Banks play a key role in the economies of the world

Published November 6th, 2000 - 02:00 GMT

Money is used to purchase commodities, resource services such as labor, all types of goods and services, as well as, investments. Therefore, money and the monetary policy have a significant impact on the operation of the economy while the banking system and the activities of the Central Bank influence the money supply.  

 

Banking plays an important role by bringing together people who want to save for the future with those who want to borrow in order to undertake investment projects. Banks create money by way of the lending function, and thereby expand the money supply by way of what is referred to as the deposit expansion multiplier.  

 

Under a fractional reserve banking system, banks are required to maintain a fraction of their deposits in the form of reserves (vault cash or deposits with the Central Bank). The excess reserves may be invested or loaned to customers. As banks extend additional loans, they create additional deposits and, thereby, expand the money supply. The investment loans of the banking industry play an important role in the allocation of resources and the banks unique capacity to create money is vital to the smooth development and growth of the economy.  

 

Another important function of the banking system is its function as the mechanism by which the policies of the Central Bank regarding money and credit creation are implemented, and the pace of economic activity is determined. The Central Bank has the responsibility to carry out monetary policy by regulating the money supply and providing a monetary climate that is in the best interest of the economy. The Central Bank also has the responsibility of the health of the banking industry, supervising its procedures and enforcing the banking regulation.  

 

An efficient banking system is a prerequisite for the proper functioning of financial markets. It is through banks that the final transactions of operators in the financial market take place. Accordingly, the level of development of the banking sector is an essential determinant of the efficiency function of financial markets. In Jordan, there are too many small banks holding poorly diversified asset portfolios. Therefore, the banking sector remains underdeveloped and in some cases uncompetitive and inefficient. The range of services provided are often narrow and transaction take a long time to be completed.  

 

On the other hand, in countries with fewer banks, large and small, banks in these countries finance a more diverse portfolio of loans. Thus, they are not vulnerable to changing conditions in geographic regions and local markets. In these countries, mega banks and smaller banks each play a vital though different role in the local economy. There is a definite need for large national and regional banks, but there is also a definite need for niche banks. To remain viable, banks need to be large to compete effectively or fill a special niche.  

 

Larger financial institutions emerge through mergers and acquisitions which have proven to be a key banking development in recent years. There are many reasons for mergers and bank purchases. Below is a brief description of some of these reasons:  

 

• Efficiencies: The combined banks can be run more efficiently than either bank on its own and is expected to result in economies of scale, including cost saving from the consolidation of duplicative personal and other infrastructure at head office and branches, and the ability to improve operation performance by spreading costs over a larger customer base and eliminating surplus capacity.  

 

• Transfer of technical skills: The combined banks will have a greater depth of management and talent than any of the merging banks on its own. The transfer of knowledge at technical levels will help better manage resources more effectively by having the appropriate technical and general management in place.  

 

• Expanded capabilities: Banks with business and assets that are highly complementary, will strategically be well positioned to offer an expanded range of banking products and services that customers will require, as well as, to compete more effectively in the local and regional markets.  

 

• Increased financial flexibility: Because of increased size and economies of scale, the combined banks will have greater financial flexibility to improve the supply of long-term capital that will stimulate investment and growth in the economy.  

 

• Diversification and growth: The combined bank will provide a geographic spread of the bank's exposure across different economic regions, thus; reducing the tendency to a cyclical pattern in financial performance.  

 

• Business and technology infrastructure: Developments in information technology (IT) (i.e. information collection, storage, processing, transmission and distribution) and their impact on the banking industry require a committed substantial benefit investment in IT by banks. The combined banks will substantially benefit in this complex field by integrating their technology more effectively and efficiently.  

 

• Increased benefit for customers: The combined banks should be able to provide customers with enhanced and expanded access to a broad selection of high quality banking products and services.  

 

In conclusion, without an efficient banking system, no modern economy could prosper. The above discussion clearly indicates that a merger among banks would create an efficient banking system which facilitates transactions in the capital market. The capital market plays several key roles, including increased domestic resource mobilisation, and improved supply of long-term capital, and more efficient allocation of existing resources.  

 

More in depth analysis should be made to further evaluate the advantages and disadvantages of mergers and acquisitions in the banking sector in Jordan and its implication on the Jordanian economy and consumers. The Central Bank of Jordan and other government authorities should also consider government incentives to facilitate bank mergers and acquisitions. Moreover, the Central Bank should formulate policies to ensure compliance with competition laws so that they are in the best interest of banking customers and the general economy. ― (Jordan Times

 

By Nabil Y. Barakat  

The writer is the chairman of the Jordan Gulf Bank. 

© 2000 Mena Report (www.menareport.com)

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