How the Financial Sector Impacts the Economy

How the Financial Sector Impacts the Economy

Office buildings with famous bank logos


Customers (individuals/families, companies) can ‘deposit’ their money with the bank. In this way, in a sense, they lend their money to the bank. In exchange, they receive interest from the bank. There are different types of deposits, such as sight deposits, savings deposits, term deposits, and certificates of deposit.

The banks then convert these deposits into loans to finance the needs of individuals and households, businesses, and the government.

Anyone who borrows money from the bank pays interest. This is because the bank provides him with a service, namely the provision of a certain amount for a certain period of time. Even companies like Advanceloan are legitimate providers of loans for interest.

This activity of the banks makes optimal use of all funds because supply and demand are matched, and the economy becomes more efficient. But it is of course exceptional that deposits and loans correspond perfectly with each other. In other words.dat the deposits are converted before becoming loans.


  • By scaling: small deposits are grouped together to be able to offer ‘large’ loans. Taken separately, the money of the thousands of savers in our country would have no economic use. By pooling these savings, the bank can convert them into credit and finance others who need money.
  • By term conversion: long- or medium-term loans are financed by short-term deposits.
  • Currency conversion: in some cases, deposits denominated in one currency are converted into credits in another currency.

For the bank, there are certain costs associated with the conversion of deposits into loans. First and foremost, there is the cost of the work tools. This includes personnel, IT systems, or the distribution network.


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In addition, costs are also incurred due to the risks that the transformation system entails. There are three categories of risks:

  • The credit risk: for example, the borrower goes bankrupt and can no longer pay off his credit. The bank may no longer be able to recover the full loan amount.
  • Liquidity risk: savers can, according to the characteristics of the deposits they hold, withdraw their money at a given time. At that time, the bank must ensure that it can repay its creditors.
  • The interest rate risk: a bank has a certain interest margin that it must try to keep positive. That margin is the difference between the income from the interest from loans and the cost of interest on deposits. Those who take out a credit can choose to take out a fixed credit and therefore pay off the same sum during the entire term of the credit. But if the interest rate on deposits rises, the banks cannot pass on those costs to their borrowers. In this way, the bank’s interest margin can become negative.

A bank can choose to take the risks for its own account. For example, it will ensure that it has sufficient equity or that its liquidity margin (that is, the extent to which it can meet its short-term payment obligations) is sufficiently high.

In addition, the bank can also choose to hedge for those risks. One of the possibilities is a swap operation such as an interest rate swap. In addition, the fixed interest rate is converted into a variable interest rate through various transactions and thus the interest rate risk is eliminated. But of course, there is a cost associated with this hedging of the risks.