BANKING| COMMERCE FORM III: TOPIC 5

 Historical Background of Banking

Explain the historical background of banking

Banking can be defined as the business activity of accepting and safeguarding money owned by other individuals and entities, and then lending out this money in order to earn a profit. However, with the passage of time, the activities covered by banking business have widened and now various other services are also offered by banks.

The banking services these days include issuance of debit and credit cards, providing safe custody of valuable items, lockers, ATM services and online transfer of funds across the country / world. It is well said that banking plays a silent, yet crucial part in our day-to-day lives. The banks perform financial

intermediation by pooling savings and channelizing them into investments

through maturity and risk transformations, thereby keeping the

economy’s growth engine revving.

Banking

business has done wonders for the world economy. The simple looking

method of accepting money deposits from savers and then lending the same

money to borrowers, banking activityencourages the flow of money to

productive use and investments. This in turn allows the economy to grow.

In the absence of banking business, savings would sit idle in our

homes, the entrepreneurs would not be in a position to raise the money,

ordinary people dreaming for a new car or house would not be able to

purchase cars or houses.

What is a bank?

In

simple words, we can say that Bank is a financial institution that

undertakes the banking activity i.e. accepts deposits and then lends the

same to earn certain profit.

HISTORICAL BACKGROUND OF BANKING.

The

world bank is said to have been derived from an Italian word ( banco)

which means bench.the early bankers transacted their business on benches

in market places. when failed, his bench was broken up by people and

this has given rise to the word banco rotto or bankrupt..the band

industries is nearly as old as civilization.

Modern

banking began to develop between the year 1200-1600.in Italy large

banking firms were established in Florence,rome,venice and other Italian

cities.

ORIGIN OF BANKS IN TANZANIA

In

Tanzania the first foreign bank to open its branch was the national

bank india which established its business in Zanzibar in year 1892.in

year 1915,the standard bank,barcklays bank and grand lays established

their services in the country.

The Types and Functions of Banks

Explain the types and functions of banks

TYPES OF BANKS

Central

bank: this is a government bank which is established to assist the

state in controlling its money. It’s also gives financial advice to the

government and acts as a banker for the commercial.

Functions of a Central Bank:

A central bank performs the following functions, as given by De Kock and accepted by the majority of economists.

1. Regulator of Currency:
   The central bank is the bank of issue. It has the monopoly of note
   issue. Notes issued by it circulate as legal tender money. It has its
   issue department which issues notes and coins to commercial banks. Coins
   are manufactured in the government mint but they are put into
   circulation through the central bank.
   Central banks have been following different methods of note issue in
   different countries. The central bank is required by law to keep a
   certain amount of gold and foreign securities against the issue of
   notes. In some countries, the amount of gold and foreign securities
   bears a fixed proportion, between 25 to 40 per cent of the total notes
   issued. In other countries, a minimum fixed
   amount of gold and foreign currencies is required to be kept against
   note issue by the central bank. This system is operative in India
   whereby the Reserve Bank of India is required to keep Rs 115 crores in
   gold and Rs 85 crores in foreign securities. There is no limit to the
   issue of notes after keeping this minimum amount of Rs 200 crores in
   gold and foreign securities.
   The monopoly of issuing notes vested in the central bank
   ensures uniformity in the notes issued which helps in facilitating
   exchange and trade within the country. It brings stability in the
   monetary system and creates confidence among the public. The central
   bank can restrict or expand the supply of cash according to the
   requirements of the economy. Thus it provides elasticity to the monetary
   system. By having a monopoly of note issue, the central bank also
   controls the banking system by being the ultimate source of cash. Last
   but not the least, by entrusting the monopoly of note issue to the
   central bank, the government is able to earn profits from printing notes
   whose cost is very low as compared with their face value.
2. Banker, Fiscal Agent and Adviser to the Government:
   Central banks everywhere act as bankers, fiscal agents and advisers to
   their respective governments. As banker to the government, the central
   bank keeps the deposits of the central and state governments and makes
   payments on behalf of governments. But it does not pay interest on
   governments deposits. It buys and sells foreign currencies on behalf of
   the government. It keeps the stock of gold of
   the government. Thus it is the custodian of government money and wealth.
   As a fiscal agent, the central bank makes short-term loans to the
   government for a period not exceeding 90 days. It floats loans, pays
   interest on them, and finally repays them on behalf of the government.
   Thus it manages the entire public debt. The central bank also advises
   the government on such economic and money matters as controlling
   inflation or deflation, devaluation or revaluation of the currency,
   deficit financing, balance of payments, etc. As pointed out by De Kock,
   “Central banks everywhere operate as bankers to the state not only
   because it may be more convenient and economical to the state, but also
   because of the intimate connection between public finance and monetary
   affairs.”
3. Custodian of Cash Reserves of Commercial Banks:
   Commercial banks are required by law to keep reserves equal to a
   certain percentage of both time and demand deposits liabilities with the
   central banks. It is on the basis of these reserves that the central
   bank transfers funds from one bank to another to facilitate the clearing
   of cheques. Thus the central bank acts as
   the custodian of the cash reserves of commercial banks and helps in
   facilitating their transactions. There are many advantages of keeping
   the cash reserves of the commercial banks with the central bank,
   according to De Kock. In the first place, the
   centralisation of cash reserves in the central bank is a source of great
   strength to the banking system of a country.
   Secondly, centralised cash reserves can serve as the basis of
   a large and more elastic credit structure than if the same amount were
   scattered among the individual banks. Thirdly, centralised
   cash reserves can be utilised fully and most effectively during periods
   of seasonal strains and in financial crises or emergencies. Fourthly,
   by varying these cash reserves the central bank can control the credit
   creation by commercial banks. Lastly, the central bank can provide
   additional funds on a temporary and short term basis to commercial banks
   to overcome their financial difficulties.
4. Custody and Management of Foreign Exchange Reserves:
   The central bank keeps and manages the foreign exchange reserves of the
   country. It is an official reservoir of gold and foreign currencies. It
   sells gold at fixed prices to the monetary authorities of other
   countries. It also buys and sells foreign currencies at international
   prices. Further, it fixes the exchange rates of the domestic currency in
   terms of foreign currencies. It holds
   these rates within narrow limits in keeping with its obligations as a
   member of the International Monetary Fund and tries to bring stability
   in foreign exchange rates. Further, it manages exchange control
   operations by supplying foreign currencies to importers and persons
   visiting foreign countries on business, studies, etc. in keeping with
   the rules laid down by the government.
5. Lender of the Last Resort:
   De Kock regards this function as a sine qua non of central banking. By
   granting accommodation in the form of re-discounts and collateral
   advances to commercial banks, bill brokers and dealers, or other
   financial institutions, the central bank acts as the lender of the last
   resort. The
   central bank lends to such institutions in order to help them in times
   of stress so as to save the financial structure of the country from
   collapse. It acts as lender of the last resort through discount house on
   the basis of treasury bills, government securities and bonds at “the
   front door”. The other method is to give temporary accommodation to the
   commercial banks or discount houses directly through the “back door”.
   The difference between the two methods is that lending at the front door
   is at the bank rate and in the second case at the market rate. Thus the
   central bank as lender of the last resort is a big source of cash and
   also influences prices and market rates.
6. Clearing House for Transfer and Settlement:
   As bankers’ bank, the central bank acts as a clearing house for
   transfer and settlement of mutual claims of commercial banks. Since the
   central bank holds reserves of commercial banks, it transfers funds from
   one bank to other banks to facilitate clearing of cheques. This is done
   by making transfer entries in their accounts on the principle of
   book-keeping. To transfer and settle claims of one bank upon others, the
   central bank operates a separate department in big cities and trade
   centres. This department is known as the “clearing house” and it renders
   the service free to commercial banks. When the central
   bank acts as a clearing agency, it is time-saving and convenient for
   the commercial banks to settle their claims at one place. It also
   economises the use of money. “It is not only a means of economising cash
   and capital but is also a means of testing at any time the degree of
   liquidity which the community is maintaining.”
7. Controller of Credit:
   The most important function of the central bank is to control the
   credit creation power of commercial bank in order to control
   inflationary and deflationary pressures within this economy. For this
   purpose, it adopts quantitative methods and qualitative methods.
   Quantitative methods aim at controlling the cost and quantity of credit
   by adopting bank rate policy, open market operations, and by variations
   in reserve ratios of commercial banks. Qualitative methods control the
   use and direction of credit. These involve selective credit controls and
   direct action. By adopting such methods, the central bank tries to
   influence and control credit creation by commercial banks in order to
   stabilise economic activity in the country. Besides the above
   noted functions, the central banks in a number of developing countries
   have been entrusted with the responsibility of developing a strong
   banking system to meet the expanding requirements of agriculture,
   industry, trade and commerce. Accordingly, the
   central banks possess some additional powers of supervision and control
   over the commercial banks. They are the issuing of licences; the
   regulation of branch expansion; to see that every bank maintains the
   minimum paid up capital and reserves as provided by law; inspecting or
   auditing the accounts of banks; to approve the appointment of chairmen
   and directors of such banks in accordance with the rules and
   qualifications; to control and recommend merger of weak banks in order
   to avoid their failures and to protect the interest of depositors; to
   recommend nationalisation of certain banks to the government in public
   interest; to publish periodical reports relating to different aspects of
   monetary and economic policies for the benefit of banks and the public;
   and to engage in research and train banking personnel etc..

FUNCTION OF COMMERCIAL BANKS.

The functions of commercial banks are explained below:

Primary functions

• Collection of deposits
• Making loans and advances

Collection of deposits:

The primary function of commercial banks is to collect deposits from

the public. Such deposits are of three main types: current, saving and

fixed.

A current account

is used to make payments. A customer can deposit and withdraw money

from the current account subject to a minimum required balance. If the

customer overdraws the account, he may be required to pay interest to

the bank. Cash credit facility is allowed in the current account.

Savings account

is an interest yielding account. Deposits in savings account are used

for saving money. Savings bank account-holder is required to maintain a

minimum balance in his account to avail of cheque facilities.

Fixed or term deposits

are used by the customers to save money for a specific period of time,

ranging from 7 days to 3 years or more. The rate of interest is related

to the period of deposit. For example, a fixed deposit with a maturity

period of 3 years will give a higher rate of return than a deposit with a

maturity period of 1 year. But money cannot be usually withdrawn before

the due date. Some banks also impose penalty if the fixed deposits are

withdrawn before the due date. However, the customer can obtain a loan

from the bank against the fixed deposit receipt.

Loans and advances:

Commercial banks have to keep a certain portion of their deposits as

legal reserves. The balance is used to make loans and advances to the

borrowers. Individuals and firms can borrow this money and banks make

profits by charging interest on these loans. Commercial banks make

various types of loans such as:

1. Loan to a person or to a firm against some collateral security;
2. Cash credit (loan in installments against certain security);
3. Overdraft facilities (i.e. allowing the customers to withdraw more money than what their deposits permit); and
4. Loan by discounting bills of exchange..

Secondary functions

• Agency services
• General utility services

Agency Services:

The customers may give standing instruction to the banks to accept or

make payments on their behalf. The relationship between the banker and

customer is that of Principal and Agent. The following agency services

are provided by the bankers:

1. Payment
   of rent, insurance premium, telephone bills, installments on hire
   purchase, etc. The payments are obviously made from the customer’s
   account. The banks may also collect such receipts on behalf of the
   customer.
2. The bank collects cheques, drafts, and bills on behalf of the customer.
3. The banks can exchange domestic currency for foreign currencies as per the regulations.
4. The
   banks can act as trustees / executors to their customers. For example,
   banks can execute the will after the death of their clients, if so
   instructed by the latter.

General Utility Services:

The commercial banks also provide various general utility services to

their customers. Some of these services are discussed below:

1. Safeguarding money and valuables:
   People feel safe and secured by depositing their money and valuables in
   the safe custody of commercial banks. Many banks look after valuable
   documents like house deeds and property, and jewellery items.
2. Transferring money:Money
   can be transferred from one place to another. In the same way, banks
   collect funds of their customers from other banks and credit the same in
   the customer’s account.
3. Merchant banking: Many
   commercial banks provide merchant banking services to the investors and
   the firms. The merchant banking activity covers project advisory
   services and loan syndication, corporate advisory services such as
   advice on mergers and acquisitions, equity valuation, disinvestment,
   identification of joint venture partners and so on.
4. Automatic Teller Machines (ATM):
   The ATMs are machines for quick withdrawal of cash. In the last 10
   years, most banks have introduced ATM facilities in metropolitan and
   semi-urban areas. The account holders as well as credit card holders can
   withdraw cash from ATMs.
5. Traveler’s cheque: A
   traveler’s cheque is a printed cheque of a specific denomination. The
   cheque may be purchased by a person from the bank after making the
   necessary payments. The customer may carry the traveler’s cheque while
   travelling. The traveler’s cheques are accepted in banks, hotels and
   other establishments.

Credit Cards:

Credit cards are another important means of making payments. The Visa

and Master Cards are operated by the commercial banks. A person can use a

credit card to withdraw cash from ATMs as well as make payments to

trade establishments.

A savings bank is a financial institution whose primary purpose is accepting savings deposits and paying interest on those deposits.

They

originated in Europe during the 18th century with the aim of providing

access to savings products to all levels in the population. Often

associated with social good these early banks were often designed to

encourage low income people to save money and have access to banking

services. They were set up by governments or by or socially committed

groups or organisations such as with credit unions. The structure and

legislation took many different forms in different countries over the

20th century.

• The advent
  of internet banking at the end of the 20th century saw a new phase in
  savings banks with the online savings bank that paid higher levels of
  interest in return for clients only having access over the web.

The Various Bank Accounts and How they Operate

Identify the various bank accounts and how they operate

TYPES OF BANKING ACCOUNTS

Checking account:

A checking account offers easy access to your money for your daily

transactional needs and helps keep your cash secure. Customers can use a

debit card or checks to make purchases or pay bills. Accounts may have

different options or packages to help waive certain monthly service

fees. To determine the most economical choice, compare the benefits of

different checking packages with the services you actually need.

• Savings account:
  A savings account allows you to accumulate interest on funds you’ve
  saved for future needs. Interest rates can be compounded on a daily,
  weekly, monthly, or annual basis. Savings accounts vary by monthly
  service fees, interest rates, method used to calculate interest, and
  minimum opening deposit. Understanding the account’s terms and benefits
  will allow for a more informed decision on the account best suited for
  your needs.
• Certificate of Deposit (CD):
  Certificates of deposit, or CDs, allow you to invest your money at a set
  interest rate for a pre-set period of time. CDs often have higher
  interest rates than traditional savings accounts because the money you
  deposit is tied up for the life of the certificate – which can range
  from a few months to several years. Be sure you do not need to draw on
  those funds before you open a CD, as early withdrawals may have
  financial penalties.
• Money market account:
  Money market accounts are similar to savings accounts, but they require
  you to maintain a higher balance to avoid a monthly fee. Where savings
  accounts usually have a fixed interest rate, these accounts have rates
  that vary regularly based on money markets. Money market accounts can
  have tiered interest rates, providing more favorable rates based on
  higher balances. Some money market accounts also allow you to write
  checks against your funds, but on a more limited basis.
• Individual Retirement Accounts (IRAs):
  IRAs, or individual retirement accounts, allow you to save
  independently for your retirement. These plans are useful if your
  employer doesn’t offer retirement benefits or you want to save more than
  your employer-sponsored plan allows. These accounts come in two types:
  the traditional IRA and Roth IRA. The Roth IRA is popular because the
  funds can be withdrawn tax-free in many situations. Others prefer
  traditional IRAs because these contributions are tax-deductible. Both
  accounts have contribution limits and other requirements you may need to
  discuss with your tax advisor before choosing your account.

Difference between the Main Means of Payments: Cheques; Bills of Exchange; Promissory Notes; Postal Orders

Differentiate the main means of payments: Cheques; Bills of exchange; Promissory notes; Postal orders

Cheque

is an instrument in writing containing an unconditional order,

addressed to a banker, sign by the person who has deposited money with

the banker, requiring him to pay on demand a certain sum of money only

to or to the order of certain person or to the bearer of instrument.”

Characteristics Of Cheque <!– [if !supportLineBreakNewLine]–> <!–[endif]–>

1. An Unconditional Order The drawer or the depositor should not lay down any condition in the cheque.
2. Drawn upon A Specified Banker The drawer issues cheque directing to a particular bank having deposit in it to pay the amount of cheque.
3. Signed By The Maker The cheque should be signed by the account holder.
4. Amount In Words And Figures The amount of cheque should be mentioned in words and figures.
5. Payable On Demand The amount of cheque must be paid by the bank as soon as it is presented at its counter.

Different Kinds / Types of Cheques

1. Bearer Cheque;When
   the words “or bearer” appearing on the face of the cheque are not
   cancelled, the cheque is called a bearer cheque. The bearer cheque is
   payable to the person specified therein or to any other else who
   presents it to the bank for payment. However, such cheques are risky,
   this is because if such cheques are lost, the finder of the cheque can
   collect payment from the bank.
2. Order Cheque;When
   the word “bearer” appearing on the face of a cheque is cancelled and
   when in its place the word “or order” is written on the face of the
   cheque, the cheque is called an order cheque. Such a cheque is payable
   to the person specified therein as the payee, or to any one else to whom
   it is endorsed (transferred).
3. Uncrossed / Open Cheque;When
   a cheque is not crossed, it is known as an “Open Cheque” or an
   “Uncrossed Cheque”. The payment of such a cheque can be obtained at the
   counter of the bank. An open cheque may be a bearer cheque or an order
   one.
4. Crossed Cheque;Crossing of cheque means
   drawing two parallel lines on the face of the cheque with or without
   additional words like “& CO.” or “Account Payee” or “Not
   Negotiable”. A crossed cheque cannot be encashed at the cash counter of a
   bank but it can only be credited to the payee’s account.
5. Anti-Dated Cheque;If
   a cheque bears a date earlier than the date on which it is presented to
   the bank, it is called as “anti-dated cheque”. Such a cheque is valid
   upto three months from the date of the cheque.
6. Post-Dated Cheque;If
   a cheque bears a date which is yet to come (future date) then it is
   known as post-dated cheque. A post dated cheque cannot be honoured
   earlier than the date on the cheque.
7. Stale Cheque;If a cheque is presented for payment after three months from the date of the cheque it is called stale cheque.

BILLS

OF EXCHANGE :A written, unconditional order by one party (the drawer)

to another (the drawee) to pay a certain sum, either immediately (a

sight bill) or on a fixed date (a term bill), for payment of goods

and/or services received. The drawee accepts the bill by signing it,

thus converting it into a post-dated check and a binding contract.

A

bill of exchange is also called a draft but, while all drafts are

negotiable instruments, only “to order” bills of exchange can be

negotiated. According to the 1930 Convention Providing A Uniform Law For

Bills of Exchange and Promissory Notes held in Geneva (also called

Geneva Convention) a bill of exchange contains: (1) The term bill of

exchange inserted in the body of the instrument and expressed in the

language employed in drawing up the instrument.

What is a ‘Promissory Note’

• A
  financial instrument that contains a written promise by one party to
  pay another party a definite sum of money either on demand or at a
  specified future date. A promissory note typically contains all the
  terms pertaining to the indebtedness by the issuer or maker to the
  note’s payee, such as the amount, interest rate, maturity date, date and
  place of issuance, and issuer’s signature. The 1930 international
  convention that governs promissory notes and bills of exchange also
  stipulates that the term “promissory note” should be inserted in the
  body of the instrument and should contain an unconditional promise to
  pay.