Answer to Question #284633 in Macroeconomics for Ayesha

Question

Discuss the evolution of banks and the functions of the financial system.

Answer 1

The purpose of banking institutions is to provide loans to the general public. Banks allowed members of the general public to expand their credit limits and make larger purchases as economies grew. Temples, which were occupied by priests and were a haven for the wealthy, were historically regarded the oldest forms of banks. The earliest Roman laws allowed for the seizure of land as a substitute for debtors' and creditors' loan payments. During the 18th century, Adam Smith, a well-known economist, proposed that a self-regulating economy, known as "the invisible hand," would allow markets to attain equilibrium. The panic of 1907 was triggered by the failure of two brokerage firms, resulting in a recession with limited liquidity. The Federal Reserve Bank was established as a result of this. Banking was removed from temples and established within separate buildings by the Romans, who were great architects and administrators. Moneylenders profited throughout this time, just as loan sharks do today, but most legitimate commerce—and nearly all government spending—involved the use of an institutional bank. The strengths of banking institutions were eventually recognized by the numerous rulers who reigned throughout Europe.

The royal authorities began to take loans to make up for bad times at the royal treasury, frequently on the king's terms, because banks functioned by the grace, and occasionally express charters and contracts, of the governing monarchy. Because of the easy access to funds, kings indulged in wasteful extravagances, costly wars, and weapons contests with neighboring kingdoms, which often resulted in crushing debt. When Adam Smith proposed the "invisible hand" theory in 1776, banking was already well-established in the British Empire. Moneylenders and bankers were able to limit the government's involvement in the banking industry and the economy as a whole, thanks to his beliefs on a self-regulated economy. Because the national banking system was intermittent, huge merchant banks took up much of the economic responsibilities that would have been handled by the national banking system, in addition to regular banking activities such as loans and corporate financing. These commercial banks used their international ties to gain political and financial dominance throughout this instability, which lasted into the 1920s. During the late 1800s, J.P. Morgan & Co. rose to the forefront of merchant banks. It had direct access to London, the world's financial capital at the time, and wielded significant political weight in the United States.

A financial system is a system that facilitates the exchange of money or capital among financial market participants such as investors, lenders, and borrowers. Credit, money, and any other kind of finance are used as trade mediums in the financial system. Financial systems are set up at many levels of a corporation, both locally and globally. The financial system is vital in moving resources through institutions like banks, which accept deposits, lend money, and borrow money. Risk management is aided by financial systems. Through organizations like insurance companies, the financial system provides for the pooling of resources and the sharing of risk. By providing criteria for clearing and settling payments, financial systems monitor and govern the entry and exit of products, assets, and services. Financial systems have a significant impact on pricing activities and decision-making in the trading of any economic resource. Interest rates, for example, are determined by the financial system in order to impact the trading of a financial asset.