The Roles Played by Banks

Due to the important role played by banks as financial intermediaries, banks have emerged as unique institutions enjoying the trust of people. As a financial institution, banks perform the following functions:

• Financial Intermediary
• Constituent of the payment system
• Provider of other financial services

Principles of Banking

In order to retain the trust of people, banks have to adhere to certain principles while conducting their business. These principles are listed below:

• Liquidity: The main source of income for banks is the spread that they earn on loans. Banks have to necessarily lend most of their deposits to stay in business. At the same time, they should always be in a position to meet the monetary demands of their customers. A single default on part of the bank can lead to serious consequences. Thus, banks need to maintain sufficient cash reserves at all times. The more the banks lend, the profit they make, but they also need to balance the opposing needs of profits and liquidity. Banks cannot afford to compromise on the liquidity in order to make profits.

• Safety: The trust of the people depends to a great extent on the perception of how prudent a bank is in its business practices. Suppose a bank is imprudent to lend to risky businesses, then such a bank will not enjoy the trust the trust of its customers. Just as liquidity and profitability are related, risk and profitability also are inversely related. Banks need to find a fine balance between the two in order to survive in business. After all, banking essentially is the handling and/or management of risks. The more prudent the bank is in managing risks, the better will it be in terms of its image and prospects of survival and growth.

• Profitability: In case of a bank that does not have enough liquidity or incase it is unsafe, then customers are likely to avoid such a bank. But moreover this trust will depend on the profitability of the bank. If the bank is unprofitable, then the trust of customers is likely to dwindle more. If a bank incurs losses or makes only meager profits year after year, then the customers will think twice before dealing with such a bank unless of course they are enjoying some other benefits. In India, people have a general belief that the public sector banks will not fail because the government as their owners will come to their rescue. These people have a different attitude towards the private sector banks. Banks need to be significantly profitable in order to retain the trust of people and to be able to survive in the long run.

• Secrecy: During the course of their business and dealings with customers, banks get to know many details about the finances of their customers. Banks need to maintain confidentiality of such kind of information because revealing of such information to the wrong persons can lead to adversely affecting the customer. For instance, a competitor of the customer or a journalist can make use of this financial information to cause loss or may be eve damage the reputation of the customer. Banks, in a way, owe a duty to their customers to ensure absolute secrecy of customer information. A bank has to take this duty very seriously in order to enjoy the trust of customers.

• Service Quality: Banking is essentially a transaction oriented business. Customers have to deal with banks for most of their financial transactions. As the intensity of the interactions is very high, customers would naturally prefer to deal with those banks that make the transactions or interactions pleasant and fast. Poor quality service in terms of errors and delays can lead to seriously eroding the confidence of customers. This is because such errors and delays in financial dealings can result in a financial loss apart from causing bitterness. Banks that do not oblige to provide quality service cannot hope to enjoy the trust and patronage of its customers.

Around the world, banking is highly regulated to ensure the health of individual banks and of the banking system as a whole. Banking regulations are aimed at encouraging banks to adhere to the principles of liquidity, safety, profitability, and secrecy and service quality in their day-to-day dealings. Such regulations are for the good of bank and the economy. Hence compliant with regulatory and statutory requirements is sacrosanct.