ROLE OF BANKS Banks play very important roles as financial intermediaries in trade and commerce.

They bring the savers and the lenders together, i.e. funds are transferred from the savers to those who wish to borrow or invest the funds. To encourage the savers to deposit funds with them, the banks pay them a certain rate of interest on their deposits. On the other hand, the bank charges those who wish to make use of these funds at a higher rate of interest. This charge is to cover the cost of the funds (interest paid to the savers), administrative and operational expenses and to earn some profits for the shareholders. MAIN FUNCTIONS OF BANKS With the expansion of trade and commerce, banks began to play more important roles to facilitate trade and commerce. Their functions are as follows: (a) To provide safe keeping for cash deposited in the current, savings and fixed deposit accounts (b) To provide a convenient and safe means of making payments through the current account or by way of bank drafts, bank transfers and bills of exchange (c) To provide finance by way of loan, overdraft, or discounting bills of exchange (d) To provide finance in foreign trade by way of documentary credit or discounting foreign bills of exchange (e) To give advice on financial investment or on the credit standing of the customers SERVICES OF COMMERCIAL BANKS 1. Accepting deposits 2. Providing a convenient means of making payments 3. Lending to customers 4. Other services

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Commerce – Students’ Guide Department of Business and Computing

1. ACCEPTING DEPOSITS Savings Account These are known as time deposits or deposit accounts. Seven days notice of withdrawal is required. Interest is paid on these accounts. There are no bank charges for operating such an account. It is suitable for investors with small savings.

Fixed Deposit: Large amounts of money can be deposited for a fixed period. Higher rates of interest are paid on this account. There are no bank charges for this account. A certificate of deposit is given to the accountholder. Money deposited can be withdrawn only when the specified date expires. Current / cheque accounts Money can be deposited and withdrawn at any time. Overdrafts, standing orders, direct debits and credit transfers are allowed on these accounts. No interest is paid on these accounts. There are bank charges for operating such accounts. It is suitable for businessmen, who need to deposit and withdraw money at any time. DIFFEERENCE BETWEEN SAVING ACCOUNT, FIXED DEPOSIT ACCOUNT AND CURRENT ACCOUNT Saving account Fixed deposit account Current account 1. It can be opened with 1. It can only be opened 1. It can only be opened with a minimum deposit of with a minimum of $500 a $1. is required to (or $1000 in some banks). open required to open account. 2. No recommendation 2. No recommendation is 2. account. 3. Account holder is 3. Account holder is given 3. Account holder is given a given a passbook for all a fixed deposit certificate cheque book for making
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certain

minimum

sum is

($500 in some banks). Recommendation required to open account.

Banking

deposits withdrawals account. 4. Money

into from can

and which can be presented withdrawals by cheques. the for be 4. payment Amount upon of the expiry date. deposit 4. Cash and cheques can be and remains fixed and can only deposited any times and

deposited withdrawn

anytime be withdrawn when the withdrawals without notice

although withdrawal at specified period expires can be made by means of a branch or ATM is unless the depositor is cheques. limited amount. 5. It earns to a certain willing to forgo the interest. 5. It earns a higher rate of 5. It does not earn interest lower interest since the bank is (unless the amount

interest than the fixed certain as to the duration deposited is very large) as deposit account. of the funds at its disposal. the deposit is subject to It can make use of the withdrawal on demand. money for investments and for loans. 6. Account holder need not 6. Account holder has to pay 6. Account holder need pay for operating the bank charges for bank charges for operating the account when the deposit falls below a certain minimum amount. 7. It is useful to the 7. 7. It is suitable for the businessman to save small sums of be money. set aside His who to It is useful to the has businessman who needs a earn of facilitating his receipts not pay bank charges operating the account. account.

individual who wishes excess funds which can convenient and safe method interest. deposit and payments. He can make services standing like order,

account enables him to use of the other current build up sufficient reserves account to finance his business overdraft, when the need arises. transfer.

direct debiting and credit

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Commerce – Students’ Guide Department of Business and Computing

Paying in slip It is a form used for paying money into bank account Bank statement A regular intervals, or on request, the bank will send to a customer a bank statement which provides a record of all that has taken place. Amount which reduce the balance in the account are shown in the payments column, and the amounts which increase the balance in the accounts are shown in the receipts column. As each payment or receipt is recorded a new figure is shown as a new balance figure in a third column. 2. PROVIDING A CONVENIENT MEANS OF MAKING PAYMENTS The cheque system A cheque is an order to a bank to pay a stated sum to the bearer of the cheque or a named person. Contents of a Cheque:

Date: The date is written on the top right hand corner of the cheque. A cheque has to be presented to the bank within six months of the mentioned date on the cheque. If not the cheque will be a stale cheque and it will be dishonoured.

The Drawee: This is the bank on which the cheque is drawn. This is printed on the cheque and helps when queries arise. The Branch Code Number: This appears on the top right hand corner and at the bottom of the cheque. The Payee’s Name: This is written on the top line of the cheque. Amount: The amount should be written in words and in figures. The amounts should be the same. If not the cheque will be dishonoured. The Drawer’s Name: This is printed or written at the bottom of the cheque. The Drawer’s Signature: The drawer’s signature should appear below the drawer’s name. If the signature is not the same as the specimen signature given to the bank, the cheque will be dishonoured.

• •

• •

The Cheque Number: This appears at the bottom left hand corner of the cheque. The Account Number: The cheque number also appears at the bottom of the cheque. This helps in the automatic handling of cheques.
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Banking

Types of Cheque: Open Cheque Anyone who finds an open cheque can cash it. So it is not safe to send an open cheque. This cheque is sent to persons who do not have bank accounts. Money for this type of cheque can be received over the counter. Bearer Cheque This has bearer written on the cheque. This cheque has the same features of an open cheque. Crossed Cheque When two parallel lines are drawn across the face of a cheque, it becomes a crossed cheque. Such a cheque has to be deposited in the bank account and sent for clearing. Money is not paid over the counter in the case of a crossed cheque. There are different types of crossings:
-

General Crossing: These cheques can be paid into any bank. General crossed cheques with “A/c Payee Only” written within the two parallel lines have to be paid into the account of the payee only.

-

Special Crossing: These cheques must be paid into the bank written between the two parallel lines. Not Negotiable Crossing: The payee cannot negotiate such cheques to another person.

-

Dishonoured Cheques A cheque may be dishonoured for the following reasons: • • • • • There may not be sufficient funds in the drawer’s account to make the payment. The cheque may be a stale cheque. That is it is presented to the bank six months after the mentioned date on the cheque. The drawer’s signature may not be the same as the specimen signature. The amount written in words and figures may not be the same. The cheque is mutilated or defaced.

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Commerce – Students’ Guide Department of Business and Computing

Credit transfers 1 A current account holder can instruct his bank to pay directly into the bank account of the payee. The bank will debit his account and credit the account of the payee. 2. Credit transfer system can be used to make single or multiple payments. Single credit transfers are frequently used by debtors to pay bills. 3. This facility is useful to the businessman who has to make a large number of payments at one time to those with bank accounts. Credit transfers can be used to pay salaries, rents, hire purchase instalments, etc. In the payment of salaries, for example, the employer has only to make out one cheque for the total amount together with a list of the employees' names and account numbers and the amount of salary to be credited. 4. This method of payment is advantageous because it is: (a) Convenient - both to payer and payee as the former is spared the trouble of writing and posting several cheques, and the latter need not go to the bank to cash the cheque. (b) Economical - the payer pays the stamp duty for only one cheque and he also saves on postage. (c) Safe - there is no risk of cheques getting lost or being dishonoured. Standing order or banker’s orders: 1 These are orders to a banker to pay regularly a fixed sum of money from one's current account in order to settle recurring payments like mortgage repayments, hire purchase transactions, rents, insurance premiums, subscriptions to clubs, etc. Advantages 1. Regular commitments are met punctually 2. Debtors need not remember due dates for payments. 3. Creditors need not send reminders to debtors to pay up their debts. Disadvantages 1. The current account holder using the facility is informed of the payment made by the bank on his behalf only when he receives the monthly bank statement, so it is possible that he may inadvertently overdraw his account if he has only a small balance in it.
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2. It is restricted to only payments of a specific amount and where payments are of an irregular sum or have increased in amounts, new instructions have to be made to the bank. To overcome this problem, direct debiting facilities are provided to the customer. Direct debit: 1. The bank may provide direct debiting facilities for payments of varying amounts at irregular intervals. (a) Under this arrangement, when the supplier sends an invoice to the buyer a direct debit form is also sent to the buyer's bank informing the latter to debit the buyer's bank informing the latter to debit the buyer's account and to transfer the money to his account. Such payments have to be authorized by the buyer. (b) This saves the buyer the trouble of remembering due dates of payment and sending off cheques. (c) The supplier or creditor gets prompt settlement of debts. (d) This differs from standing orders in that it is the creditor who gives payment instructions and not the debtor. The amount and date of payment are not fixed as in the case of standing orders. Remittance 1. Remittances are used to send money from one place to another without the actual physical movement of cash. Examples of bank remittances include bankers' cheques, bank drafts, mail transfers and telegraphic transfers: (a) A bankers' cheque or cashier's order is a bank's cheque drawn upon itself. It can be used for payments of any amount within the same town. It is highly acceptable since the drawer of the cheque is a bank. (b) A bank draft is an unconditional order in writing drawn by one bank on another requesting the drawee bank to pay a third party on demand a specified sum of money. (c) A mail transfer is a written instructions given by a remitting bank to its branch or agent bank to pay a certain sum of money to a third party Such a remittance is sent by mail. The remitter has to pay the commission and postal charges. (d) A telegraphic transfer is an instruction that is cabled or telexed to a branch or agent bank by the remitting bank to pay a certain sum of money to a third party. The remitter will be charged commission and cable or telex cost. 2. All local remittances are payable in local currency while foreign remittances are 7

Commerce – Students’ Guide Department of Business and Computing

payable in foreign currencies drawn on an overseas bank. For the latter, the remitter has to pay the equivalent amount in local currency 3. To the remitter, bank remittances are safe, cheap and convenient to use. To remitting bank, remittance service provides income from commission, foreign exchange and the short-term use of interest-free funds. Documentary credits (letter of credit) Documentary credit is a letter of undertaking issued by importer’s bank (hereafter called the issuing bank) to pay an overseas exporter against the exporter’s shipping documents such as the bill of lading, certificate of insurance, invoice, etc. which must adhere strictly to the terms and conditions of letter of credit. The exporter can receive payment for the amount due the instant he deposits the shipping documents with the agent bank (or advising bank) which is in his country. Bank draft  It is a cheque drawn by one bank on another bank, demanding that the latter pay a specified sum to the payee named on the draft.  The advantages of using the bank draft to remit money are the same as those of a cashier's order.  It can be used to remit money to other towns in the same country or even abroad. Debit cards This is an example of the Electronic Funds Transfer at the Point Of Sale (EFTPOS). Payments are made electronically from personal accounts to retailers’ accounts. Connect and Switch is examples of debit cards. For this system: • • • There should be electronic equipment installed at the retail outlet. There should be cards with Personal Identification Numbers issued to bank’s customers. There should be a system for transmitting messages from the retailer’s terminal to the bank’s terminal. The customer’s card is inserted in the retailer’s terminal and if there is sufficient money in the customer’s account, the right amount will be transferred from the customer’s account to the retailer’s account.
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Credit cards: This enables the customer to obtain instant credit and also cash advances. The bank charges interest from the day cash is withdrawn or from the day goods are bought on credit. The advantage to the retailer is the increase in sales. The best- known credit cards in UK are Barclaycard, Access and Trust card. The bank gives the credit card to the customers, who can then get credit from retailers. The retailers prepare three copies of the bill. One is sent to the bank, one is given to the customer and one is kept by the retailer. The bank pays the retailer immediately on receiving the copy of the bill. At the end of the month the bank sends the statement to the customer who has to pay the money within 25 days on receiving the statement. Interest is charged on the amount of goods purchased.

Electronic Fund Transfers EFT offers several services that consumers may find practical:

Automated Teller Machines or 24-hour Tellers are electronic terminals that let you bank almost any time. To withdraw cash, make deposits, or transfer funds between accounts, you generally insert an ATM card and enter your PIN. Some financial institutions and ATM owners charge a fee, particularly to consumers who don't have accounts with them or on transactions at remote locations.

Pay-by-Phone Systems let you call your financial institution with instructions to pay certain bills or to transfer funds between accounts. You must have an agreement with the institution to make such transfers.

Personal Computer Banking lets you handle many banking transactions via your personal computer. For instance, you may use your computer to view your account balance, request transfers between accounts, and pay bills electronically.

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Commerce – Students’ Guide Department of Business and Computing •

Point-of-Sale Transfers let you pay for purchases with a debit card, which also may be your ATM card. The process is similar to using a credit card, with some important exceptions. While the process is fast and easy, a debit card purchase transfers money - fairly quickly - from your bank account to the store's account. So it's important that you have funds in your account to cover your purchase. This means you need to keep accurate records of the dates and amounts of your debit card purchases and ATM withdrawals in addition to any checks you write. Your liability for unauthorized use, and your rights for error resolution, may differ with a debit card.

3. LENDING TO CUSTOMERS 1. Commercial banks lend money to their customers in the following ways: (a) By extending a direct loan in which the borrower's bank account is credited with the amount of the loan and interest is paid on the full loan. (b) By giving overdraft facilities to their customers who are able to withdraw more than the amount deposited in their current accounts after making prior arrangements with the bank. Interest is charged on the amount overdrawn. (c) By discounting bills for their customers. Bills are documents bearing the promise of either the government (i.e. Treasury bills) or well-known banking houses or persons of good credit standing (i.e. bills of exchange) to pay a stated sum of money at a stipulated date. 2. Banks purchase these bills from their customers at a discount on their face value. The discount is interest earned by the banks for holding the bills until maturity. The bank pays the holder of the discounted bill the amount stated less the interest on the sum for the number of days still to run before the due date. 3. Discounting bills is a kind of credit facility offered by the bank to its customers because the bank advances payment to a customer who has allowed his debtor a certain period of credit, and collects the debt from the debtor (i.e. the customer's debtor) when it falls due. 4. The commercial bank is able to carry out its lending activities for the following reasons: (a) It knows from experience that only a small portion of its customers' deposits is withdrawn as cash at any one time; so it keeps a sufficient amount of cash to meet such withdrawals. (b) It can use the rest of the deposits in the bank profitably by either investing or
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lending them to customers. In fact, the commercial bank can lend out many times more than the cash deposited with it through multiple credit creation, subject to the limits imposed by the Central Bank with regard to the ratio of cash to total deposits. (c) It pays interest to its depositors to encourage them to keep their money in the bank. The interest rate charged on loans and overdrafts will be higher so that the difference earned is used to pay for operating expenses and any residue becomes the bank's profits. 5. The differences between overdrafts and loans are summarized in the following table: Bank overdraft 1. Customer must have current account. He is allowed to overdraft his account up to a certain amount for an agreed period. The amount of debit balance outstanding is the amount of the overdraft taken. 2. Less formalities are observed as borrower need not fill in forms whenever he wants credit. Being already a customer of the bank, the borrower need not have reference as to if he amount of overdraft required is small. 3. Interest is charged on the actual amount and the number of the days the account is $2,000 for 100 days and the interest rate is 10% per annum then the interest charged = 10/100 × $2000 × 100/365 = $54.79 Total amount payable at the end of 100 days =$2000 + 54.79 = $2054.79 Bank loan 1. Borrowers need not have a current. If he has a current account, then his account is credited with the agreed amount of the loan for an agreed period of time, while a special loan account is debited with the same amount. 2. The borrower has to go through the formal procedure of applying for loan. If he is not a customer of the bank, he needs references. The bank must be position, security on the loan and the purpose of the loan. 3. Interest is charged on the whole amount borrowed for the full period of is fully used or not. For example, for a loan of $2,000 for a year at 8% per annum, interest charged for the year = 8/100 × $2000 =$160 Total amount payable at the year =$ 2,000 + $160 4. Any money paid into the customer’s account reduces the overdraft, e.g. a =$2,160 4. Money paid into the borrower’s account doesn’t reduce his debts. 11

his financial standing. Security is unnecessary satisfied with the borrower’s financial

overdrawn, e.g. if the account is overdrawn by the loan irrespective of whether the loan

Commerce – Students’ Guide Department of Business and Computing

customer overdraws his account by $2000 on 1 January and pays into his account $1,000 on 30 June and another $1000 on 31 December. No other withdrawals or payments are made into his account during the year. The rate of interest on the overdraft is 11% per annum. Interest payable = Amount standing to his debts × rate of interest × Period the outstanding amount is overdrawn Interest payable up to 30 June =$2000 × 11/100 × ½ =$110 Interest payable up to 31 December = $ 1,000 × 11/100 × ½ =$ 55 Total amount of interest payable for the year =$110 + $55 = $165. Interest payable for overdraft is $165 while the interest payable on the bank loan for the same amount and the same period is $150. This is because the rate of interest charged on a bank overdraft is higher than for a bank loan. (In practice, interest on overdraft is calculated on a monthly basis, hence increasing the total debit balance by the amount of the added interest payable. So in actual fact the customer will have to pay a large interest than that calculated above.)

However, when the loan is repaid periodically under standing orders, interest is payable on the reduced amounts standing to the debit of the loan account. For example, a borrower takes a bank loan of $2000 on 1 January at an interest rate of 10% per annum. The loan is to be repaid in two half-yearly installments. Amount payable per period = Installment + interest payable where (i) Installment = Loan/ No. of installments (ii) Interest payable = Interest rate per annum × installment period × Amount outstanding (Amount outstanding = Loan – Installment paid to date) 30 June : 1st installment Amount payable = $ 1000 + [10/100 × ½ × $2000] =$1000 + $100 =$1100 31 December : 2nd installment Amount payable = $1000 + [ 10/100 × ½ × $1000] = $1000 + $50 = $1050 Total amount paid by the end of the year =$ 1100 + $1050 = $2150 ( If repayment is not made periodically, total amount payable at the end of the

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Banking

year = $2000 + [10/100 × $2000] = $2000 + $200 = $2200 The borrower saves $50 ($2200 - $2150) 5. As the banker doesn’t know when and how much of the agreed amount he would be called upon to provide for the customer, he charges a higher rate of interest because of this element of uncertainty. 6. An overdraft is suitable for the customer who is unsure to how much, when and for how long he needs credit, e.g. loans for business purpose like the purchase of goods for sale. 6. This is suitable for the borrower who is sure that he will require the loan for a certain time, e.g. loans for personal purposes like the purchase of household equipment and cars, or for business purpose like the purchase of fixed assets. if he pays by installments. 5. Since the banker is certain as to the amount of the loan demanded, he charges a lower rate of interest.

TRENDS IN BANKING Automated Teller Machine (ATM) service Banks that have computerized their systems of operation are providing ATM services to their savings and current account holders. This facility enables the customer to perform banking transactions anytime in the day at ATMs installed outside the bank and at key locations. Some of the banking transactions include withdrawals up to a certain amount each day, transfer of funds between accounts, deposit of cash or cheques, bank balance enquiry, request for cheque books and statements of accounts. Some banks in Singapore have even extended the ATM service to include payments of purchases and bills at participating shops or organizations where special machines are installed. The ATM cards can be used at these machines to authorize payment (e.g. NETS service at major shopping complexes.) Telebanking As an extension of ATM services, some banks have introduced telebanking services to their customers. Customers can pay bills or make loan repayments to 13

Commerce – Students’ Guide Department of Business and Computing

pre-authorized corporations, check bank balances, order cheque books, request statements of accounts through the use of their telephones. Telebanking operates 24 hours a day anywhere via the push-button telephone linked with the bank's computer centre. With the widespread use of such services, together with ATM and credit card facility, a cashless and chequeless society is emerging. Internet Banking Internet banking enables the account holder to instantly search his statements; sign up to receive free mobile text alerts; pay bills and transfer money between accounts. Banking online is the convenient way to:
• • • •

Check the account balances and transactions, cut down on paperwork by stopping the postal statements, pay bills like credit cards and utility bills, transfer money between your accounts or into someone else's bank account,

Set up, change or cancel standing orders and view or cancel Direct Debits.

Night Safe facility A special wallet provided by the bank is inserted in to safe in the outside of the wall of the bank to which customers are given the key. The following day the wallet is opened by the customer or bank Clark and customer account is credited accordingly

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Prepared By: Emmanuel George

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