It is “common knowledge” that:
Banks’ degree of contribution to the development of economy is next to nothing. Providing interest bearing loans banks simply cash in on individual and corporate needs for financial funds.
Banks create money just out of thin air. They get money from other people but do not do anything in return.
Care to guess? This is a part of wide spread stereotypes about banking. Whatever the reason for such views, they do not seem to be complimentary, do they?
Is it really true what is pictured? In order to answer the question we need to sort the wheat from the chaff and see what is true and what is false. So, let us start our analysis of banking from the logical beginning - the historical outlook.
A little bit of history
First references of early forms of banking date back to the times of classical Antiquity. The banks of the ancient world before Christ were those of merchants which made grain loans to farmers and traders who carried goods between cities. This began around 2000 BC in Assiria and Babylonia. Later in ancient Greece and during the Roman Empire two main important innovations were added in banking: deposits and changed money.
At that time banking was already highly developed and subject to Roman Law, money deposits were to be safeguarded and not lent out. A specialty were banker associations or societates argentariae, where members supplied capital to form them, but they had unlimited liability to prevent fraud. Most banks failed during the economic crisis of the third and fourth centuries A.D.
It’s impossible to separate history of banking from that of money. Baking development per se was based on simultaneous or even forestall rise of monetary circulation. In this sense money has been accumulating to be further safely stored in a bank. And in turn, banks have been developing to suit the process in the best way.
Historically, the implication of money has had dramatic changes over the past millenniums evolving from its primitive commodity format to token money. Commodity money is goods with either industrial or consumption uses which enabled to swap goods for other goods in barter economy. Token money which face value exceeds its cost of production includes paper money (banknotes), coins and IOU (I owe you - vast variety of money obligations). Token money, providing four major functions to its owner as medium of exchange, unit of account, store of value and standard of deferred payment, form a cornerstone of contemporary banking and financial system.
Bank as we see it now, finds its more or less contemporary lineaments in the Middle Ages in the rich cities of the Northern Italy, such as Florance, Venive and Genova. The Bardi and Peruzzi families dominated banking in 14th century Florence establishing branches in many other parts of Europe. The oldest bank still in existence is Monte dei Paschi di Siena, headquartered in Siena, Italy, which has been operating continuously since 1472. By the way, since that time on Italian terms “nostro” y “loro” have been generally used in banking to label correspondent accounts in interbank transactions. “NOSTRO” means our bank’s account is opened with a foreign bank (as a rule in foreign currency), “LORO” means their bank account is opened with us.
The major difference of medieval banks with the contemporary ones is that while ancient banks did store currency and valuables, they did not pay interest on those deposits. They simply provided safe storage and proper accounting. Besides, ordinary folk did not put money in banks, and the bank draft (or signature cheque) had not yet been invented. In contrast to the actual banking practice on loans, that of Middle Ages did not presume loan servicing since payment on the principal and the accrued total interest were supposed to be effected at once as it was due.
Working assignment: ______________________________________________
Translate into Russian the words and expressions boldfaced and make them stick in your mind.
Summarize the contents of the extract on the historical outlook of banking.
Use your Internet resources to add up additional facts on the topic.
What differentiates ancient banking from contemporary one?
Banking today
Nowadays the role of bank in the social life could be hardly overestimated. Banks have become a key institute entitled to play a leading role as a sort of blood-vascular system of Economy, or, in industrial terms, a lubricant that oils its wheels thus facilitating to execute the widest range of financial transactions.
According to The World Top 10 net, the top 10 banks in the world in terms of assets are:
CITIBANK
JP MORGAN CHASE
HSBS
BANK OF AMERICA
CREDIT AGRICOLE GROUP
ROYAL BANK OF SCOTLAND
MITSUBISH TOKYO FINANCIAL GROUP
MIZUHO FINANCIAL GROUP
HBOS
BNP PARIBAS
The list of Top 10 Russian banks goes as follows:
SBERBANK
VTB
GAZPROMBANK
VTB24
ROSSELHOZBANK
BANK OF MOSCOW
ALFA-BANK
FK OTKRYTIE
UNICREDIT BANK
PROMSVIAZBANK
Banking is an activity based on well-defined laws and by-laws that strictly regulate this sphere of economic and financial activity. Because money can affect many economic variables that are important to the well-being of any economy, politicians and policymakers throughout the world care about the conduct of monetary policy, the management of money and interest rates. The organization responsible for the conduct of a nation’s monetary policy and inter alia for supervision of banks in most countries, save the U.S., is the Central bank. The Central bank does not conduct commercial banking activities. Its goal is to attain stable economic growth in the nation, and through its actions, influence the flow of money and credit in the economy.
In the U.S. The Federal Reserve System is entrusted to perform those functions. The Federal Reserve System (or simply The Fed) is a quasi-governmental entity which. consists of the Board of Governors, The Federal Open Market Committee, 12 Federal Reserve banks, 25 branches, member financial institutions, and advisory committees.
Are banks allowed to trade cars or Invest in car manufacturing and trading? The answer to the questions stems from national banking legislation that views a bank as a financial intermediary. A financial intermediary is an institution that specializes in bringing lenders and borrowers together.
In what sense are banks financial intermediaries? A bank is a business and its owners or managers aim to maximize profits. A bank makes profits by lending and borrowing. To get money in, the bank offers favorable terms to potential depositors. British clearing banks offer interest on sight deposits only to important customers, but they usually offer free checking facilities to people whose sight deposits or current accounts do not fall below a certain level. They do not charge directly for the expenses of clearing and processing checks. And they offer interest on time deposits.
Let us see how the London clearing banks lend out their money. Most is lent out as advances of overdrafts to households and firms, usually at interest rates well in excess of the rate simultaneously being paid to the bank customers with time deposits. Some is used to purchase securities such as long-term government bonds. Some is more prudently invested in liquid assets. Although these do not pay such a high rate of interest, the bank knows that it can get its money back quickly if people start withdrawing a lot of money from their sight deposits. And some money is held as cash, the most liquid asset of all.
What economic services does the bank provide?
It is transforming household loans to the bank into bank loans to a wide range of people – governments wishing to finance a budget deficit, firms borrowing to build a new factory, and individuals borrowing to start a new business or to buy a new home. The bank is using its specialist expertise to acquire a diversified portfolio of investments though depositors merely observe that they get an interest rate on their time deposits or free chequing facilities. Without the existence of the intermediary, depositors would have neither the time nor the expertise to decide which of these loans or investments to make. That is the economic service that the bank as an intermediary provides.
Banks are not the only financial intermediaries. Insurance companies, pension funds, and building societies also take in money in order to re-lend it. It means that banks and other intermediaries are not allowed to manufacture cars but can legally share profits of car manufacture by investing in car industry.
Banks’ typology / classification.
Banks classification is based on considering the idea from different angels.
According to the ownership, banks can be divided into state owned and private. In most countries, save the US and England, the Central Bank is a purely state owned enterprise, while the bulk of other banks are private entities. In the US The Federal Reserve Act of 1913 established the present day Federal Reserve System and brought all banks in the US under the authority of the Federal Reserve. It could be mentioned as well banks of mixed state and private ownership. The most notable Russian examples are Sberbank, VTB bank and some other institutions.
According to their customers banks can be differentiated between wholesale and retail. Wholesale banks render services mostly to business entities (legal entities) while that of retail work with a wide range of individuals (natural persons).
According to the functions they performed banks can be divided into commercial, savings, trustee, clearing, etc. Commercial banks are the most common type of banks. They are financial intermediaries with a government license to make loans and issue deposits, including deposits against which cheques can be written. In the UK, the commercial banking system comprises about 600 registered banks, the National Girobank operating through post offices, and about a dozen of trustee savings banks.
Much the most important single group is the clearing banks. The clearing banks are so named because they have a central clearing house for handling payments by cheque. A clearing system is a set of arrangements in which debts between banks are settled by adding up all the transactions in a given period and paying only the net amounts needed to balance inter-bank accounts.
To illustrate this concept let’s suppose you bank with Barclays (Barclays Bank) but visit a supermarket that banks with Lloyds (Lloyds bank). To pay for your shopping you write a cheque against your deposit at Barclays. The supermarket pays this cheque into its account at Lloyds. In turn, Lloyds presents the cheque to Barclays which will credit Lloyds' account at Barclays and debit your account at Barclays by an equivalent amount. Because you purchased goods from a supermarket using a different bank, a transfer of funds between the two banks is required. Crediting or debiting one bank's account at another bank is the simplest way to achieve this.
However on the same day someone else, call her Joan Groover, is probably writing a cheque on a Lloyd's deposit account to pay for some stereo equipment from a shop banking with Barclays. The stereo shop pays the cheque into its Barclays' account, increasing its deposit. Barclays then pay the cheque into its account at Lloyds where Ms Groover's account is simultaneously debited. Now the transfer flows from Lloyds to Barclays.
Although in both cases the cheque writer's account is debited and the cheque recipient's account is credited, it does not make sense for the two banks to make two separate inter-bank transactions between themselves. The clearing system calculates the net flows between the member clearing banks and these are the settlements that they make between themselves. Thus the system of clearing cheques represents another way society reduces the costs of making transactions.
Working assignment:_______________________________________________
Translate the terms and expressions boldfaced into Russian and make them stick in your mind.
Use Internet resources to add up brief characteristics to the list of the biggest international and domestic banks.
Why do we compare the bank with a sort of lubricant that oils the wheels of international Economy?
Explain the concept of bank as intermediary.
What is the typology of banks?
Explain the concept of bank clearing and its social significance.
Summarize the contents of the extract on banks typology.
Go to www.youtube.comto examine a video material “How Islamic Banking works?”. What differentiate Islamic banks from that of other countries?
Amazing facts about banks. Do you know that…?______________
To open the vaults at the Bank of England, you need a key which is 3 feet long.
As of 2009, the USA had 8,200 banks, while Canada had 72.
The principles of banking
Jokes:___________________________________________________________
A guy walks into a bank and says to the teller at the window, “I want to open a fuckin’ checking account”. To which the lady replied, ‘I beg your pardon, what did you say?”
“Listen up dammit, I said I want to open a fucking’ checking account right now”
“Sir, I’m sorry but we do not tolerate that kind of language in this bank!”
The teller left the window and went over to the bank manager and told him about the situation. They both return and the manager asked, “What seems to be the problem here?”
“There is no damn problem”, the man said, “I just won 50 million in the lottery and I want to open a fuckin’ checking account in this damn bank!”.
“I see sir”, the manager said, “and this bitch is giving you a hard time?”_____________________
How does a bank make money (generate revenues)? Some people think banking is the easiest way to get material welfare to its owners because it suggests money comes just out of the blue on a silver platter. Just from nowhere. This is far from the truth.
The goldsmith bankers were an early example of a financial intermediary standing between lenders and borrowers. They rendered intermediary services. Although the details of banking activities vary across countries, the general principle is much the same everywhere.
A commercial bank borrows money from the public, crediting them with a deposit. The deposit is a liability of the bank. It is money owed to depositors. In turn the bank lends money to firms, households, or governments wishing to borrow. Each intermediary hopes to receive some material reward for their services and indeed they get a commission for each transaction they have performed.
The crucial thing here is that some of their liabilities are used as a means of payment, and are therefore part of the money stock. Let’s examine how it all works.
Financial assets controlled by the bank are of twofold origin: bank’s own funds and borrowed funds. Bank’s own funds are composed of its authorized fund (seed capital), fixed assets like premises, equipment, land, etc. and some revenues generated as a result of bank’s professional activities.
How does the bank generate revenues? It makes money by:
lending to individuals (retail banking) as well as to corporate customers other banks included (wholesale banking) according to their loan requests.
overdrafts. Overdraft is a technical loan granted to a customer who has spent more money than he or she has in their bank account to settle short term disbalance between withdrawals and the remainder.
getting commissions from transactions such as money transfers, currency exchange, accounts opening, etc.
receiving return on investment (ROI)
account opening
issuing guaranties and LCs (Letters of Credit)
It must be added that one of most efficient way to raise a vast amount of capital by the bank suggests issuing shares to be hereinafter floated on the Stock Exchange. Unfortunately however this way of raising funds involves two essential reservations. The first – only public limited banks are authorized to issue shares. The second – shares issued by the bank are in fact its financial obligations to the customers and in accounting terms correspond to bank’s liabilities and not assets. In other words this is borrowed money subject to immediate return to the lender upon request.
Now let us examine the origin of bank’s borrowed funds. They could be customers’ deposits and loans received from the Central Bank and other banks. In turn deposits could be further subdivided into sight (on call) deposits and fixed or time deposits. Sight or on call deposit is money you place on your bank account and that could be easily withdrawn at any moment. The reverse side of the coin stems from the fact that basically no interest is offered (accrued) on sight deposits. Fixed or time deposits are those that can not be withdrawn until the stipulated date. Time inflexibility is balanced here with a good chance to make your wallet thicker since this type of deposits usually offers interest.
As we see it now, banks can use their own funds as well as customers’ deposits to execute banking transactions ante omnia those of lending. The banks have to find profitable ways to lend what has been borrowed. However, the question may arise, is it really safe way to conduct a business since borrowed funds might be massively withdrawn from the bank by the customers causing deadlock in its activities. Good question! The answer stems from the main principles of banking which is an art of compromise between two conflicting aims – profit maximization, on the one hand, and meeting basic customers’ demands in terms of hedging their assets, on the other hand.
The bank seeks to make as much profit as it can and thus takes risks of lending money (it’s own and customers deposits) on interest bearing terms. To reconcile these things the bank first must keep a proportion of its most liquid assets in cash to meet unexpected cash demand of customers. Multiyear experience suggests that a proportion of liquid assets in cash needed to meet customers’ demands for withdrawals varies very little from one bank to another and in most cases doesn’t exceed 6% of total bank’s liquid assets. It means the remainder can be used for lending.
The second thing the bank must do is to ensure that the investments and loans it grants as well as depositary function it offers are safe. To hedge its own and customers’ assets some money reserves should be kept to cover bad debts. Bad debt is a loan or other financial obligation which payment is overdue. Accordingly a thorough analysis of borrower’s loan request should be carried out by the bank’s loan department or committee before taking an appropriate decision to grant a loan.
Working assignment:_______________________________________________
Translate the terms and expressions boldfaced into Russian
How does the bank make money (generate revenues)? Go to www.youtube.comto watch the following video lectures:
“How Banks Literary Make Money?” (by The Silver Guild)
“How is money really made by banks?” (by Positive Money).
“How the Banking Industry Works?”
Explain the idea of overdraft.
Are shares issued by the public limited bank its assets?
They say that banking is an art of compromise. Why?
Go to www.youtube.comto watch a video lecture “At a Bank” by Twominuteenglish.com focusing on the words and expressions that might be useful when visiting a bank. Differentiate between major types of bank accounts (current / checking / deposit / loan, etc.).
Amazing facts about banks. Do you know that…?________________________
An old man gained the trust of ABN Amro bank in Antwerp’s diamond district by bringing the workers chocolate. He was given VIP access to the bank vault in 2007 and stole $28 million worth of diamonds.
A nine-year-old boy robbed a New York bank in 1981 by pointing a toy-gun at a teller and got away $118.
Italian banks take Parmigiano cheese as collateral for loans and keep hundreds of thousand cheese wheels in their climate-controlled vaults for the 2 years it takes to mature.