A banker or bank
is a financial institution
whose primary activity is to act as a payment agent for customers and to borrow
and lend money. It is an institution for receiving, keeping, and lending money.
The first modern bank was founded in Italy
in Genoa in 1406 and its name was Banco di San
Giorgio (Bank of St. George).
Many other financial
activities were added over time. For example banks are important players in
financial markets and offer financial services such as investment funds. In
some countries such as Germany, banks are the primary owners of industrial
corporations while in other countries such as the United States banks are prohibited from owning
non-financial companies. In Japan,
banks are usually the nexus of cross share holding entity known as Zaibatsu. In France
"Bancassurance" is highly present, as most banks offer insurance
services (and now real estate services) to their clients.
History
Main
article: History of banking
Banks have influenced
economies and politics for centuries. Historically, the primary purpose of a
bank was to provide loans to trading companies. Banks provided funds to allow
businesses to purchase inventory, and collected those funds back with interest
when the goods were sold. For centuries, the banking industry only dealt with
businesses, not consumers. Banking services have expanded to include services
directed at individuals, and risks in these much smaller transactions are
pooled.
Origin of the word
The name bank
derives from the Italian word banco "desk/bench", used during the Renaissance
by Florentines
bankers, who used to make their transactions above a desk covered by a green
tablecloth. However, there are traces of banking activity even in ancient
times.
In fact, the word
traces its origins back to the Ancient Roman Empire, where moneylenders would
set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are
derived. As a moneychanger, the merchant at the bancu did not so much invest money as merely convert the foreign
currency into the only legal tender in Rome—that of the Imperial Mint.
Traditional banking activities
Banks act as payment
agents by conducting checking or current accounts for customers, paying cheques drawn by
customers on the bank, and collecting cheques deposited to customers' current
accounts. Banks also enable customer payments via other payment methods such as
telegraphic transfer, EFTPOS, and ATM.
Banks borrow money by
accepting funds deposited on current account, accepting term deposits and by
issuing debt securities such as banknotes and bonds.
Banks lend money by making advances to customers on current account, by making
installment loans, and by investing in marketable debt securities and other
forms of money lending.
Banks provide almost
all payment services, and a bank account is considered indispensable by most
businesses, individuals and governments. Non-banks that provide payment
services such as remittance companies are not normally considered an adequate
substitute for having a bank account.
Banks borrow most funds
from households and non-financial businesses, and lend most funds to households
and non-financial businesses, but non-bank lenders provide a significant and in
many cases adequate substitute for bank loans, and money market funds, cash
management trusts and other non-bank financial institutions in many cases
provide an adequate substitute to banks for lending savings to.
Definition
Cathay Bank in Boston's Chinatown
The definition of a
bank varies from country to country.
Under English common law, a banker is defined as a
person who carries on the business of banking, which is specified as:
- Conducting
current accounts for his customers
- Paying
cheques drawn on him, and
- Collecting
cheques for his customers.
In most English common
law jurisdictions there is a Bills of Exchange Act that codifies the law in
relation to negotiable instruments, including cheques,
and this Act contains a statutory definition of the term banker: banker
includes a body of persons, whether incorporated or not, who carry on the
business of banking' (Section 2, Interpretation). Although this definition
seems circular, it is actually functional, because it ensures that the legal
basis for bank transactions such as cheques
do not depend on how the bank is organized or regulated.
The business of banking
is in many English common law countries not defined by
statute but by common law, the definition above. In other English common law
jurisdictions there are statutory definitions of the business of banking
or banking business. When looking at these definitions it is important
to keep in mind that they are defining the business of banking for the purposes
of the legislation, and not necessarily in general. In particular, most of the
definitions are from legislation that has the purposes of entry regulating and
supervising banks rather than regulating the actual business of banking.
However, in many cases the statutory definition closely mirrors the common law
one. Examples of statutory definitions:
- "banking
business" means the business of receiving money on current or deposit
account, paying and collecting cheques drawn by or paid in by customers,
the making of advances to customers, and includes such other business as
the Authority may prescribe for the purposes of this Act; (Banking Act
(Singapore), Section 2, Interpretation).
- "banking
business" means the business of either or both of the following:
- receiving
from the general public money on current, deposit, savings or other
similar account repayable on demand or within less than [3 months] ... or
with a period of call or notice of less than that period;
- paying
or collecting cheques drawn by or paid in by customers
Since the advent of EFTPOS (Electronic Funds Transfer at Point Of Sale), direct
credit, direct debit and internet banking, the cheque has lost its primacy in
most banking systems as a payment instrument. This has lead legal theorists to
suggest that the cheque based definition should be broadened to include
financial institutions that conduct current accounts for customers and enable
customers to pay and be paid by third parties, even if they do not pay and
collect cheques.[6]
Accounting for bank accounts
Bank statements are
accounting records produced by banks under the various accounting standards of
the world. Under GAAP and IFRES there are two kinds of accounts: debit and credit.
Credit accounts are Revenue, Equity and Liabilities. Debit Accounts are Assets
and Expenses. This means you credit accounts to increase their balances and you
debit accounts to increase their balances.
This also means you
debit your savings account every time you deposit money into it (and the
account is normally in deficit) and you credit your credit card account every
time you spend money from it (and the account is normally in credit).
However, if you read
your bank statement, it will say the opposite- that you have credited your
account when you deposit money and you debit when you withdraw it. If you have
cash in your account you have a positive or credit balance and if you are
overdrawn it will say you have a negative or a deficit balance.
The reason for this is
because the bank, and not you, has produced the bank statement. Your savings
might be your assets, but it is the bank's liability, so your
savings account is a liability account which is a credit account and should
have a positive credit balance. Your loans are your liabilities but the bank's
assets so they are debit accounts which should have a negative balance.
Below where bank
transactions, balances, credits and debits are discussed, they are done so from
the viewpoint of the account holder which is traditionally what most people are
used to seeing.
Wider commercial role
However the commercial
role of banks is wider than banking, and includes:
- Issue
of banknotes
(promissory notes issued by a banker and
payable to bearer on demand)
- Processing
of payments by way of telegraphic transfer, EFTPOS, internet banking or other means
- Issuing
bank drafts
and bank cheques
- Accepting
money on term deposit
- Lending
money by way of overdraft, installment loan or otherwise
- providing
documentary and standby letters of credit (trade finance),
guarantees, performance bonds, securities underwriting
commitments and other forms of off balance sheet exposures
- Safekeeping
of documents and other items in safe deposit boxes
- Currency
exchange
Economic functions
The economic functions
of banks include:
- Issue
of money, in the form of banknotes and current accounts subject to cheque
or payment at the customer's order. These claims on banks can act as money
because they are negotiable and/or repayable on demand, and hence valued
at par and effectively transferable by mere delivery in the case of banknotes, or by drawing a cheque, delivering
it to the payee to bank or cash.
- Netting
and settlement of payments -- banks act both as collection agent and
paying agents for customers, and participate in inter-bank clearing and
settlement systems to collect, present, be presented with, and pay payment
instruments. This enables banks to economize on reserves held for
settlement of payments, since inward and outward payments offset each
other. It also enables payment flows between geographical areas to offset,
reducing the cost of settling payments between geographical areas.
- Credit
intermediation -- banks borrow and lend back-to-back on their own account
as middle men
- Credit
quality improvement -- banks lend money to ordinary commercial and
personal borrowers (ordinary credit quality), but are high quality
borrowers. The improvement comes from diversification of the bank's assets
and the bank's own capital which provides a
buffer to absorb losses without defaulting on its own obligations.
However, since banknotes and deposits are generally unsecured, if the bank
gets into difficulty and pledges assets as security to try to get the
funding it needs to continue to operate, this puts the note holders and
depositors in an economically subordinated position.
- Maturity
transformation -- banks borrow more on demand debt and short
term debt, but provide more long term loans. In other words; banks borrow
short and lend long. Bank can do this because they can aggregate issues
(e.g. accepting deposits and issuing banknotes) and redemptions (e.g.
withdrawals and redemptions of banknotes), maintain reserves of cash,
invest in marketable securities that can be readily converted to cash if
needed, and raise replacement funding as needed from various sources (e.g.
wholesale cash markets and securities markets) because they have a high
and more well known credit quality than most other borrowers.
Law of banking
Banking law is based on
a contractual analysis of the relationship between the bank and the customer.
The definition of bank is given above, and the definition of customer is any
person for whom the bank agrees to conduct an account.
The law implies rights
and obligations into this relationship as follows:
- The bank
account balance is the financial position between the bank and the
customer, when the account is in credit, the bank owes the balance to the
customer, when the account is overdrawn, the
customer owes the balance to the bank.
- The
bank engages to pay the customer's cheques up to the amount standing to
the credit of the customer's account, plus any agreed overdraft limit.
- The
bank may not pay from the customer's account without a mandate from the
customer, e.g. a cheque drawn by the customer.
- The
bank engages to promptly collect the cheques deposited to the customer's
account as the customer's agent, and to credit the proceeds to the
customer's account.
- The
bank has a right to combine the customer's accounts, since each account is
just an aspect of the same credit relationship.
- The
bank has a lien on cheques deposited to the customer's account, to the
extent that the customer is indebted to the bank.
- The
bank must not disclose the details of the transactions going through the
customer's account unless the customer consents, there is a public duty to
disclose, the bank's interests require it, or under compulsion of law.
- The
bank must not close a customer's account without reasonable notice to the
customer, because cheques are outstanding in the ordinary course of
business for several days.
These implied
contractual terms may be modified by express agreement between the customer and
the bank. The statutes and regulations in force in the jurisdiction may also
modify the above terms and/or create new rights, obligations or limitations
relevant to the bank-customer relationship.
Entry regulation
Main article: Banking regulation
Currently in most
jurisdictions commercial banks are regulated by government entities and require
a special bank license to operate.
Usually the definition
of the business of banking for the purposes of regulation is extended to
include acceptance of deposits, even if they are not repayable to the customer's
order, however money lending, by itself, is generally not included in the
definition.
Unlike most other
regulated industries, the regulator is typically also a participant in the
market, i.e. government owned bank (a central bank). Central banks also typically
have a monopoly on the business of issuing banknotes.
However, in some countries this is not the case, e.g. in the UK the Financial Services Authority licenses
banks and some commercial banks, such as the Bank of Scotland,
issue their own banknotes in competition with the Bank of England,
the UK government's central bank.
Some types of entity may
be partly or wholly exempt from bank license requirements and are regulated by
separate regulators, e.g. building societies
and credit unions.
The requirements for
the issue of a bank license vary between jurisdictions but typically include:
- Minimum
capital
- Minimum
capital ratio
- 'Fit
and Proper' requirements for the bank's controllers, owners, directors,
and/or senior officers
- Approval
of the bank's business plan as being sufficiently prudent and plausible.
Banking channels
Banks offer many
different channels to access their banking and other services:
- A branch, banking centre or financial centre
is a retail location where a bank or financial institution offers a wide
array of face-to-face service to its customers.
- ATM is a computerized
telecommunications device that provides a financial institution's
customers a method of financial transactions in a public space without the
need for a human clerk or bank teller. Most banks now have more ATMs than
branches, and ATMs are providing a wider range of services to a wider
range of users. For example in
- Mail
is part of the postal system which itself is a system wherein written
documents typically enclosed in envelopes, and also small packages
containing other matter, are delivered to destinations around the world.
This can be used to deposit cheques and to send orders to the bank to pay
money to third parties. Banks also normally use mail to deliver periodic
account statements to customers.
- Telephone banking is a service provided by
a financial institution which allows its customers to perform transactions
over the telephone. This normally includes bill payments for bills from
major Creditors (e.g. for electricity).
- Online
banking is a term used for performing transactions, payments
etc. over the Internet through a bank, credit union or building society's
secure website.
Types of banks
Banks' activities can
be divided into retail banking, dealing directly with
individuals and small businesses; business banking,
providing services to mid-market business; corporate banking, directed at large
business entities; private banking,
providing wealth management services to high net worth individuals and families;
and investment banking, relating to activities on
the financial markets. Most banks are
profit-making, private enterprises. However, some are owned by government, or
are non-profits.
Central banks are normally government owned banks, often charged with
quasi-regulatory responsibilities, e.g. supervising commercial banks, or
controlling the cash interest rate. They generally provide liquidity to the banking
system and act as the lender of last resort in event of a crisis.
Types of retail banks
- Commercial
bank: the term used for a normal bank to distinguish it from an
investment bank. After the Great Depression, the U.S. Congress
required that banks only engage in banking activities, whereas investment
banks were limited to capital market
activities. Since the two no longer have to be under separate ownership,
some use the term "commercial bank" to refer to a bank or a
division of a bank that mostly deals with deposits and loans from
corporations or large businesses.
- Community Banks:
locally operated financial institutions that empower employees to make
local decisions to serve their customers and the partners
- Community development banks:
regulated banks that provide financial services and credit to under-served
markets or populations.
- Postal savings banks: savings banks
associated with national postal systems.
- Private banks manage the assets of high net worth
individuals.
- Offshore
banks: banks located in jurisdictions with low taxation and
regulation. Many offshore banks are essentially private banks.
- Savings bank:
in
- Building societies and Land-banks:
conduct retail banking.
- Ethical banks:
banks that prioritize the transparency of all operations and make only
what they consider to be socially-responsible investments.
- Islamic banks:
Banks that transact according to Islamic principles.
Types of investment banks
- Investment
banks "underwrite" (guarantee the sale of) stock and bond
issues, trade for their own accounts, make markets, and advise
corporations on capital markets
activities such as mergers and acquisitions.
- Merchant
banks were traditionally banks which engaged in trade finance.
The modern definition, however, refers to banks which provide capital to
firms in the form of shares rather than loans. Unlike venture capital firms, they tend not
to invest in new companies.
Both combined
- Universal
banks, more commonly known as financial services companies, engage in
several of these activities. For example, First Bank
(a very large bank) is involved in commercial and retail lending, and its
subsidiaries in tax-havens offer offshore banking services to customers in
other countries. Other large financial institutions are similarly
diversified and engage in multiple activities. In Europe and
Other types of banks
Islamic banking
- Islamic banks
adhere to the concepts of Islamic law. Islamic banking revolves around several well
established concepts which are based on Islamic canons. Since the concept
of interest is forbidden in Islam, all banking activities must avoid
interest. Instead of interest, the bank earns profit (mark-up) and fees on
financing facilities that it extends to the customers.
Banks in the economy
Size of global banking industry
Worldwide assets of the
largest 1,000 banks grew 16.3% in 2006/2007 to reach a record $74.2 trillion.
This follows a 5.4% increase in the previous year. EU banks held the largest
share, 53%, up from 43% a decade earlier. The growth in
The
Bank crisis
Banks are susceptible
to many forms of risk which have triggered occasional systemic crises. Risks
include liquidity risk (the risk that many depositors
will request withdrawals beyond available funds), credit risk
(the risk that those who owe money to the bank will not repay), and interest rate risk (the risk that the bank will
become unprofitable if rising interest rates force it to pay relatively more on
its deposits than it receives on its loans), among others.
Banking crises have
developed many times throughout history when one or more risks materialize for
a banking sector as a whole. Prominent examples include the U.S. Savings and Loan crisis
in 1980s and early 1990s [10] the Japanese banking crisis during the
1990s, the bank run
that occurred during the Great Depression, and the recent liquidation by
the central Bank of Nigeria, where about 25 banks were liquidated.
Numerous banks have
suffered as a result of the Sub-prime mortgage crisis, which has occurred
on a global scale, affecting investment banks such as Lehman Brothers in the
Challenges within the banking
industry
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The banking industry is
a highly regulated industry with detailed and focused regulators. All banks
with FDIC-insured deposits have the FDIC as a regulator; however,
for examinations, the Federal Reserve
is the primary federal regulator for Fed-member state banks; the Office of the Comptroller of the
Currency (“OCC”) is the primary federal regulator for national
banks; and the Office of Thrift Supervision, or OTS, is
the primary federal regulator for thrifts.
State non-member banks are examined by the state agencies as well as the FDIC.
National banks have one primary regulator—the OCC.
Each regulatory agency
has their own set of rules and regulations to which banks and thrifts must
adhere.
The Federal Financial Institutions Examination Council
(FFIEC) was established in 1979 as a formal interagency body empowered to
prescribe uniform principles, standards, and report forms for the federal
examination of financial institutions. Although the FFIEC has resulted in a
greater degree of regulatory consistency between the agencies, the rules and
regulations are constantly changing.
In addition to changing
regulations, changes in the industry have led to consolidations within the
Federal Reserve, FDIC, OTS and OCC. Offices have been closed, supervisory
regions have been merged, staff levels have been reduced and budgets have been
cut. The remaining regulators face an increased burden with increased workload
and more banks per regulator. While banks struggle to keep up with the changes
in the regulatory environment, regulators struggle to manage their workload and
effectively regulate their banks. The impact of these changes is that banks are
receiving less hands-on assessment by the regulators, less time spent with each
institution, and the potential for more problems slipping through the cracks,
potentially resulting in an overall increase in bank failures across the
The changing economic
environment has a significant impact on banks and thrifts as they struggle to
effectively manage their interest rate spread in the face of low rates on
loans, rate competition for deposits and the general market changes, industry
trends and economic fluctuations. It has been a challenge for banks to
effectively set their growth strategies with the recent economic market. A
rising interest rate environment may seem to help financial institutions, but
the effect of the changes on consumers and businesses is not predictable and
the challenge remains for banks to grow and effectively manage the spread to
generate a return to their shareholders.
The management of the
banks’ asset portfolios also remains a challenge in today’s economic
environment. Loans are a bank’s primary asset category and when loan quality
becomes suspect, the foundation of a bank is shaken to the core. While always
an issue for banks, declining asset quality has become a big problem for financial
institutions. There are several reasons for this, one of which is the lax
attitude some banks have adopted because of the years of “good times.” The
potential for this is exacerbated by the reduction in the regulatory oversight
of banks and in some cases depth of management. Problems are more likely to go
undetected, resulting in a significant impact on the bank when they are
recognized. In addition, banks, like any business, struggle to cut costs and
have consequently eliminated certain expenses, such as adequate employee
training programs.
Banks also face a host
of other challenges such as aging ownership groups. Across the country, many
banks’ management teams and board of directors are aging. Banks also face
ongoing pressure by shareholders, both public and private, to achieve earnings
and growth projections. Regulators place added pressure on banks to manage the
various categories of risk. Banking is also an extremely competitive industry.
Competing in the financial services industry has become tougher with the
entrance of such players as insurance agencies, credit unions, check cashing
services, credit card companies, etc.
As a reaction, banks
have developed their activities in financial instruments, through financial market
operations such as brokerage and trading and become big players in such
activities.
Profitability
A bank generates a
profit from the differential between the level of interest it pays for deposits
and other sources of funds, and the level of interest it charges in its lending
activities. This difference is referred to as the spread between the
cost of funds and the loan interest rate. Historically, profitability from
lending activities has been cyclical and dependent on the needs and strengths
of loan customers. In recent history, investors have demanded a more stable
revenue stream and banks have therefore placed more emphasis on transaction fees,
primarily loan fees but also including service charges on an array of deposit
activities and ancillary services (international banking, foreign exchange,
insurance, investments, wire transfers, etc.). Lending activities, however, still
provide the bulk of a commercial bank's income.
In the past 10 years
American banks have taken many measures to ensure that they remain profitable
while responding to increasingly changing market conditions. First, this
includes the Gramm-Leach-Bliley Act,
which allows banks again to merge with investment and insurance houses. Merging
banking, investment, and insurance functions allows traditional banks to
respond to increasing consumer demands for "one-stop shopping" by
enabling cross-selling of products (which, the banks hope, will also increase
profitability). Second, they have expanded the use of risk-based pricing from business lending to
consumer lending, which means charging higher interest rates to those customers
that are considered to be a higher credit risk and thus increased chance of default on loans. This helps to offset the
losses from bad loans, lowers the price of loans to those who have better
credit histories, and offers credit products to high risk customers who would
otherwise been denied credit. Third, they have sought to increase the methods
of payment processing available to the general public and business clients.
These products include debit cards, pre-paid cards, smart cards,
and credit cards.
They make it easier for consumers to conveniently make transactions and smooth
their consumption over time (in some countries with under-developed financial
systems, it is still common to deal strictly in cash, including carrying
suitcases filled with cash to purchase a home). However, with convenience of
easy credit, there is also increased risk that consumers will mismanage their
financial resources and accumulate excessive debt. Banks make money from card
products through interest payments and fees charged to consumers and transaction fees
to companies that accept the cards.