Five Important Economic Factors Affecting Banks Sample Essay

Economic Factors Affecting Banks

How important is the banking industry?

Since the 17th century the banking industry has marked its niche as one of the most important financial sectors in any economy. Indeed a country’s economic prowess can progress or slow down depending on the performance of its banks. In both the Great Depression of 1929 and the economic recession of 2008, the banking sector was one of the major factors that contributed to the witnessed economic meltdowns. It is thus important to analyze what economic factors affect the banking sector.

What economic factors can affect banks?

Regardless of the country a bank is situated in, there are certain factors that influence the bank, its activities and success or failure. The following five factors have been categorized as crucial factors that may affect banks in every part of the world.

  • The income of the country and its economic level always affects the banking sector. It goes without saying that banks thrive under economic boom as compared to recession times. Income flows in a country affect banks in terms of the amount of capital they can access and clients that are ready to bank with them. Income also determines spending and borrowing limits hence is a crucial factor within the banking sector. In a country with enough income, banks which face economic hurdles can be salvaged by their respective governments.
  • Inflation Rates. When inflation is high, banks tend to suffer. This is because inflation tends to affect the value of currency and this often has a ripple effect in the banking sector. Apart from liquidity structures and processes, inflation causes instability in currencies. It also erodes client confidence especially foreign investors who can choose whether or not to use a particular country’s currency.
  • Economic policies. Macroeconomic policies can have far reaching impacts on the banking sector. If a country makes unfavorable policies, the banking sector is bound to lose while sound macroeconomic policies can make all the difference and enable a country’s banks to actually grow.
  • Exchange Rates across the world. Exchange rates across the world also affect banks all over the globe. Strong currencies such as the US Dollar, British Pound, Japanese Yen, European Euro and Canadian Dollar amongst others have a cross cutting impact on other currencies and financial markets in the world. When the exchange rates for these currencies fall the banking sectors can experience problems.
  • Laws and regulations. Every country has in place specific regulatory framework for financial institutions to either provide guidance, supervisory or monitoring roles for these institutions. These laws are important in determining major decisions such as interest rates, banking services, loan regulations and even minor aspects of banking such as opening and closing hours. A country with stringent laws and regulations for the banking sector can actually curtail business. Nevertheless a liberal regulator is also quite dangerous because some banks can easily lose focus in the bid to make higher profits. It is therefore important to maintain a logical regulatory framework that addresses the needs of both the bank and its consumers.

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