Modern banking in the early 1990s offers a far wide range of services to the customers. Deposits are the funds that customers leave in their accounts. Advances are money lent by a bank, generally in the form of an overdraft. Money transmission enables customers to make payments without having to carry around large sums of cash.
Modern banking in the early 1990s offers a far wide range of services to the customers. Deposits are the funds that customers leave in their accounts. Advances are money lent by a bank, generally in the form of an overdraft. Money transmission enables customers to make payments without having to carry around large sums of cash.
Modern banking in the early 1990s offers a far wide range of services to the customers. Deposits are the funds that customers leave in their accounts. Advances are money lent by a bank, generally in the form of an overdraft. Money transmission enables customers to make payments without having to carry around large sums of cash.
Every bank performs three banking functions: It accepts and safeguards deposits of money from customers It permits money to be withdrawn or transferred from one account to another It lends the surplus of deposited money to suitable customers who wish to borrow. 30
While these are the most basic functions, modern banking in the early 1990s offers a far wide range of services to the customers. In fact a large retail bank often offers some 300 different services to its personal and business customers.
These services can be grouped under the following headings: -Deposits and savings; -Advances; -Money transmission; -Financial and advisory services; -Foreign services. Deposits are the funds that customers leave in their accounts, whether these are current accounts, which are for current money that is not intended to be saved, or deposit or savings accounts, which are for money that will not be required immediately. Customers with a current account are usually issued with a checkbook, which enables them to draw or write out checks that instruct the bank to pay cash from the account or to make payments to other people. Deposit and savings account holders do not have the
30 David Cox, Success in elements of banking, 1990 Banks and their role in the economy benefits of a checkbook; instead they are paid interest on money left with the bank. Advances are money lent by a bank, generally in the form of an overdraft on a current account, by which the customer draws out more money than he has put into the account. They may also be made by means of a loan or personal loan. Interest is charged on all advances, the rate varying with the method of granting of granting the advance, the creditworthiness of the customer and the length of time for which the funds are borrowed. Advances represent that part of customers deposits, which the bank considers may safely be lent, while the remainder is retained in the form of cash and other assets. Money transmission enables customers to make payments without having to carry around large sums of cash, because the check is a convenient method of settling a debt. Equally a customer can pay in money at any bank branch for the credit of an account at another branch by completing a simple form known as bank giro credit. He may also instruct his bank to debit or deduct amounts from his account to make regular payments to meet recurring debts, such as club subscription, life assurance premiums or mortgage repayments, by means of the standing order or direct debit systems. Besides enabling customers and, to some extent, non-customers to transfer funds quickly and easily by means of a piece of paper or electronically, the bank physically move many notes and coins from branch to branch every day. Financial and advisory services cover a wide range of facilities that can be tailored to suit the individual needs of the customer. One example might be a business service such as factoring, in which the bank administers a clients sales ledger and enables a company to obtain an advance against debts, which are due to it. The banks are always willing to give advice, from suggesting suitable investments to a customer with a few hundred dollars, to advising a private limited company of the best time to go public, that is to have its shares quoted on a stock exchange. Foreign services of the banks include travelers check and currency services; they also made international payments. All large bank links with overseas banking groups, so payments of this kind can easily be made.
A sound banking system depends partly on the control exercised by the central bank and, to a large extent, on trust: that is, the customers trust that his deposits will be looked after in the best possible way and that when he wishes to withdraw his money, the funds will be available. The banks have a major responsibility to behave like good citizens in business: while profitability remains a major consideration, this must sometimes be set aside in favor of an informed and ethical judgement that takes account of the interests of others. Whenever banks lend money, they must remember that the source of their funds is customers deposits, and it is so important that they should lend where there is a minimal risk of non-payment. They have often been criticized for not lending money more freely, but a high risk of loss will frequently deter them from granting an advance even if the highest rates of interest could be charged.
The economic importance of banks The banks are important economically because they act as financial intermediaries between the large number of depositors and those who wish to borrow: in this way the encourage savings by providing the means the means of attracting and collecting funds through the various types of accounts they offer and their extensive branch network, while at the same time they put such funds to effective use. The provisions of finance to businesses encourages enterprises and leads to the provision of extra jobs, increased production and less reliance on the import of foreign goods. Lending to personal customers, on the other hand, stimulates demand for goods, which again helps to increase production. The banks are able to create money by granting loan or overdraft facilities to a customer to buy goods, since paying for these goods effectively produces new money as soon as the borrowers check is paid into the sellers bank account. Thus, by allowing in advance, a bank deposit has been created; this process is known as the credit-creation multiplier. Whenever overdraft or loan facilities are granted by a bank, the customer will have a reason for wishing to borrow-to buy a new car, perhaps-and will draw a check on his or her account to pay for it. The check will be paid into another bank account (that of the garage selling the car) thus creating a new deposit and, when it has passed through the clearing system, will take up the facilities granted by the bank. Therefore by granting a loan or an overdraft, a new deposit has been created somewhere in the banking system and the money stock increased.
The banks generally lend 65 per cent or more of their total deposits, the remainder being held in the form of easily realizable assets so that the banks will always have sufficient resources to enable them to repay their depositors. Every loan creates a new deposit, and the proportion of every new deposit may be re-lent to create still further deposits. The process can continue until the total of the new deposits created is several times the amount of the original advance.
An example will show just how this process works. Bank A grants its customer, M, an overdraft of $500 to pay some new furniture. M writes out a check an hands it to the seller of the furniture, N, who pays it into his account with bank B. The banks keeps 35% of the deposit as reserves and re-lends the other 65%, $325, to customer O to pay for its holiday. O gives the check for this amount to the travel agent P, who pays it into his account with bank C. This bank lends 65% of the deposit, $211, to customer Q, who issues a check for this amount, which creates another deposit within the banking system, and so the process goes on (as in the figure).
Original overdraft granted for$500 Check drawn and deposit created...$500 Overdraft granted: 65% of $500.$325 Overdraft granted: 65% of $325.$211 Overdraft granted: 65% of $211.$137 Overdraft granted: 65% of $137...$89 Overdraft granted: 65% of $89.....$58 Overdraft granted: 65% of $58.....$38 Overdraft granted: 65% of $38.....$25 Overdraft granted: 65% of $25.....$16 Overdraft granted: 65% of $16.....$10 Overdraft granted: 65% of $10.......$7
Figure 1. The credit-creation process
The amount by which the banks create further bank deposits, and thus increase the money stock, is measured by the credit-creation multiplier. From figure 1, it can be calculated that original advance of $500 has created deposits totaling $1 416. In this example is, therefore, a multiplier effect of:
Total amount of new deposits created/amount of original advance =$ 1416/$500=2.8 times
The multiplier is easy to calculate if you know the percentage of deposits retained as reserves and not re- lent. In the example, 35% was retained as reserves. Divide the percentage (35 per cent) into 1(100 per cent) and the answer, approximately 2.8 times, is the multiplier effect. If banks kept only 10 per cent of deposits as reserves, then the multiplier effect would be 10 times (100 divided by 10), so that our original deposit of $500 could create up to $5000 of new deposits. If reserves were 50 per cent, than the multiplier effect would be 2 times (100 divided by 50), so the original deposit of $500 could create up to $1000 of new deposits. It is important to appreciate that the banks ability to create money can be expanded or restricted by altering the reserve percentages that that maintain.
As we have seen, one of the main limitations to credit creation is the amount of reserves that banks maintain. A further limitation is that of leakages in the flow of money out of the banking system. For example, the public may wish to hold more cash, thus lowering the level of bank deposits; certain transactions between the Government and the public have the effect of transferring funds from bank accounts of members to the Governments bank account at the central bank.
Of course, a bank manager does not have to wait for deposits to be paid in before loan or overdraft facilities can be granted; but the bank, as a whole must consider its total deposits when formulating its lending policy. However, the rate at which banks are able to create deposits depends, to some extent, on the rate at which banks are able to increase their lending. The volume of bank lending is determined by the banks themselves, by the demand for advances in the economy and by the competition from other lenders.
5.2. Types of banks
The merchant banks Merchant banks carry a great variety of businesses, and each tends to specialize in certain activities or transactions with particular countries. Some activities, however, are basic to all of them. These are acceptance of deposits, underwriting, and management of clients funds. The tern merchant banking comes from the early years when merchants in London were willing to finance international trade by allowing overseas merchants to draw bills of exchange on them. Merchant banks in England prefer to be called acceptance houses; indeed, this was made clear by Sir Edward Reid, a past chairman of the Accepting Houses Committee. An Acceptance House is a firm or company, an important part of whose business is accepting Bills of Exchange to provide short-term finance for the trade of others.
Girobank In England, the giro banks were established because of the need to modernize the remittance services of the post offices (postal and money orders) and the substantial increase in recent years of the sort of transactions for which a giro system is particularly appropriate: the payment of rates and bills by installments, hire purchase, mail order remittance, and payments for the renting of consumer durable. Personal customers are offered a wide range of financial services including full current account checkbook banking and particularly convenient money transfer service between girobank accounts. The payer sends a completed transfer form, which has a message space on the reverse, to the bank. On receipt the payers account is debited and the transfer form is forwarded, with a credit slip, to the payee. Many household bills-gas, electricity, telephone etc. incorporate a Girobank transfer form as part of the bill, with relevant information such as customer reference and amount pre-encoded. Girobank customers simply complete the form and send it to Girobank. Non-account holders can pay these bills over the counter at post office. Regular payments can be made by standing order or direct debit either to another Girobank account or from Girobank to an account with any other bank. Retail banks Retail banks have extensive branch networks and offer a wide range of services to their many thousands of personal and business customers through their large branch networks. By participating in the clearing system they enable the payments mechanism to operate by exchanging cheques and credits between other banks. It should be noted that other banks, particularly some of the American banks, are rapidly developing a retail banking service to rival that of the more traditional High Street banks.
Consortium banks As the name suggests, a consortium bank is formed by a group of other banks, usually from several different countries. The Bank of England defines it as a bank which is owned by other banks but in which no one bank has a direct shareholding of more than 50 percent and in which at least one shareholder is an overseas bank. The first consortium bank to be formed in England was Midland and International Banks in 1964. These banks are formed in order to be able to put together large loan packages to meet the financial requirements of large multinational companies for long periods of time. They are also able to arrange syndicated loans: this means sharing out large loans among syndicates of banks. The bank that is organizing the loan, called the lead bank, contact up to fifty other banks inviting them to participate.
The building societies The building societies in England are the banks largest competitor in the area of deposit taking. The main role of them is to take in funds from customers, and to lend money to other customers for house purchase. Building societies therefore act as financial intermediaries between savers and borrowers. Over the time, the societies have expanded their activities, providing a wide range of financial services and becoming more and more like the banks. The building society basic service rage consists of: savings facilities, borrowing for house purchase and other financial services. Historically, the first two activities have played a major role in the development of societies. Building societies are mutual institutions. They operate to serve the mutual interests of their members, and any surpluses are used for the members benefit. The society is owned by its members. These members are the people who put their money in a share account. These shareholders are then paid a dividend (interest) on their holding (savings). Credit unions Credit unions are more popular on the continent and America then in the UK. The first credit unions grew up in Germany and Italy in the 1850s and 1860s.America took up the idea in the first half of the 20 th century. The unions were set up as cooperative societies to offer loans to members out of the pool of savings built up by the members. Members of a credit union usually have a common interest or bond e.g. work, location, and church. In the UK the first credit union was established in 1964 and 1979 the Credit Union Act was passed to stimulate expansion in the number of societies by providing them with own legal framework. The main aims of credit unions are to encourage savings and provide members with a source of cheap credit mainly for low- income groups and establish good budgeting and stimulate a spirit of self- help and community involvement.
Study-case: Romanian Savings Bank Romanian Savings Bank (Casa de Economii si Consemnatiuni) is the oldest bank established in Romania. On November 24, 1864 Prince Alexandru Ioan Cuza approved the Law for the establishment of the Deposits and Consignations Bank (Casa de Depunere si Consemnatiuni), making thus the first successful attempt to create the Romanian Banking System. Until1880, when the Central Bank was established, the Deposits and Consignations Bank also played the role of issuing bank. In 1880, the Savings (Casa de Economii) was established as an appendix to the Deposits and Consignations Bank. Since 1864, the bank performed a wide range of transactions specific to an universal bank. In 1947, through the merger of this two banks patrimonies, Casa de Economii, Cecuri si Consemnatiuni was established, and in 1949, following a new reorganization, the name of the institution became Romanian savings Bank (Casa de Economii si Consemnatiuni) as it is today. The object of activity was restricted though, mainly to attracting household savings and financing the state budget. In 1996 Romanian Savings Bank was reorganized based on law no. 66, becoming a joint- stock commercial bank with the state as unique shareholder, represented by the Ministry of Finance. According to this law, Romanian Savings Bank offers a wide range of services and products, such as: attracting, keeping and investing the individual and legal persons availabilities in ROL and performing collections, payments and settlement transactions in customers account; providing loans to the population for houses purchases, building, modernizing, receiving amounts for consignment; providing loans to small and medium enterprises, to Public Administration Authorities, performing money market and T-Bills operations, transactions on financial and banking market.
Summary
Definition of the bank: 1. Financial intermediary 2. Risk administrator: - interest rate risk - exchange risk - maturity risk/ delivery risk/ credit risk - liquidity risk - country risk (political, economical) - transfer risk/ payment risk 3. Institution of public interest
The basic functions of any bank - Accepts and safeguards deposits of money from customers - Allows money to be withdrawn or transferred from one account to another - Lends the surplus of deposited money to suitable customers who wish borrow
Banking services I Retail banking activities: 1. Financing: mortgage loans; loans for consumer goods; short, medium and long terms. 2. Payments: check, card and giro account. 3. Advisory services 4. Other services: safeguard and deposits. II. Corporate banking activities 1. Financing: advances and overdraft, long and medium loans, leasing, forfeiting, factoring, banking guarantees, export financing. 2. Payments: check, draft, B/E, card, giro account. 3. International transaction: services for exporter, payment method, documents in international trade, services for importer. 4. Investment services 5. Advisory services. 6. Other services: safeguard and deposit cash management.
I nternational transactions 1. Services for exporter: - trade inquiries - credit information - economical and political reports - trade regulations - exchange control regulation - forward foreign exchange 2. Payments methods: - advance payment (AP) - letter of credit (L/C) - documentary collections - open account (OA) 3. Documents in international trade: - invoice - transport documents - insurance documents - certificates 4. Services for importers
Types of banks I. a) The so-called commercial banks: - Retail banks - Wholesale/corporate banks b) Savings banks c) Mortgage banks d) Consumer-credit banks
II. A) Universal Banks B) Specialized banks
Check out questions
1. What are the basic functions of any bank?
2. Write three banking instruments or facilities used by the exporters.
3. Write three types of instruments or banking facilities offered to the legal persons and not to the natural persons.
4. Explain briefly how the banks act as a risk administrator.
5. How does a sound banking system contribute to the prosperity of a country?
6. What is meant by deposit banking and in what ways does it contribute to the expansion of trade and industry?
7. What are the main services provided by the banks?
8. Give two reasons why is preferable to borrow from a financial intermediary rather than from an acquaintance.
9. Summarize the main services provided by the retail banks.
Choose the correct answer(s) 10. In a particular economy banks are required to keep 20 per cent of all deposits in the form of reserves; this gives a credit-creation multiplier of: a. five b. one-sixth c. six d. one- fifth.
11. The banks provide a range of services grouped under the following headings: a. deposits and savings, advances, money transmission, advisory services and international ones. b. only deposits c. deposits, credits and payments d. advisory services in some cases.
12. The basic function of a bank is to a. issue cheque books b. accept deposits c. respond to status enquiry.
13. A consortium is: a. a decision on monetary policy b. a group of financial institutions c. a savings scheme for small savers.
References
1. F.E.Perry, The elements of banking, sixth edition, Routledge & The Chartered Institute of Bankers London, 1989.
2. Don Wright & Wally Valentine, Business of banking and financial services, third edition, Northcote House, 1992.
3. Graham Bannock, R.E. Baxter and Evan Davis, Dictionary of Economics, fifth edition, Penguin books, 1992.