the economic structure and the increasing importance of services in the financial sector. This development is not fundamentally negative because the service sector is growing overall and creating new jobs. Nevertheless, the increasing dependence of the economy on the activities of the financial industry is associated with risks. The enormous values thatFinance is generated, especially through speculative activities, pose a risk of jeopardizing the stability of the entire economy. The danger is that the financial industry puts its own stability above the real economy, which can lead to serious problems in the long term. The ever-increasing interdependence and the complexity of financial productsrequire stricter regulation and better monitoring. This is the only way to minimize the risk of a new collapse. The importance of the financial sector should therefore be measured not only by its contribution level, but also by its ability to secure the stability of the overall system and to identify risks at an early stage. only a balanced and well-controlledFinancial economy can lay the foundation for sustainable growth and social prosperity.