Bank practice and procedures

(AcFn2113)

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 1.1. INTRODUCTION
1.1.1. World Banking History
 There are different assumptions
 as to the origin of the word “BANK”.
 One assumption is that
 it is derived from the French word ‘Banque’ or
 it is derived from the Italian word “Banco”

which means in English a bench.



 It is derived from the experience of the merchants of Greece

and Rome.
 They used to sit on a bench in the center of the market and
receive deposits from the public and pay to the public
from the deposit.
 They were referred as ‘benchers’.
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 1.1. INTRODUCTION
…Cont’d
 Mainly concerned with currency exchange,”

? Who are the ancestors of present day bankers

Ans. Merchants, Gold smiths and money lenders.

 Then they started Safe keeping of gold’s and coin at

templets and granting loans on interest.

 Bank of Venice(1157) is the first public bank(Rome &

Greek)

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 1.1. INTRODUCTION
…Cont’d

 Public Bank established in Barcelona in 1401( money

exchange, deposit receiving, discounting of bills of
exchanges for both the citizens and foreigners.

 Bank of England was established in 1694.

London goldsmiths, money lenders, merchants and
money exchangers were the most of the private
bankers.

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 1.1.2. Development of Banking in Ethiopia
The first bank in Ethiopia was bank of Egypt
( around 1896)
 It was established and owned by the National Bank of
Egypt,
 an affiliate of the Bank of England

Turned to the establishment of Bank of Abyssinia

in March 1905( Ras Mekonnen/AAU main campus.)

Bank of Abyssinia has opened

 branches at Dire Dawa, Gore and Dessie and
 agencies at Harrar and Gambella with the
construction of Franco-Ethiopia railway

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 1.1.2. Development of Banking ….
Bank of Ethiopia (29th August 1931)
During Itallian Occupation,Branches of
different Italian Banks, Barclays Bank
They withdrew in 1943 with the Britsh
troop and Banko di Indo china
established.
 August 1942 National and Commercial
Bank proclamation has issued-State
Bank of Ethiopia
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 1.1.2. Development of Banking ….
1945 Agricultural Bank established
1949 Changed to Agricultural and Commercial
Bank
1951 changed in to Development Bank of
Ethiopia.
1961 Imperial Saving and Home ownership
public association has established
1963 split of central Banking and Commercial
Banking Activities.

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 1.1.2. Development of Banking ….
Events of 1963
 Commercial bank of Ethiopia established as share
company for the objective of:
 Carrying out all banking activities,
 Attracting public deposits,
 Promoting banking habit and facilitating transactions.
 DBE for:
 Agricultural banking and commercial banking activities.
 Ethiopian Investment Corporation for:
 General investment banking business.

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 1.1.2. Development of Banking ….

 Addis Ababa Share Company first private domestic

bank established in October 1964.
 Mortgage company of Ethiopia (1965):
 the construction of commercial, industrial and residential
buildings against mortgage of immoveable properties.
 1974 all banks nationalized . Three Government
owned banks:
i. Commercial Bank of Ethiopia
ii. Agricultural and Industrial Bank and
iii. Mortgage Bank of Ethiopia,
 After Derg Regim many private banks has been established:
 BOAS.C., AIBS.C., Dashen Bank S.C.,UB S.C., Wogagen Bank S.C etc

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 Take Home Assignment # 1 (10%)
 Discuss the World Banking
History & Development of
Banking in Ethiopia.
 Deadline: October1, 2023 G.C.
 Presentation: 5% out of 10%
 Paper: 5% out of 10%

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 1.2. MEANING OF BANK
Definition
A bank is a financial intermediary that accepts
deposits and channels those deposits into lending
activities, either directly by loaning or indirectly
through capital markets.

It links customers that have capital deficits and

customers with capital surpluses.

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 1.2. MEANING OF BANK (CONT’D)
The term BANK in the modern times refers to an
institution which:
 deals with money; it accepts deposits and advance loans
 plays a significant role by facilitating international trades
 Connects international markets.
 deals with credit; it has the ability to create credit,
 is a commercial institution; it aims at earning profits,
and
 creates a demand deposits which serve as a medium of
exchange, and as a result,
 the bank manages the payment system of the country.
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  List and Discuss the classification
and functions of banking

Instruction:
 Make a group of three members
and discuss thoroughly.

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 1.3. CLASSIFICATIONS & FUNCTIONS OF
BANKING

1.3.1. CLASSIFICATIONS OF BANKING

1) BASED ON OWNERSHIP
 On the basis of ownership, banks can be
classified into three
i. Public Sector Banks:-These are owned and
controlled by the government.(CBE,DBE &
NBE)
ii. Private Sector Banks:-These are owned
and controlled by the private individuals or
corporations and not by the government or
14 co-operative societies.(BOA,NIB,etc)
 1.3. CLASSIFICATIONS & FUNCTIONS OF
BANKING

1.3.1. CLASSIFICATIONS OF BANKING

2) BASED ON DOMICILE (Residence)
On the basis of domicile the banks are divided
into two
i. Domestic Banks:-They are registered and
incorporated within a country.(e.g all Banks in
Ethiopia)
ii. Foreign Banks:- These are foreign in origin
and have their head offices in the country of
origin.(City Bank, Commercial Bank of Dubai
etc)
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 1.3. CLASSIFICATIONS & FUNCTIONS OF
BANKING
1.3.1. CLASSIFICATIONS OF BANKING
3) BASED ON THEIR FUNCTIONS
a) Commercial Banks
b) Industrial Banks (or Development Bank)
c) Agricultural Banks
d) Exchange Banks ( or Foreign Exchange Banks)
e) Savings Banks
f) Cooperative Banks
g) Central Bank/National Bank
h) Indigenous Bank
i) Consumer Banks

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 a) Commercial Banks
 They perform all kinds of banking business.
 They generally finance trade and commerce.
 They usually
 accept Short-Term Deposits and Advance
Short-Term Loans to the businesspersons and traders
and
 avoid medium- term and long term loans.

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 b) Industrial Banks ( Investment
Banks)
 They collect cash by issuing shares & debentures
and providing long-term loans to industries.

 Their main objective is to provide long-term loans

for expansion and modernization of industries.

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 c) Agricultural Banks

 Provide credit to farmers for short-term,

medium-term and long-term needs.
 Here also, an example of agricultural bank
could be Development Bank of Ethiopia.

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 d) Exchange Banks (Foreign Exchange
Banks)
 deal in foreign exchange and specialize in
Financing Foreign Trade.

 Functions of Exchange Banks :-

Remitting money from one country to another
country,
Discounting of foreign bills,
Buying and Selling Gold and Silver, and
Helping Import and Export Trade.

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 e) Savings Banks
 Promote saving habits among the general public
and mobilize their small savings.
 They are helpful for salaried people and low income
groups.
 The deposits collected from customers are invested
in bonds, securities, etc.
 At present most of the commercial banks carry the
functions of savings banks.
 Postal department also performs the functions of
saving bank.

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 f) Cooperative Banks

 Cooperative banks are those financial institutions

which are organized on the principle of
cooperatation.
 The functions of these banks are just similar to
commercial banks.
 They provide short-term and medium-term loans
to their members only

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 g) Central Banks (National Bank)

 Every country of the world has a central bank.

 They are the bankers of the other banks. i.e It is the
custodian of member bank’s reserves.
 They provide specialized functions i.e. issue of
paper currency, working as bankers of
government, supervising and controlling foreign
exchange.
 It is a non-profit making institution.
 It does not deal with the public but it deals with
other banks.
 The principal responsibility of Central Bank is
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thorough control on currency of a country.
 h) Indigenous Banks

 Indigenous banks means Money Lenders.

 They collect deposits from general public and grant
loans to the needy persons out of their own funds as
well as from deposits. These indigenous banks are
popular in villages and small towns. They perform
combined functions of trading and banking activities

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 i) Consumer Banks

 Consumers bank is a new addition to the existing type of banks.

 Usually found only in advanced countries like U.S.A. and

Germany.
 The main objective of this bank is to give loans to consumers

for purchase of the durables like Motor car, television set,

washing machine, furniture, etc.
 The consumers have to repay the loans in easy installments.

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 1.3.2. FUNCTIONS OF BANKING
 A modern bank performs a variety of

functions.
some basic functions performed by the banks
are discussed as follows:
1) Accepting Deposit
2) Advancing Loan
3) Credit Creation
4) Facilitating payment
5) Agency Service
6) General Utility Function
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 1)ACCEPTING DEPOSITS
Accepting deposits is the
primary functions of a bank.
 To attract savings from all
sorts of individuals, the banks
maintain different types of
accounts:
i. Fixed deposit account
ii. Current deposit account
iii. Saving deposit
account(Different
types)

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 i. Fixed Deposit Account
 They are money deposited for a specific period of
time.
 Interest is calculated for the whole amount for the
same period.
 If the depositor withdraws the deposit before the
expiry date, the depositor will pay penalty rate plus
ii. theCurrent Deposit
banker should Accounts
be willing to pay before the expiry
 date.
Current accounts are checking accounts or demand
deposit accounts.
 Current accounts are operated through cheques.
 Current account is owned by businesspersons and firms.
No interest income on the amount mentioned in the
28 account.
 iii. Saving Deposit Account
 Are different in type.
 are opened by individual savers and small
business owners.
 it is opened for saving purpose
 Interest is generally calculated on
monthly/weekly/daily basis on the minimum
balances that remains in the account

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 2) ADVANCING LOANS
The various types of
LOANS granted by the
bank are:
a) Term loan
b) Merchandise loan
c) Overdraft facility
d) Reshipment Export
Facility
e) Letter of credit facility
f) Letter of Guarantee

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 a) Term loan
Term Loans are loans granted for a fixed
period of time.
The time period may be short-term, intermediate
and long-term loans.
 SHORT-TERM LOAN is usually a loan granted up to
one year,
 INTERMEDIATE LOANS are from one to five years
and
 LONG TERM LOAN is a loan granted for above five
years.
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 a) Term Loan (….cont’d)
Types of term loan
i. Project loan
ii. Working capital loan
iii.Motor vehicle loan
iv.Consumer loan,
v. Mortgage loan
vi.Partial financing loan,
vii.Agricultural loan
viii.Industrial loan etc.

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 b) Merchandise loan
 A short term credit facility provided by a bank
against which the merchandise or documentary
evidence(rail way receipt, warehouse receipt or air
way bill.) is held as collateral for the loan.
 It could be revolving or one time.

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 c) Overdraft Facility

 Is a form of credit by which a customer allowed to

draw beyond the deposit of its current account for the
sol purpose of its day-to-day operation needs of viable
and ongoing business.
 It is a renewable facility ( every six month or annually)
 It may be granted either on clean basis, or against
collateral.

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 d) Pre-shipment Export Facility

 A loan granted for the purpose of raw material

processing and converting in to finished goods,
purchasing, warehousing, packaging and
transporting the goods until shipment.
It could be revolving or one time,
Must be settled with in ninety days from the
advance of the loan.

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 e) Letter of Credit Facility

It is the credit facility in which the bank extends the

business to engage in import and export activities.
It is granted on percentage of the value of the
document based on the credit worthiness of the
business,
It could be revolving(renewable annually/semi-
annually or one time).

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 There are different types of letters of credit,
which can be discussed as follows;
a) Clean letter of credit: Under this form
acceptance of bills is unconditional
b) Documentary L.C: Bills acceptance is
conditional on the receipt of the documents of title
to goods.
c) Revocable L.C: The bill can be canceled at any
time by the issuing banker
d) Irrevocable L.C: The bill can’t be canceled
before expiry of the period.

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 Class Activity
 Identify the parties involved in Letter of credit of the following
transaction:
 Ato Zeberga wants to import goods on credit from an Italian exporter
known as Maldini. Now Mr. Maldini may not be willing to sell his
goods on credit to an Ethiopian importer, Ato Zeberga, he rather
prefers the credit to be guaranteed by a known bank in Ethiopia. Here
Commercial Bank of Ethiopia, who is the banker to Ato Zeberga,
writes a letter to another banker in Italy, may be Bank of Italy, to pay
the agreed sum of money in the transaction, when the goods are
arrived to the buyer, which might be communicated as it is realized.
Then, the Italian bank will advice Mr. Maldini to deliver goods
according to the agreement with Ato Zeberga. As the arrival of the
goods is reported to Bank of Italy through Commercial Bank of
Ethiopia, Bank of Italy will pay the amount or credit Mr. Maldini’s
account, if he has an account in the same bank, or may transfer to
another bank where he has an account, if it is instructed to do so.

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 Answer
Here,
 Ato Zeberga is the customer,
 Commercial Bank of Ethiopia is the issuing
bank,
 Bank of Italy is the advisory bank and
 Mr. Madini is the seller or creditor or
beneficiary in the instrument

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 e) Letter of Guaranty

It is written promise /irrevocable obligation by the

bank to compensate(pay sum of money) to the
beneficiary(local or foreign)in the event that the
obligator fails to honor its obligation in accordance
with the terms and conditions the
guarantee/agreement/contract.

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 3.Credit creation
 It is a unique function of the bank.
 When a bank advances loan to its customer, it does not lend
cash
o but opens an account in the borrower's name and
o credits the amount of loan to this account.
 Thus, whenever a bank grants a loan, it creates an equal
amount of bank deposit.

4. Facilitating Payment
 Through a check, the depositor directs the bankers to
make payment to the payee.
 Check is the most developed credit instrument in the
41money market.
 5.Agency Service
 Banks perform certain AGENCY FUNCTIONS for and on
behalf of their customers on top of their main
functions such as:
a) COLLECTION and PAYMENT of credit instruments
like Check, Bills of Exchange, Promissory Notes, etc
b) Carrying out of Standing Orders
They pay:
o Insurance premiums
o Subscriptions on clubs & societies, and
o Similar payments of a regularly recurring nature
c) Purchasing & Sale of Securities
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 d) Collection of DIVIDENDS on shares on behalf of his
customer.
e) Income Tax Consultancy
f) Acting as Trustee and Executor. They administer
properties of their customers, as they are deceased. Banks are
assigned by either the deceased customer before his death or
may be nominated by the court.
g) Acting as representative and correspondent: They get
passports, traveler's tickets, book vehicles and plots for their
customers and receive letters on their behalf.
h) Remittance of funds
 The important methods of transferring funds from one place to
another through banks are:
i. Bank draft
ii. Telegraphic Transfers and Mail transfer
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 i. Bank Draft
 It is an order to pay money
 drawn by one branch/office of the bank
 upon another branch of the same bank
 to pay a specific sum of money
 to a person named therein or to his order.

Essential Features of a Bank Draft

A bank draft possesses the following important features.
a) It is drawn by one branch of a bank upon some other branch
of the same bank
b) It is payable on demand, not payable to the banker
c) It is equivalent to a bill of exchange
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 i. Bank Draft
 A bank draft has three parties
1) The DRAWER Branch
 the branch that receives money to be
remitted.
2) The DRAWEE Branch
 the branch that is ordered to pay the remitted
money to a person named in the draft; and
3) The PAYEE
 the party in whose favor money is transferred

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 ii. Mail/Telex Transfers
A mail transfer is an internal message sent through
ordinary postal channel advising the payee branch or bank
to pay a specifically stated amount of money to a specified
payee or to his order.
The following are the necessary
requirements.
 The name of the beneficiary
 His/her account number, if any
 The amount to be transferred, and
 The name of the branch where the account is maintained
or the beneficiary can receive.
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 6) General Utility Function
A. Traveler's Cheques
Banks to avoid the risk of loss or inconvenience in to carrying
large amount of cash while traveling issue Traveler’s cheques.
B. Safe Custody of Valuable and Securities
Banks accept valuables for safe custody purpose.
Valuables such as:
negotiable securities,
jewelers and
documents of the title to property, etc.

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 C. Foreign Exchange
 In assisting foreign trade by discounting foreign bills of
exchange and facilitating foreign currency, a bank has
sometimes arrange for the payment of costs to the transport,
insurance and warehousing of goods.
D. Collection of Statistics
 Banks collect statistics relating to industry, trade and
commerce, money and banking and publish journals and
bulletins containing research articles on economic and
financial matters.
E. Underwriting Securities
 They underwrite securities issued by the government, public
or private bodies.
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49
 Group Discussion
1) Define & discuss what is meant by a bank.
2) Identify & discuss the classification of a bank.
3) Identify the functions of a bank. Discuss.

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