Course: Banking

Lector: Dr. Jafar.F.Jafarov

Lecture date: 2022

Chapter 1. Fundamentals of organization and operation of the banking

system

Chapter Outline

 Introduction
 Historical background of emergence of the banks
 Key definitions (concepts) about bank
 Banking system and its legal framework
 Banks' classification functions and role in the economy
 Permissible and prohibited activities of banks
 Bank secrecy

References

1.The Law of the Republic of Azerbaijan on Banks

2. Civil Code of the Republic of Azerbaijan
3. Shelagh Heffernan, Modern banking. Cass Business School, City University,
John Wiley & Sons, Ltd. London. 2015
4. Z.F.Məmmədov, Bank işi. Dərslik. Bakı. 2016
5. www.cbar.az

Introduction

Nowadays, the banking sector acts as the backbone of modern business.

The banking sector is a major segment of the U.S, Japan, Canada, Germany,
Turkey, even Azerbaijan economy, as well as world economies. The modern
banking system is one of the most important sectors of the national economy
of any developed country. A banking system is a group or network of
institutions that provide financial services for us. These institutions are
responsible for operating a payment system, providing loans, taking deposits,

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and helping with investments. Development of any country depends mainly
upon the banking system.
Study of problems of development and improvement of banks' activity
has been always relevant under the market conditions. From the literature
review, it is clear that banking created during the period of slavery, when the
state was formed, has gradually transferred from East and Greece-Rome to
Europe, later on, survived to the present day. Bank concept comes from Italian
word “Banco” means table. The first classical banks were emerged in England
for providing loans to industry-trade commerce in XVII centuries. We can
consider the evolution of credit system is based on capitalism in Western
Europe.
At the same time, the banking system and entrepreneurship have
become a special area of capital investment, the number of banks has
increased and the range of operations they perform has expanded. From this
period banks have began to issue loans and banknotes.
A bank is a financial institution which deals with deposits. It receives
money from those who want save in the form of deposits and it lends it to
those who need it.
To understand better let’s identify the key concepts that are used in
banking sphere.
Bank—legal entity, that attracts deposits and other returnable funds from
individuals and legal entities, issues loans on its behalf and from its own funds,
as well as makes transfers and cash settlements in aggregate at a client’s
request.

Bank Holding Company — company, that has one or more subsidiary banks
with a banking license, the activities of which are regulated and supervised by
the bank regulatory authorities of the country where the headquarters is
domiciled.

Subsidiary Bank— bank, more than fifty percent of voting shares in the charter
capital of which is owned by the founder bank or the bank holding company, or
such a bank, in which, in accordance with agreement, by and between itself
and the founder bank or the bank holding company, the founder bank or the
bank holding company are authorized to influence significantly the decision
making process.

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Bank branch — separate unit of the bank, which is not a legal entity, located
outside the bank location, for the liabilities of which the bank itself is
responsible, enabled to implement all or partial banking operations scope
allowed to the bank.

Bank department — separate unit, which is not the legal entity, located
outside the bank, for the liabilities of which the bank itself is responsible,
which attracts deposits and/or conduct transfers, and cash settlements in the
territory of the Republic.

Bank representative office — separate unit of the bank, which is not the legal
entity, located outside the bank, not entitled to be engaged in banking
activities, that solely represents and protects its interests.

Non-bank credit institution — legal entity that has the status of a non-bank
credit institution under the law.

Bank license — special permit issued in accordance with the procedures

herein, that provides exclusive rights to attract deposits or other returnable
funds from individuals or legal entities, issue loans on its behalf and at its own
expenses, as well as make transfers and cash settlements at a client’s request.

Bank loan — monetary funds, issued as a debt for fixed amount with or
without securitization, subject to repayment of interest (commissioning fees)
at a predetermined time (with the right of prolongation of the term) in
accordance with the signed contract. The term “loan” also includes another
right, related to requirement of repayment of any undertaken liability on
repayment of funds, guarantee, warranty, purchase of debt securities at
discount or through interest repayment and repayment of funds issued in any
form or under the terms and conditions herein.

Deposit — funds, deposited or transferred to current, savings (deposit) or

other account on bank's balance, stipulating the repayment of or transfer to
another account at the requirement of a client (depositor) with or without
payment of interest or commissioning fees under terms and conditions of an
appropriate contract.

Features of a bank

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 1. Dealing in Money - The Bank is a financial institution which deals with
people’s money.
2. Acceptance of Deposits - A Bank accepts money in the form of
deposits repayable on demand.
3. Giving advances - A bank lends out money in the form of loans to
those who need it for different purposes.
4. Payment and Withdrawal - A Bank provides easy payment and
withdrawal facility to its customers in the form of cheques.
5. Profit and Service orientation - A bank is a profit seeking institution
which is service oriented.
6. An Intermediary role - A Bank acts as an intermediary between
borrowers and lenders. It collects money from those who have a money-
surplus and gives it to those who are in need of money.

Banking system
Bank system has its specific features. System is a Greek word and means are
elements that interact with each other. Bank system includes the following
types.
- administrative centralized banking system
- market economy banking system
Administrative system is a single-tier system and the state is the sole
owner of the banks. Banks are created by the government, government
determines it’s organizational and management structures, and, if necessary,
abolishes it.
Market economy banking system is based on double-tier system and there
are various property rights (state, shareholder, and cooperative, mixed) on
banks. There is no monopoly on banks’ creation, any legal entity and physical
persons can create banks within the law.

Specific peculiarities of banking system

 banking system is a set of elements that serve the same purpose;
 banking system elements may vary depending on economic conditions;
 banking system is a dynamic system;
 Banking system is a managerial system

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According to the bank legislation of Azerbaijan, there is double-tier banking
system in Azerbaijan.
I – Central Bank – single-tier, it is a state property
II- Commercial banks – double-tier
In Azerbaijan, all the banks and non-bank credit institutions can implement
their activities on basis of bank license. The bank is established by at least
three legal entities or individuals in the form of an open joint stock company.
Political parties, public unions, funds, and other non-commercial organizations
cannot be shareholders of the bank. The bank may issue only registered
shares. Each bank is surrounded by General Meeting of Shareholders,
Supervisory board, Audit Committee, and Board of Directors.

Bank classification

Banks are classified as follows: investment banks, universal banks and

specialized banks.
Investment banks - banks specializing in corporate segment services and
financing based on investment principles.
Universal banks - are financial institutions that provide all types of banking
services to their customers. Somehow they are called whole sale banks.
Specialized banks - These are financial institutions that specialize in lending
to a specific area.
By the decision of Board of the Central Bank of AR, dated July 25, 2021, the
total capital of operating banks, as well as the charter capital of newly
established banks was increased by at least 50 million manat.

Permissible activities of banks

After getting the license banks can implement the following activities:
- attraction of demand and time deposits and other repayable funds;
- Issuing the loans (including consumer and mortgage loans);
- opening and maintaining accounts of individuals and legal entities,
including correspondent accounts of banks;

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 - release of means of payment (including credit and debit cards, bank
transfer bills);
- attraction and placement of precious metals in deposits;
- providing the services of a financial advisor, financial agent or
consultant;
- Encashment of banknotes and coins.

Prohibited activities of banks

No bank may engage in wholesale or retail trade, production, transport,
agriculture, mining, construction and insurance activities, or participate as a
partner, associate or shareholder, except for insurance companies.

Bank secrecy
In accordance with the Civil Code of the Republic of Azerbaijan, the
bank shall ensure confidentiality of bank accounts, operations and
residues on the account, as well as client information, including name,
address and management. Banks shall maintain confidentiality of data on
existence of client property in the bank's depository, data on owners of
such property, its type and value.