What do banks and financial markets do for the economy?
The role of money in the wider economy, the functions of commercial banks and the central bank, the importance of financial markets, and how the financial sector supports households and firms.
A focused answer for AQA GCSE Economics on the role of money in the economy, the functions of commercial banks and the central bank, financial markets, and how the financial sector supports households and firms.
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What this dot point is asking
AQA wants you to explain the role of money in the wider economy, the functions of commercial banks and the central bank, the importance of financial markets, and how the financial sector supports households and firms. The big idea is that the financial sector moves money from those who have it (savers) to those who can use it (borrowers and investors).
The role of money in the economy
Money lets people save, borrow, invest and spend, smoothing income over time so that people do not have to spend exactly what they earn each week. A working financial system channels savings into productive investment, which raises the economy's capacity and supports long-run growth. Without it, savings would sit idle and firms would struggle to fund expansion.
Commercial banks
Their main functions are to:
- Accept deposits and keep money safe, paying interest to savers.
- Lend money to households and firms (mortgages, loans, overdrafts), which funds spending and investment.
- Provide a payments system (cards, transfers, direct debits) that lets the economy trade smoothly.
By lending out most of the deposits they receive, banks help create credit, which expands the money available for spending and investment.
The central bank
The central bank is the bank for the banks: it does not deal with the public directly, but its decisions on interest rates affect every household and firm through the cost of borrowing and the return on saving.
Financial markets
Financial markets bring together those who want to lend or invest and those who want to borrow or raise capital:
- Money markets for short-term borrowing and lending.
- Capital markets where firms raise long-term finance by issuing shares (a stake in the company) and bonds (loans that pay interest).
- Foreign exchange markets where currencies are traded, setting exchange rates.
How the sector supports households and firms
- Households can save and earn interest, borrow for big purchases such as a home, and insure against risk.
- Firms can borrow or raise capital to invest in new equipment, manage their cash flow, and obtain currency to trade abroad.
A healthy financial sector therefore underpins consumption, investment and growth; a financial crisis (as in 2008) shows how damaging it is when the sector fails.
Worked example
Try this
Q1. Name the central bank of the UK. [1 mark]
- Cue. The Bank of England.
Q2. Explain how commercial banks help the economy to grow. [3 marks]
- Cue. By lending savers' deposits to firms, they fund investment that raises output and creates jobs.
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20196 marksExplain two functions of commercial banks in the economy.Show worked answer →
Commercial banks act as financial intermediaries between savers and borrowers. One function is to accept deposits and keep money safe, while paying interest to savers, which encourages saving.
A second function is to lend money to households and firms, for example mortgages and business loans, which funds spending and investment and helps the economy grow.
Other functions include running the payments system (cards and transfers). A 6 mark answer names two functions and explains why each matters to the wider economy. Markers reward the link from lending to investment and growth.
AQA 20214 marksOutline the role of the central bank as lender of last resort.Show worked answer →
The central bank (the Bank of England in the UK) acts as lender of last resort, meaning it will lend money to commercial banks that are temporarily short of funds but otherwise sound.
This prevents a single bank's cash shortage from triggering a wider panic, where savers rush to withdraw money (a bank run) and the whole financial system seizes up. By guaranteeing emergency funds, the central bank maintains confidence and financial stability. Markers reward a clear definition of the role and a link to preventing bank runs and protecting the financial system.
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Sources & how we know this
- AQA GCSE Economics (8136) specification — AQA (2017)