The Function of Banks

Banks serve a variety of functions in the economy. They act as safe places for people to store their wealth, they help to facilitate trade by providing alternative methods of payment, but most importantly, they bring together savers and borrowers. Each of these functions is critical to the smooth operation of the economy.

In John Locke's Second Treatise of Civil Government, he observes that in order for people to enjoy their private property they must be secure in that property. Thomas Jefferson paraphrases Locke in the Declaration of Independence when he states: “we are endowed by our Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.” What Jefferson refers to as happiness, Locke refers to as property. Although Locke and Jefferson were not referring to banks but governments, banks do serve an important function in a free society by providing a safe place for people to store their wealth. When you know that your private property is secure, then you are better able to enjoy your freedoms.

Historians trace the development of the check to the Knights Templar and Hospitallers who used signed documents in order to transfer wealth among their order's houses.

By providing their customers with check-writing privileges, debit cards, credit cards, and access to cashier's checks, banks help to facilitate trade. With multiple means of access to stored wealth, consumers are able to make purchases more often and in more places. This allows businesses to employ more land, labor, and capital, which in turn results in a fully employed economy.

Acting as a go-between or intermediary between savers and borrowers is probably the most important function of banks. Banks induce people to save their money by offering to pay interest. These savings are then lent to borrowers at an interest rate higher than that paid to savers, allowing the bank to profit. The saver benefits because he earns interest on a safe and relatively liquid financial investment without having to evaluate whether a potential borrower is a good risk. The borrower benefits by having access to a large pool of funds. This is important to the economy because borrowers can now purchase durable goods or invest in capital or housing, which creates jobs and leads to economic growth.

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