Concept of bank

• The legal definition changes over time and the functions of a bank have changed
over years.
• In the U.S. a “bank” is defined by federal and state laws and by bank regulators.
• National Currency Act of 1863 created the OCC (Office of the Comptroller of
Currency) and said a national bank will carry out the “… business of banking.”
For example, discounting notes, exchanging coin and bills , and receiving deposits.

• Bank Holding Company Act of 1956 changed the definition to accepting deposits
that can be withdrawn on demand and making commercial loans.
• Nonbank bank: a firm that undertakes many of the activities of a commercial bank
without meeting the legal definition of a bank

• Competitive Equality Banking Act of 1987 broadened definition to accepting

deposits and making loans.
• Today a legal definition is that a bank makes loans, has insured various deposits,
and has banking powers under state and federal government laws.
•
• Definition of a Bank
• Chamber’s Twentieth century Dictionary defines a bank as, “an institution
for the keeping, lending and exchanging etc. of money”.
• According to Banking Regulation Act, “Banking means the accepting for the
purpose of lending or investment of deposits of money from the public,
repayable on demand or otherwise and withdrawable by cheque, draft, and an
order or otherwise”.
• Oxford Dictionary defines a bank as "an establishment for custody of money,
which it pays out on customer's order."
• Prof. Kent defines a bank as, “an organization whose principal operations are
• concerned with the accumulation of the temporarily idle money of the general
public for the purpose of advancing to others for expenditure”.
• Banking Regulation Act of 1949 defines banking as “accepting for the purpose of
lending or investment, of deposits of money from the public, repayable on demand or
otherwise, and withdrawable by cheque, draft, order or otherwise”.
Evolution of Banking
• The term bank is either derived from Old Italian word
banca or from a French word banque both mean a Bench
or money exchange table. In olden days, European money
lenders or money changers used to display (show) coins of
different countries in big heaps (quantity) on benches or
tables for the purpose of lending or exchanging.
• According to some authorities, the work “Bank” itself is
derived from the words “bancus” or “banqee,” that is, a
bench. The early bankers, transacted their business on
benches in the market place. There are others, who are of
the opinion that the word “bank” is originally
• derived from the German word “back” meaning a joint
stock fund, which was Italianized into “banco” when the
Germans were masters of a great part of Italy.
• This appears to be more possible. But whatever is the
origin of the word ‘bank’, “It would trace the history of
banking in Europe from the Middle Ages.”
• =========================================
Similarly, if we see broadly , we can found,
• The evolution of banking can be traced back to the early times of
human history. The history of banking begins with the first prototype
banks of merchants of the ancient world, which made grain loans to
farmers and traders who carried goods between cities. This began
around 2000 BC in Assyria and Babylonia. In olden times people
deposited their money and valuables at temples, as they are the safest
place available at that time. The practice of storing precious metals at
safe places and loaning money was prevalent in ancient Rome.
• However modern Banking is of recent origin. The development of banking
from the traditional lines to the modern structure passes through Merchant
bankers, Goldsmiths, Money lenders and Private banks. Merchant Bankers
were originally traders in goods. Gradually they started to finance trade and
then become bankers. Goldsmiths are considered as the men of honesty,
integrity and reliability. They provided strong iron safe for keeping
valuables and money. They issued deposit receipts (Promissory notes) to
people when they deposit money and valuables with them. The goldsmith
paid interest on these deposits. Apart from accepting deposits, Goldsmiths
began to lend a part of money deposited with them. Then they became
bankers who perform both the basic banking functions such as accepting
deposit and lending money. Money lenders were gradually replaced by
private banks. Private banks were established in a more organised manner.
The growth of Joint stock commercial banking was started only after the
enactment of Banking Act 1833 in England.
 Characteristics of Banker/Banking
• 1. Banker deals with others’ money
• 2. Banks repay deposits either on demand or after
the expiry of specified period
• 3. They utilize deposits for lending/investment
• 4. They perform subsidiary services and
innovative functions
• 5. Banking should be dominant part of business of
bank
• 6. A bank should hold itself out as a bank
 Importance of banks
• Bankers play very important role in the economic development of the nation. The
health of the economy is closely related to the growth and soundness of its banking
system. Although banks create no new wealth but their fund collection, lending and
related activities facilitate the process of production, distribution, exchange and
consumption of wealth. In this way, they become very effective partners in the process
of economic development.
• 1. Banks mobilize small, scattered and idle savings of the people, and make them
available for productive purposes
• 2. By offering attractive interests, Banks promote the habit of thrift and savings
• 3. By accepting savings, Banks provide safety and security to the surplus money
• 4. Banks provide convenient and economical means of payments
• 5. Banks provide convenient and economical means of transfer of funds
• 6. Banks facilitate the movement of funds from unused regions to useful regions
• 7. Banking help trade, commerce, industry and agriculture by meeting their financial
requirements
• 8. Banking connect saving people and investing people.
• 9. Through their control over the supply of money, Banks influence the economic
activities,
• employment, income level and price level in the economy.
 Types / Kinds of Bank
• (a) On the basis of Functions
• (b) On the basis of Ownership
• (c) On the basis of Registration
• (d) On the basis of Domicile
 Types of banks:

On the basis of Functions

– 1. Commercial banks/Deposit banks
– Banks accept deposits from public and lend them mainly for
commercial purposes forcomparatively shorter periods are called
Commercial Banks. They provide services to the general public,
organisations and to the corporate community. They are oldest
banking institution in the organised sector.
– 2. Industrial banks/Investment banks
– Industrial banks are those banks which provide fixed capital to
industries. They are also called investment banks, as they invest
their funds in subscribing to the shares and debentures of industrial
concerns.
– 3. Agricultural banks
– Agricultural banks are banks which provide finance to agriculture
and allied sectors
4. Exchange banks
Exchange banks finances foreign exchange business (export, import business) of a
country. Special exchange banks are found only in some countries. The main
functions of exchange banks are remitting money from one country to another
country, discounting of foreign bills, buying and selling gold and silver, helping
import and export trade etc.
5. Savings bank
Savings banks are those banks which specialize in the mobilization of small
savings of the middle and low income group. In India, saving bank activities are
done by commercial banks and post offices. Features of savings banks are;
Mobilize small and scattered savings
Promote habit of thrift & savings
Keep only small portion in hand and invest major part in govt. securities
They do not lend to general public.
6. Central / National banks
It is the highest banking & monetary institution in a country. It is the leader of all
other banks. Since it is occupying a central position, it’s known as Central Bank. It
is operating under state’s control and is not a profit motive organization. Reserve
Bank of India (India), Bank of Canada (Canada), Federal Reserve System(USA),
Nepal Rastra Bank ( NRB) etc are the examples of Central Banks.
• Merchant Bank:-
• The bank provides services like acceptance of bills of exchange, corporate finance,
Leasing, hire-purchase and insurance broking. It is a whole sale bank and accepts large
sums for fixed term from individual, companies and financial institutions. Baring,
lazards are examples of Merchant Bank.
• Consortium Banks:-
• A Consortium bank is owned by other banks. The bank is formed to meet the
financial requirements of large companies for long period of time. The
bank receives the funds from the parent Bank. It can also arrange syndicate
loans. International energy Bank, British Middle East Bank, Orion Bank are
the examples of consortium Banks.
• Labour Bank:-
• The Bank is opened by trade union of labourers. The purpose of this bank is to manage
worker funds like pension funds, Provident fund etc in a better way. The Labourers also
keep their saving in it. The bank provides loans to the concerns which are under the
control of trade union. E.g. Union Bank, Saving Bank of Chicago, State Bank of Kansas
city.
• School Bank:-
• The banks provide banking facilities to the students in schools. The boxes or bags are
supplied to the students who keep their saving in boxes. Accounts are opened in the
name of students. The bank officers go to the school after regular interval and collect the
amount of their saving. In U.S.A Beloit saving Bank started working school bank in
1882.
• Mortage Bank :-
• These banks provide loans to people against moveable and immovable
property. HBFC is doing the working of Mortage Bank.
• Cooperative Bank:-
• These banks are set up to provide credit facilities to farmers and small
producers. The bank is opened by persons of similar occupations living in
same areas for providing banking facilities. In Pakistan the Co-Operative bank
registered under the Co-Operative societies Act 1925 and can be registered
with registrar of Co-Operative societies at provincial headquarters.
• On the Basis Of Ownership:-
• Public sector Bank:-
• Such banks are owned by government and works under the direct
control of the government. The chief executive of such banks is
appointed by federal government. NBP are examples of public sector
banks, First woman Bank.
• Private Sector Bank:-
• These banks are under the direct ownership of the private organization
of Co-Operative Societies. The banks are controlled by the individuals
or Pvt Organization, MCB, ABL and KASB Bank is the examples.
• On The Basis Of Registration:-
• Scheduled Bank:-
• These are the banks which are registered in the list of central bank. They are bound to
follow the instruction and policies of central bank.
• Non Scheduled Banks:-
• These are the banks which are not registered in list and policies, Instruction of central
Bank.
• On The Basis Of Domicile:-
• Domestic Bank:-
• The banks which are registered and incorporated with in the country are called domestic
bank. These banks provide financial assistance domestically. In Pakistan the banks
regulated under Pakistan Banking companies’ ordinance 1962 are domestic banks. E.g.
N.B, H.B.L, Askari Bank are examples of Domestic banks.
• Foreign Bank:-
The bank which have their origin and head offices in foreign country are called foreign bank.
Foreign banks are the branches of the banks incorporated abroad. The standard chartered
Bank Ltd, National and Grind lays Bank Ltd, Al-Falah Bank Ltd are examples of foreign
banks.
 Functions Of Bank
The functions of banks are briefly highlighted in following Diagram or Chart.
• A. Primary Functions of Banks ↓
The primary functions of a bank are also known as banking functions. They
are the main functions of a bank.
• These primary functions of banks are explained below.
1. Accepting Deposits
The bank collects deposits from the public. These deposits can be of different
types, such as :-
• Saving Deposits
• Fixed Deposits
• Current Deposits
• Recurring Deposits
• a. Saving Deposits
This type of deposits encourages saving habit among the public. The rate of
interest is low. At present it is about 4% p.a. Withdrawals of deposits are
allowed subject to certain restrictions. This account is suitable to salary and
wage earners. This account can be opened in single name or in joint names.
b. Fixed Deposits
Lump sum amount is deposited at one time for a specific period. Higher rate of
interest is paid, which varies with the period of deposit. Withdrawals are not
allowed before the expiry of the period. Those who have surplus funds go for
fixed deposit.
c. Current Deposits
This type of account is operated by businessmen. Withdrawals are freely allowed.
No interest is paid. In fact, there are service charges. The account holders can get
the benefit of overdraft facility.
d. Recurring Deposits
This type of account is operated by salaried persons and petty traders. A certain
sum of money is periodically deposited into the bank. Withdrawals are permitted
only after the expiry of certain period. A higher rate of interest is paid.
2. Granting of Loans and Advances
The bank advances loans to the business community and other members
of the public. The rate charged is higher than what it pays on deposits. The
difference in the interest rates (lending rate and the deposit rate) is its
profit.
• The types of bank loans and advances are :-
• Overdraft
• Cash Credits
• Loans
• Discounting of Bill of Exchange
a. Overdraft
This type of advances are given to current account holders. No separate account is
maintained.
 A certain amount is sanctioned as overdraft which can be withdrawn within a
certain period of time say three months or so.
 Interest is charged on actual amount withdrawn. An overdraft facility is
granted against a collateral security or with goodwill.
 It is generally sanctioned to businessman and firms

b. Cash Credits
 The client is allowed cash credit upto a specific limit fixed in advance. It can
be given to current account holders as well as to others who do not have an
account with bank.
 Separate cash credit account is maintained. Interest is charged on the amount
withdrawn in excess of limit.
 The cash credit is given against the security of tangible assets and / or
guarantees. The advance is given for a longer period and a larger amount of
loan is sanctioned than that of overdraft.
c. Loans

 It is normally for short term say a period of one year or medium term say a
period of five years.

 Now-a-days, banks do lend money for long term.

 Repayment of money can be in the form of installments spread over a period
of time or in a lumpsum amount.
 Interest is charged on the actual amount sanctioned, whether withdrawn or not.
 The rate of interest may be slightly lower than what is charged on overdrafts
and cash credits.
 Loans are normally secured against tangible assets of the company.

d. Discounting of Bill of Exchange

 The bank can advance money by discounting or by purchasing bills of

exchange both domestic and foreign bills.
 The bank pays the bill amount to the drawer or the beneficiary of the bill by
deducting usual discount charges.
 On maturity, the bill is presented to the drawee or acceptor of the bill and the
amount is collected.
• B. Secondary Functions of Banks
The bank performs a number of secondary functions, also
called as non-banking functions. These important secondary
functions of banks are explained below.
1. Agency Functions
The bank acts as an agent of its customers. The bank performs
a number of agency functions which includes :-
• Transfer of Funds
• Collection of Cheques
• Periodic Payments
• Portfolio Management
• Periodic Collections
• Other Agency Functions
a. Transfer of Funds
The bank transfer funds from one branch to another or from one place to
another.
b. Collection of Cheques
The bank collects the money of the cheques through clearing section of its
customers. The bank also collects money of the bills of exchange.
c. Periodic Payments
On standing instructions of the client, the bank makes periodic payments
in respect of electricity bills, rent, etc.
d. Portfolio Management
The banks also undertakes to purchase and sell the shares and debentures
on behalf of the clients and accordingly debits or credits the account. This
facility is called portfolio management.
e. Periodic Collections
The bank collects salary, pension, dividend and such other periodic
collections on behalf of the client.
• f. Other Agency Functions
They act as trustees, executors, advisers and administrators on behalf
of its clients. They act as representatives of clients to deal with other
banks and institutions.
2. General Utility Functions
The bank also performs general utility functions, such as :-
• Issue of Drafts, Letter of Credits, etc.
• Locker Facility
• Underwriting of Shares
• Dealing in Foreign Exchange
• Project Reports
• Social Welfare Programmes
• Other Utility Functions
• a. Issue of Drafts and Letter of Credits
Banks issue drafts for transferring money from one place to another. It
also issues letter of credit, especially in case of, import trade. It also
issues travellers' cheques.
•
b. Locker Facility
The bank provides a locker facility for the safe custody of valuable
documents, gold ornaments and other valuables.
c. Underwriting of Shares
The bank underwrites shares and debentures through its merchant banking
division.
d. Dealing in Foreign Exchange
The commercial banks are allowed by RBI to deal in foreign exchange.
e. Project Reports
The bank may also undertake to prepare project reports on behalf of its
clients.
f. Social Welfare Programmes
It undertakes social welfare programmes, such as adult literacy
programmes, public welfare campaigns, etc.
g. Other Utility Functions
It acts as a referee to financial standing of customers. It collects
creditworthiness information about clients of its customers. It provides
market information to its customers, etc. It provides travellers' cheque
facility.
size and share of commercial banks
• By Size and share, we can assume the
transaction of bank.
• Investment
• Reputation/ goodwill/ Faith of people.
• Easiness
• Reliability
• Dependability
• Opportunity
Major Factors Affecting Banking And Market Shares

• Inflation and volatile interest rates:

– Rising interest rates caused shorter-term deposit costs to rise faster
than longer-term loans.
– Also, as rates rose, the market value of their assets declined and
borrowers defaulted on loans with greater frequency than normal.
• Securitization:
– Banks are pooling loans for various kinds and selling securities
with claims on these loans.
• Technological advances:
– Telecommunications and computers are increasing economies of
scale and economies of scope for banks.
• Consumers have become more sophisticated.
• Capital markets have increased their competition with
banks in attracting firms seeking debt funds.
• Deregulation:
– The elimination of laws that placed geographic limits on banks,
their products and services, and the rates they can pay has
stimulated bank mergers and consolidation in the banking industry
(e.g., 14,400 banks in 1985 compared to 8,500 banks in 2000).
• Despecialization and competition among financial
institutions with one-stop shopping centers.
• Global integration of financial markets is increasing
competition from foreign financial service firms.
What are the principal sources and uses of funds for
banks? / (Assets And Liabilities Of Commercial Bank)

• Assets
– Loans
commercial and industrial (C&I) loans
real estate loans
consumer loans
– Investments
short-term, liquid securities (e.g., U.S. Treasury securities)
long-term securities
– Cash
– Other assets
buildings, equipment, etc.
• Liabilities
– Deposits
transactions deposits
nontransactions deposits
– Nondeposit sources of funds
• Equity
– Relatively small compared to debt sources of funds. Highly
leveraged compared to nonfinancial firms.
 Bank Profitability
• Bank management must balance between
liquidity and profitability
• Net Interest Income
– Difference between total interest income
(interest on loans and interest on securities and
investments) and interest expense (amount
paid to lenders)
– Closely analogous to a manufacturing
company’s gross profit
 Bank Profitability
• Net interest margin—net interest income as a
percentage of total bank assets
• Factors that determine bank’s interest margin
– Better service means higher rates on loans and lower
interest on deposits
– Might have some monopoly power, but this is
becoming more unlikely due to enormous competition
from other banks and nonbank competitors
– Also affected by a bank’s risk—interest rate and credit
 Bank Profitability
• Service charges and fees and other operating
income
– Additional source of revenue
– Become more important as banks have shifted from
traditional interest income to more nontraditional
sources on income
• Salaries and wages
– Banks are very labor-intensive
– Pressure to reduce personnel and improve productivity
 Bank Profitability
• Security gains/losses
– Results from the fact that securities held for investment are shown
at historical cost
– This may result in a gain or loss when the security is sold
• Net Income after Taxes
– Net Income less taxes
– Return on Assets (ROA)—Net Income after taxes expressed as a
percentage of total assets
– Return on Equity (ROE)—Net Income after taxes divided by
equity capital
 Bank Risk
• Leverage Risk
– Leverage—Combine debt with equity to purchase assets
– Leveraging with debt increases risk because debt requires fixed
payments in the future
– The more leveraged a bank is, the less its ability to absorb a loss in
asset value
– Leverage Ratio—Ratio of bank’s equity capital to total assets [9%
in 2002]
– Regulators in US and other countries impose risk-based
requirements—riskier the asset, higher the capital requirement
 Bank Risk
• Credit Risk
– Possibility that borrower may default
– Important for bank to get as much information as
possible about borrower—asymmetric information
– Charge higher interest or require higher collateral for
riskier borrower
– Loan charge-offs is a way to measure past risk
associated with a bank’s loans
– Ratio of non-performing loans (delinquent 30 days or
more) to total loans is a forward-looking measure
 Bank Risk
• Interest Rate Risk
– Mismatch in maturity of a bank’s assets and liabilities
– Traditionally banks have borrowed short and lent long
– Profitable if short-term rates are lower than long-term rates
– Due to discounting, increasing interest rates will reduce the
present value of bank’s assets
– Use of floating interest rate to reduce risk
– The one-year re-pricing GAP is the simplest and most commonly
used measure of interest rate risk
 Bank Risk
• Trading Risk
– Banks act as dealers in financial instruments such as
bonds, foreign currency, and derivatives
– At risk of a drop in price of the financial instrument if
they need to sell before maturity
– Difficult to develop a good measure of trading risk
since is it hard to estimate the statistical likelihood of
adverse price changes
 Bank Risk
• Liquidity Risk
– Possibility that transactions deposits and savings account can be
withdrawn at any time
– Banks may need additional cash if withdrawals significantly
exceed new deposits
– Traditionally banks provided liquidity through the holding of
liquid assets (cash and government securities)
– Historically these holdings were a measure of a bank’s liquidity,
but have declined as a percentage of total assets during the past 30
years (41%-1970; 24%-2002)
– During past 30 years banks have used miscellaneous liabilities to
increase their liquidity