The Role of Banks: lending and payments
Banks act as facilitators between those who have money and those who need money, while also providing the systems for funds to flow between payers and payees.
The primary role of banks is to take in money from those with cash in hand and to lend money to borrowers. Banks then receive loan repayments which can be used in new lending to other borrowers.
The traditional view of this process has been that banks “create” money by providing some of the money on deposit in the form of loans to borrowers, which returns to the banking system as deposits. This money can then be lent again and again, resulting in a multiplier effect. More recently, money creation has focused on how lending creates bank deposits i.e. whenever a bank provides a loan to a customer, a deposit is created.
Banks cannot lend freely without limits. They have to be able to lend profitably in a competitive market, while also managing liquidity risks (i.e. that they have sufficient liquid assets to repay depositors or investors when required) and credit risks (that some borrowers may not repay their loans). These lending activities are regulated and safeguarded by global/international standards and EU regulations.
Just as money can be created, it can also be destroyed. For example, in the case of a mortgage being used to purchase a second hand property, the purchaser could use the proceeds from the sale to pay an existing mortgage, effectively bringing the amount of money created back to zero.
Banks are also key players in national and international payment systems. Some 112 billion cashless payments were made by customers of EU credit institutions in 2015. Almost half (53 billion) of those were card payments, while about a quarter were credit transfers (29 billion) or direct debits (24 billion).
The Single European Payments Area (SEPA) aims to harmonise and integrate payment markets across Europe, with one set of euro payment instruments: credit transfers, direct debits and payment card, common standards and practices and a harmonised legal basis. SEPA covers more than 520 million people in the 28 EU Member States and six non-EU countries (Iceland, Liechtenstein, Monaco, Norway, San Marino and Switzerland).