Economic stability, whether at the national or international level, has far-reaching effects in the banking industry. Economic stability and the health of the banking industry are closely related; declines in economic stability have negative implications for the banking business. Whenever economic crises such as recession or a lowered value of currency plague economies, the banking industry is affected regarding profitability, public confidence, business model and federal regulatory interventions.
First, economic instability affects the profitability levels of the banking industry. Low-profit levels rise as the direct effect of a reduction in the number of consumers of banking services capable of soliciting banking services (Ivashina & Scharfstein, 2010). For instance, the value of currency in economies suffering from high inflation rates reduces. The implication, according to Lu and Whidbee (2013), is that consumers are more reluctant to approach banks for loans. The consumer is less willing to pay interest on low-value currency since doing otherwise would mean achieving less than they would with a loan obtained at a stable economic period when the currency has more purchasing power. Eventually, banks whose business model rest on the issuance of loans lose revenue.
Secondly, economic slowdowns have the long-term effect of reducing customers’ trust in banks. When the economy suffers, the profitability of banks also lowers due to surging operational costs and customers are less likely to seek banking services such as credit facilities. In such dire operational environments, banks are at a risk of closing business (Ivashina & Scharfstein, 2010). As was the case with the great depression in the United States, some banks opted to close business. The overall effect in such scenarios is a reduction in the money supply. As is with high-interest rates, the effect is a reduction in the purchasing power of consumers. Hence, consumers face more challenges in their acquisition of goods and services that were previously affordable. Unable to access loans to improve their financial situations from banks closing due to losses, the reputation of the closed banks suffers…..