Imagine that you live in a world without any banks. Further imagine that you have saved a substantial sum of money that you don’t plan on spending anytime soon. What can you do with those funds?
One answer is that you could simply store the money—
Alternatively, you could lend the money out, say, to a growing business. This would have the great advantage of putting your money to work, both for you, since the loan would pay interest, and for the economy, since your funds would help pay for investment spending. There would, however, be a potential disadvantage: if you needed the money before the loan was paid off, you might not be able to recover it.
It’s true that we asked you to assume that you had no plans for spending the money soon. But it’s often impossible to predict when you will want or need to make cash outlays; for example, your car could break down or you could be offered an exciting opportunity to study abroad. Now, a loan is an asset, and there are ways to convert assets into cash. For example, you can try to sell the loan to someone else. But this can be difficult, especially if you need cash on short notice. So, in a world without banks, it’s better to have some cash on hand when an unexpected financial need arises.
In other words, without banks, savers face a trade-