Macroeconomics 1st Edition by Dean Karlan,Jonathan Morduch

Exercise 20

After graduating, you take an unusual job: consulting with the queen of a small, newly populated island in the middle of the sea. You've provided advice to her on matters related to government and the economy, and while she has taken your advice most of the time, she has so far turned down your suggestion to have a banking system. She claims that banks will make the economy more complicated and do little to make the lives of her subjects easier.
Over the past several months, though, the queen has discussed with you several issues that have arisen in the newly formed economy. For each of the three quotes from the queen below, refer to one of the three functions of banks discussed in this chapter to explain how a banking system could help with the issue described.
a. "When my subjects have money left over after spending, they want to keep it somewhere safe and earn some interest on it. But that's hard for most of them because they have no way of finding out who wants to borrow and whether it would be a good idea to lend to them."
b. "My subjects are lucky that we have very little crime, so they can safely keep their extra money inside their houses and take only what cash they need for a day's spending. However, many of them have complained that if an emergency occurs when they're all the way on the other side of the island, they can't access their funds."
c. "Some of my subjects who are in the know about good borrowers have been making loans and earning interest. But lately there have been a couple of borrowers who defaulted on loans, and when they did, the lenders were totally out of luck. All that money just disappeared! And those bad experiences have made other potential lenders afraid, so that now borrowing and lending have dried up almost completely. If only there were some easy way for them to divide their savings among several different borrowers, they might feel safe enough to start lending again!"