Relation B/w Loans & Economy

The banking system has an important role in the modern economy. The reason is banks act as a bridge between those who have surplus money and those who are facing money shortage for any of their needs. 

Some want to invest, and hence keep their money in the bank in forms of FDs, RDs and even in savings accounts while the others who are facing money crises come to the bank to borrow money in the form of loans. Some borrow for their business needs while others do it for their personal needs. In short to fulfil their monetary needs people borrow corporate and non-corporate loans from banks.

Hence, banks act as the biggest support for most industrialists, small businessmen and even for salaried individuals. This results in Bank loans facilitating commerce.

The market is wider and hence banks have extended retail loans to unsecured personal loans, home loans, consumer durables as well as to farmers seeking farm credits. This helps borrows to fulfil their monetary needs which further results to fulfil even their basic needs. 

Let’s understand this with an example- For a home loan buyers purchasing a house, at the beginning of their carrier would have been impossible as purchasing a house requires a huge amount which one can only afford after saving for a minimum of 20 years. But with the help of home loans, one can get their dream home just by paying a small amount as down payment and rest can be paid in instalments for a flexible tenure of 20 to 30 years. On the same hand lending personal loans has made life easier for the common masses who used to face cash crunches now and then. It not only helps them in emergencies to meet their requirements but also helps them to meet their wants. 

On the other hand, individuals whether salaried or businessmen, middle classes or Corporate institutions and even governments have their deposits kept for their operating expenses and development works. Doing this makes them earn interest on their money and get the same by keeping their money in the banks in the form of FDs, savings Rd’s and so on.

During Inflation 

Inflation generally occurs when there is growth in the supply of money in the economy. As a result, the price for goods & services increases, resulting in a higher inflation rate. 

Inflation is the condition where there is a general increase in the prices of goods and services in the economy. This results in a decrease in the purchasing power of consumers. In this condition, a lot of money is circulated chasing only goods. 

To control the situation the government increases the interest rates on loans and deposits. This further results in high-interest rates on loans. This reduces the borrowing percentage and increases the amount of savings and deposits. Doing this reduces the amount of money in circulation and hence inflation can be controlled.

During Deflation

Deflation is the state when the pricing of goods and services significantly drops. The condition is serious as this may affect the economy negatively. To control the situation, the government reduces the interest rates on loans and deposits. This limits savings and attracts people to take loans which contributes to the economy again.

Investment Debt

You must be wondering what it is about and how it contributes to the economy?

Well, an Investment debt is the one where going into debt is a kind of investment. This can be understood better through this example-  

An entrepreneur opts for a business loan to maintain the cash flow of his business, pay staff & to buy inventories. This further results in the production of goods & services from that particular business which results in an addition to the economy apart from adding to the owner’s profit. 

Consumption Debt

Consumption loans are totally different from an Investment debt as it doesn’t have the potential to grow money from debt on an individual basis but can contribute to the economy.

With a consumption loan, the utilization obligation shifts future utilization to the present, leaving less use for what’s to come.

A travel loan or a personal loan can be taken as an example of consumer debt. Here an individual takes an advance from the bank and utilizes it in the present and promises the bank to repay it in the future. Since future utilization has been utilized at present, an individual needs to make up for it by offering future efficiency. 

The above points explain well the role of loans in the economy. Banks provide facilities for different kinds of economic activities and hence play a great role to maintain the economy of a country.