A bank deals in money and money substitutes; it also provides a range of financial services. In a formal sense, it borrows or receives “deposits” from firms, individuals, and (sometimes) governments and, on the basis of these resources, either makes “loans” to others or purchases securities, which are listed as “investments.” In general, it covers its expenses and earns its profits by borrowing at one rate of interest and lending at a higher rate. In addition, commissions may be charged for services rendered.
A bank is under an obligation to repay its customers’ balances either on demand or whenever the amounts credited to them become due. For this reason, a bank must hold some cash (which for this purpose may include balances at a bankers’ bank, such as a central bank) and keep a further proportion of its assets in forms that can readily be converted into cash. It is only in this way that confidence in the banking system can be maintained. In its turn, confidence is the basis of “credit.” Provided its promises are always honored (for example, to convert notes into gold or deposit balances into cash), a bank can “create credit” for use by its customers—either by issuing additional notes or by making new loans (which in turn become new deposits). A bank is able to do this because the public believes the bank can and will without question honor these promises, which will then be accepted at their face value and circulate as money. As long as they remain outstanding, these promises continue to constitute claims against that bank and can be transferred by means of checks or other instruments from one party to another. In essence, this is what is known as “deposit banking.” With some variations, it is the accepted basis of commercial banking as practiced in the modern world. Indeed, deposit banking cannot be said to exist as long as the assets held by a bank consist only of cash lodged by depositors. Once the accounts of banks begin to show more deposits than cash, part of these deposits must represent loans that have been made by a banker to his customers, that is, deposits created by the banking system.
Although no adequate documentation exists prior to the thirteenth century, banking is known to have a longer history. However, many of the early “banks” dealt primarily in coin and bullion, much of their business being concerned with money-changing and the supply of lawful foreign and domestic coin of the correct weight and fineness. A second and important group consisted of merchant-bankers who dealt not only in goods but also in bills of exchange, which provided for the remittance of money and the payment of accounts at a distance, without shipping actual coin. This was possible because many of these merchants had an international business and held assets at a number of points on the trading routes of medieval Europe. For a consideration, a merchant would be prepared to accept instructions to pay out money through an agent elsewhere to a named party, the amount of the bill of exchange to be debited by the agent to the merchant-banker’s account. In addition to the consideration paid, the merchantbanker would also hope to make a profit from the exchange of one currency for another. Since there was the possibility of loss, any profit or gain was not regarded as usurious. There were also techniques for making concealed loans by supplying foreign exchange at a distance but deferring payment for it until a later date. The interest charge was camouflaged by fluctuations in the rate of exchange between the date of ordering goods and the date of payment for them.
The acceptance of deposits was another early banking activity. These might relate either to the deposit of money or valuables merely for safekeeping or for purposes of transfer to another party or to the deposit of money in current account. A balance in current account might also represent the proceeds of a loan granted by the banker. Indeed, by oral agreement between the parties, recorded in the banker’s journal, a loan might be granted merely by allowing a customer to overdraw his account. In all these instances, a banker was held liable to meet on demand the claims of his depositors.
By the seventeenth century English bankers had begun to develop a depositbanking business, and the techniques evolved there and in Scotland were in due course to prove highly influential elsewhere. As men of wealth and reputation, the London goldsmiths already kept money and other valuables in safe custody for customers. They also dealt in bullion and foreign exchange and this led to their acquiring and sorting coin for profit. In order to attract coin for sorting, they offered to pay a rate of interest and, in this way, began to supplant as deposit bankers their great rivals the “money scriveners.” These were notaries who had come to specialize in bringing together borrowers and lenders and had themselves been accepting deposits.
It was soon discovered that when merchants deposited money with a goldsmith or scrivener they tended, as a group, to maintain their deposits at a fairly steady level; the goldsmith was able to “depend upon a course of Trade whereby Money comes in as fast as it is taken out.” In addition, customers preferred to leave their surplus money with the goldsmith and to hold only enough for their everyday needs. Hence, there was likely to be a fund of idle cash that could be lent out at interest to those who could use such money to advantage.
Invention of the check. There had also grown up a practice whereby the customer could arrange for the transfer to another party of part of his credit balance with his banker by addressing to him an order to this effect. This was the origin of the modern check (the earliest known example in England is dated 1670). It was but a short step from making a loan in specie to permitting customers to borrow by issuing checks. One technique was to debit a loan account with the full amount borrowed and immediately to credit an equivalent amount to a current account against which checks could be drawn. Alternatively, the customer might be permitted to overdraw his account. In the former case, interest was charged on the full amount placed to the debit of the loan account; in the latter, interest was charged only on the amount actually borrowed. But, in both cases, the customer was permitted to borrow by issuing checks in payment for goods or services. The checks represented claims against the bank, which had a corresponding claim against its customer.
Bank notes. Another means whereby a bank could create claims against itself was by issuing notes. If the volume of notes so issued exceeded the amount of specie or bullion held, additional money would have been created. The amount that was issued depended on the banker’s calculation of the possible demand from his customers for specie; the public would accept such notes only because of the banker’s known integrity. The evidence suggests that in London the goldsmith bankers were developing the use of the bank note at about the same time as the check, although the first bank notes in Europe were issued in 1661 by the Bank of Stockholm (later to become the Bank of Sweden). Some commercial banks are still permitted to issue their own notes, but most such issues have now been taken over by the central bank.
In Britain the check proved to be such a convenient means of payment that gradually the public came to prefer the use of checks for the larger part of their monetary transactions, using coin (and, later, notes) for the smaller kinds of payments. In consequence of this development, the banks grew bold and accorded their borrowers the right to draw checks far in excess of the amount of cash actually held. In other words, the banks were then creating “money”—claims that were generally accepted as means of payment. This money came to be known as “bank money” or “credit.” If bank notes are excluded, this money consists of figures in bank ledgers and is money only because of confidence in the ability of the banks to honor their liabilities when called upon to do so.
When a check is drawn and passed to another party in payment for goods or services, the check will usually be paid into another bank account, although certain checks may be cashed by direct presentation. If the check has been drawn by a borrower (and assuming that the overdraft technique is employed), the mere act of drawing and passing the check will create a loan as soon as the check is paid by the borrower’s banker. Because every loan so made tends to return to the banking system as a deposit, deposits will tend, for the system as a whole, to increase (and to decrease) approximately to the same extent as loans. If the money lent has been debited to a loan account and the amount of the loan has been credited to the customer’s current account, a deposit will be created immediately.
Negotiable instruments. In England, where the mercantile courts had greater scope than on the Continent, one of the most important factors in promoting the development of banking was the legal recognition of the negotiability of credit instruments. When orders of payment were first introduced in Europe they were certainly nonnegotiable, but in England many such orders were drawn in terms similar to those of a bill of exchange and, when the doctrine of negotiability had been established and accepted by the Courts of Common Law, the check was explicitly defined as a bill of exchange and recognized as a negotiable instrument. This helps to explain some of the differences between banking arrangements in Continental Europe and in Britain, as well as in countries influenced by British traditions. In particular, Continental limitations on the negotiability of an order of payment stood in the way of the extension of deposit banking based on the check that became such a feature of British development in the eighteenth and early nineteenth centuries. Meanwhile, Continental countries were developing a system of Giro payments, whereby transfers were effected on the basis of written instructions to debit the Giro account of the payer and to credit that of the payee.
Despite the above differences, the various banking systems have many similarities. This may be attributed to the fact that all banks trade in a type of “commodity” (money and money substitutes) that has particular characteristics. Thus, in all banking institutions (with the partial exception of those in the U.S.S.R. and those based on the same system), there is some emphasis on the need for liquidity (or the ease with which assets can be converted into cash without substantial loss) and on margins of safety in lending. Even where certain of the commercial banks are state owned (for example, in Australia, Egypt, France, and India), this has remained true.
It is more interesting, therefore, to establish why banking systems in the several countries do differ from one another, sometimes in quite material respects. The problems that face banks are much the same the world over but there is considerable variety in the solutions that are put forward to resolve them. Hence, it is in the details of organization and technique that one tends to find the differences. Yet there is a tendency for the differences to become less pronounced because of growing efficiency in international communication and the disposition to emulate practices that have proved successful elsewhere. Those differences that survive are largely the result of influences deriving from the economic and sociopolitical environment. These similarities and differences can be discussed in terms of: (a) the structure of commercial banking systems; and (b) the varying emphases in the types of business that are done by banks in different countries.
Although one must be careful not to oversimplify, it is possible to classify banking structures as falling within one or another of certain broad categories. For example, “unit banking” still describes fairly accurately the commercial banking arrangements that obtain over large areas in the United States, which has nearly fourteen thousand banks and not very many more bank branches. In a number of other countries it is more usual to find a small number of commercial banks, each of which operates a highly developed network of bank branches. In England and Wales, for example, only 11 banks (5 much larger than the rest) do nearly all the domestic banking business through more than 11,500 branches and agencies. Between these two extremes, there are many instances of “hybrid” systems, where the services of banks that are national in scope are supplemented by those that restrict their activities to either a region or a locality. Examples of such banking systems would be those of France and India. Although these hybrid systems are slowly changing their character (banks are tending to become fewer in number and individually larger, often with networks of branches), so far they have remained different enough from the two other main types of banking systems to warrant separate classification.
Unit banking—the United States
Over large areas of the United States, bank organization is still passing through a phase of structural development that many other countries went through some decades ago. This is not to deny that there has been much experimentation in the evolution of the American banking system, but its development has been subject to constraints that have certainly influenced the path that was chosen. For example, the United States has a federal form of government with a constitution that permits both federal and state legislatures to pass laws to regulate banking. A bank can, therefore, be subject to the banking laws of its own state as well as to those passed by the federal Congress. Some states permit branch banking (sometimes subject to restrictions); others prohibit it. Of itself, this has cut across any integrating forces operating on a nationwide basis. Thus the constitutional arrangements, reinforced by the political influence of small local bankers, provided the legal framework that encouraged the establishment and retention of a large number of unit banks. It must be emphasized that it was not federalism as such but the division of powers within the federation that constituted the barrier to concentration. In Australia, which also has a federal constitution, the federal government has exclusive power to legislate for all banking except that conducted by banks owned by a state government and operating within the state, and for the most part the laws relating to banks have been applied nationally. As it happens, there have been no legal impediments to the spread of branch banking in Australia, and this system is in fact well developed.
The initial establishment of a large number of banks in the United States was due to the scarcity of capital in relation to profitable opportunities for investment as the frontiers of settlement were pushed rapidly westward by the early pioneers. To satisfy the heavy demand for loans and for a medium of exchange, banks sprang up across the country. At this time, too, communications between the frontiers of settlement and the established centers of commerce and finance were still undeveloped. It was only with the coming of the railroads that east-west traffic expanded at all rapidly. Steady territorial expansion also converted the United States into a country of immense distances; there was an obvious need for a large number of banks to serve the diverse and rapidly expanding demands of a growing and constantly migrating population.
As long as communications remained imperfect, therefore, it is not difficult to explain the existence of large numbers of competing institutions. But why the subsequent failure of bank mergers or amalgamations to produce a concentration of financial resources in the hands of large banking units serving local needs through a network of branches? The retention of a primarily unit-banking system long after the barriers of distance had been broken down can be attributed in part to the federal constitution; disinclination to change was further strengthened by the widespread distrust of monopoly and the deep-rooted fear that a “money trust” might develop. There was wide acceptance of a political philosophy that emphasized the virtues of individualism and free competition. Moreover, restrictions on branching, bank mergers, and holding companies were a feature of both the state and federal banking laws. However, in parts of the United States bank branches are already numerous (especially in California, where branching is statewide; also in New York, although there the area covered by a branch network is restricted) and, despite regulation, a large number of bank mergers have been approved.
The demand for larger banking units is generally a concomitant of economic growth, with which may often be associated a rapid increase in population and its aggregation in industrial centers. A prior condition not only of growth but also of the integration of an economy and its financial institutions (without which larger units could scarcely emerge) is the development of adequate transport facilities and communications. Without efficient communications, banks could not clear checks drawn on other banks and effect their remittances easily and quickly. Branch banking is not necessarily a function of growth, but in England it was associated with it. Again, good communications were a prerequisite, in order to control branches at a distance. The Scots, for example, who from the establishment of the Bank of Scotland in 1695 favored the establishment of branches, were not initially very successful—primarily because of poor communications and the difficulty of moving adequate supplies of coin. It was not until after the Napoleonic Wars that these banks began to expand their branches with vigor. The banks then sought to overcome their difficulties by appointing as “agents” to take charge of their branches local men of standing and repute, for whom banking was often merely a sideline. Only much later, as communications improved, was responsibility for authorizing advances gradually shifted from the “agent” to the head office.
By the 1830s in England, the stream of industrial progress was running fast and already the size of the business unit was growing. A large number of small private banks were proving inadequate to meet the needs of an industrial structure no longer capable of financing itself. Bigger industrial units required financial units with greater resources, whether for lending or in the form of the more extensive connections essential to the provision of an increasing range of services. Small banks, unable to stand the strain of these enlarged demands, often became overextended and failed. This was the economic basis for the growth in bank size that was encouraged by legislation, beginning in 1826, permitting joint-stock ownership. The more widely spread proprietary, less exposed to the vagaries of human frailty, was a much more important influence on growth than limited liability, which at first—and until after the failure of the City of Glasgow Bank in 1878—was regarded with some suspicion.
Although most of the early joint-stock banks tended for some time to remain localized in their business, joint-stock ownership, latterly with limited liability, furnished the basis for the subsequent growth of the English banks in both resources and geographic coverage. These developments, which assisted in attracting deposits and in spreading the banking risk over a wider range of industries and areas, were undoubtedly encouraged by the competitive spirit and desire for personal power. They were greatly accelerated by the bank amalgamation movement that began during the nineteenth century and came to fruition during the first two decades of the twentieth century, giving Britain substantially the kind of banking system that it has today.
Different again from the unit banking of the United States and the primarily branch-banking systems of, for example, Britain, Australia, Canada, New Zealand, and South Africa are the hybrid banking systems. These are characterized by a small number of banks with branches throughout the country that hold the larger part of total deposits; the balance of deposits are lodged in a relatively large number of small banks. Although there are differences of degree and the long-term trend would seem to be toward concentrating bank deposits in fewer institutions, it has been found in many instances (for example, in France, Germany, Italy, the Netherlands, and India) that the number of the small banks decreases rather slowly. In Japan, where there is a small number of large city banks with branch networks and a larger number of local banks, there was a small increase in the total following World War ii and then virtual stability.
It is pertinent to inquire why the decrease should be slow and what obstacles exist to impede integration. Their precise character will vary from country to country; only a few examples can be offered here. These will be drawn from France and India. Frenchmen, for example, are individualists; this is reflected in the large number of small businesses that still exist and in the continuing demand for the small banking unit that can provide a more individual and personal service than the larger bank. Again, particularism is still strong in some parts of France; this manifests itself in support for local institutions. Moreover, the local banker can often attract business simply because of his special knowledge of the local industries and people; this enables him to accept risks that the big banks will decline. Also, in the past, the larger institutions in France preferred to open their own branches in new areas rather than to absorb local and regional banks.
In a less developed country like India, where a relatively large number of small banks still exists, there are other kinds of impediments. India is primarily an agricultural country, with an economic and social structure based largely on villages. These are often separated by both distance and poor communications. Integration of banking, based as it is on the spread of new ideas and institutions, is also impeded by the great barriers of ignorance and illiteracy; some degree of literacy is an obvious prerequisite for operating a bank account. In addition, there are the barriers of language and caste, as well as the difficulties that arise from joint family ownership (for example, when providing security for a bank loan). Again, habits of thrift are not easy to inculcate until incomes can be lifted sufficiently to provide a margin for saving. Hence the still strong preference for the indigenous banker with his flexible methods, and even for the moneylender. Both have existed for centuries. The indigenous banker, who is also a merchant, offers genuine banking services—accepting deposits (when available) and remitting funds; making loans quickly and with a minimum of formality; and, by means of the hundi (an indigenous credit instrument in promissory note form), financing a significant, if decreasing, part of India’s domestic trade and commerce.
It is hoped that the moneylender in India will gradually be displaced, however, by the development of a network of rural credit cooperatives, although in some areas progress has been very slow. In addition, as an act of policy and over a period of years, a progressively larger number of “pioneer” bank branches have been opened in rural areas, initially by the semipublic Imperial Bank of India and more recently by its nationalized successor, the State Bank of India. Meanwhile, many of the smaller banks that tend to serve the persons or concerns that initially sponsored them have begun to disappear.
Norway provides an interesting example of the effects on banking structure of physical geography. Almost everywhere the country is mountainous, and overland transport (especially in winter) is often difficult. Although airlines and telecommunications are beginning to knit the country together more effectively, it will be some time before improved communications can break down the particularisms that favor the continued existence of the local banks.
Yet in all these countries there is already evidence of much integration as a result of the steady growth in the size of branch networks, as well as in the share of total business done by the more important banks. Regional and local banks have been absorbed, a process that has been quickened by the need for larger resources than can be mustered by the smaller banks. In France, regional and some local banks have become associated with an institution in the capital. In India small banks have amalgamated on a regional basis, usually with the active encouragement of the Reserve Bank of India, which has hoped thereby to impart a greater degree of strength and stability to the Indian banking system. India has also encouraged the progressive extension of “pioneer branches,” a technique that has also been employed in Pakistan. In all these countries (as in the United States) there is widespread use of bank correspondents. Indeed, when banking systems are either of a unit or hybrid type, institutions must carry a rather higher proportion of total funds as balances with correspondents than do branch-banking institutions, in order to compensate the correspondent for providing a range of services that otherwise could be supplied only by setting up a local branch.
It remains to inquire into the degree to which there are variations in the types of business done by commercial banks in different countries and to establish the reasons for such differences. The essential characteristics of banking business can be most readily understood within the framework of a simple balance sheet.
The main liabilities are capital (including reserve accounts) and deposits—domestic and foreign—whether of corporations, firms, private individuals, other banks, or (sometimes) governments; whether repayable on demand (that is, sight or current accounts) or after the lapse of a period of time (time, term, or fixed deposits, but also including on occasion savings deposits).
The most important assets items are: cash, (which may be in the form of credit balances with other banks—for example, with the central bank or with correspondents); liquid assets, such as money at call and short notice, day-to-day money, short-term government paper (for example, Treasury bills and notes), and commercial bills of exchange, all of which may be readily converted into cash without risk of substantial loss; investments or securities (medium-term and long-term government securities, including those of local authorities such as states, provinces, or municipalities; also, in certain countries, participations and shares in industrial concerns); advances and loans to customers of all kinds, but primarily those in trade and industry, including in some countries term and mortgage loans (discounts, that is, discounted commercial bills of exchange, may sometimes be shown here, instead of under liquid assets); and premises, furniture, and fittings (usually written down to quite nominal figures).
A bank balance sheet must also include an item to cover contingent liabilities (for example, on bills of exchange whether “accepted” or endorsed by the bank); this will be exactly balanced by a “contra” item on the other side, representing the customer’s obligation to the bank (for which the bank might also have taken security). Virtually all banks of any size nowadays provide acceptance credits (sometimes called bankers’ acceptances), primarily to finance external trade. As the acceptor of a bill, a bank lends its name and reputation to it and thereby ensures the readier discount of paper that might otherwise have been difficult to place. A bank endorsement may serve a similar purpose.
Deposit banks, as their name suggests, operate largely on the basis of their deposits. These consist of borrowed money (and therefore liabilities), but insofar as an increase in deposits provides a banker with additional cash (an asset), this increase in cash will supplement his loanable resources. Capital and reserve accounts, which are the other important liability item, now serve primarily as the ultimate cover against losses (for example, on loans and investments). But they usually represent only a small part of the total liabilities of deposit banks. In the United States, the capital accounts are also significant as they provide the statutory basis of a bank’s lending limit to the individual borrower. However, those institutions concerned with investment banking (for example, the French banques d’affaires), a proportion of whose loans and industrial investment is likely to be long-term and therefore less liquid, must necessarily depend to a rather greater extent on their own capital resources.
For the banking system as a whole, an increase in deposits may arise in two ways: (a) if the banks increase their loans they will either transfer the money borrowed to a current account and create a new deposit directly or they will accord the borrower a limit up to which he may draw checks, which when they are deposited by third parties create a new deposit; or (b) the growth in deposits may stem from enlarged government expenditure financed by the central bank—claims on the government equivalent to cash will be paid into the commercial banks as deposits and their ownership thereby transferred from their initial recipients to the banks themselves. In the first case, as bank deposits increase, there is a related increase in the potential liability to pay out cash; in the second, the increase in deposits with the commercial banks will be accompanied by a corresponding increase in bank holdings of money claims equivalent to cash.
For the individual bank, an increase in its loans may result in a direct increase in deposits, either by transfer to a current account (as above) or by transfer to another customer of the same bank. Again, there will be an increase in the potential liability to pay out cash. But an increase in loans by another bank (including central bank loans to the government) may result in increased deposits with the first bank matched by a corresponding claim to cash (or its equivalent). Thus, the individual bank can generally expect that an increase in deposits will result in some net acquisition of cash or in a corresponding claim for receipt of cash from a third party. It is in this sense that an accretion to deposits provides the basis for further bank lending.
Except in countries where banks may still be small and insecure, the banks as a whole can usually depend on current account debits being offset very largely by the related credits, although an individual bank may from time to time experience marked fluctuations in its deposit totals. Further inertia may be added to the deposit structure by accepting money contractually for a fixed term or repayable only subject to notice. Nevertheless, at the banker’s discretion, funds may in fact be withdrawn prior to due date. Alternatively, a bank may lend against the security of such a deposit. Overdependence on foreign deposits, which tend to be more volatile than those of domestic origin, may have the opposite effect, since rumors from a distance are apt to prompt precipitate action.
Indeed, at all times, confidence in the banks is the true basis of stability. This is greatly enhanced where there exists a central bank prepared to act as “lender of last resort.” Deposit insurance (as in the United States and India) is another means of maintaining confidence as it protects the small depositor against loss in the event of a bank failure. This was also the ostensible purpose of the “nationalization” of bank deposits in Argentina from 1946 to 1957. The recipient bank acted merely as the agent of the government-owned and government-controlled central bank, all bank deposits being guaranteed by the state.
Cash and liquidity requirements. The essence of the banker-customer relationship is the banker’s undertaking to provide his customers with cash on demand or after an agreed period of notice. Hence the necessity to hold a cash reserve and to maintain a “safe” ratio of cash to deposits. This ratio may be established by convention (as in England) or by statute (as in the United States and elsewhere). In either case, the choice has been based on experience. However, where a minimum cash ratio is imposed by law a bank’s assets will in fact be impounded and, in the absence of any revision of the required ratio, be unavailable to meet sudden demands for cash by the bank’s customers. Indeed, the necessity to provide some dayto-day flexibility is one reason why required ratios are often based on the averaged cash holdings of an institution over a legally specified period.
One of the first bankers to publicize the importance of maintaining an adequate proportion of deposits in cash (or other liquid form) was George Rae; this was in 1875. Whatever the amount of cash held (short of covering demand deposits 100 per cent), no bank could meet depositors’ claims in their entirety if all customers were to exercise fully their rights to demand cash. If that were a common phenomenon, it would not be possible to base banking on the receipt of deposits. But for the most part the public is prepared to leave its surplus funds on deposit with the banks, confident that their money will be repaid as required. Nevertheless, there are occasions when unexpected demands for cash may exceed what might reasonably have been anticipated. A banker must, in consequence, always hold part of his assets in cash and a proportion of the remainder in assets that without significant loss can be quickly converted into cash. In theory, even his less liquid assets should be self-liquidating within a reasonable time.
While no banker can safely ignore the necessity to maintain adequate reserves of liquid assets, some tend to emphasize instead the desirability of limiting the sum of loans and investments to a certain percentage of deposits (say, to 70 per cent). They would feel “uncomfortable” if their loandeposit ratio were to run for any length of time at too high a level; investments are often regarded as something of a residual. But whichever ratio were adopted as a guide to action would matter little, since the effects would be much the same.
There are three main ways in which a bank’s assets may be mobilized: (a) loans may be “callable” (repayment may be demanded immediately or at short notice); (b) securities may be sold in an organized market; or (c) paper representing investments or loans may be discounted at the central bank or submitted as security for an advance. However, any precipitate calling in of loans would so disrupt the delicate nexus of debtor-creditor relations as to exaggerate the loss of confidence liable to occasion a run on the banks. So would heavy selling of marketable assets, with sharply falling prices and consequent losses. Ready cash may be obtainable only at a high price. Either the banks must maintain cash reserves and liquid assets at a high level, or there must exist a “lender of last resort” (for example, a central bank) able and willing (albeit subject to conditions) to provide the banks with cash, when required, in exchange for or against the security of eligible assets. In either event, liquid assets (including cash) are an essential component of the bank balance sheet, and, indeed, in some countries the commercial banks may be required to maintain a minimum liquid asset ratio. This is common, for example, in western European countries and also applies in effect to the English, Australian, and Canadian banks. In Asia, the requirement is usually limited to cash reserve ratios only, although Malaysia is an exception. A minimum liquid assets ratio has also been prescribed for commercial banks by several of the new African central banks (for example, in Ghana and Nigeria) and in Jamaica. At the same time, a central bank resorts to such requirements nowadays less as a means of maintaining appropriate levels of commercial bank liquidity than as a technique for influencing directly the lending potential of the banks.
The commercial banks rightly regard their investments (often consisting largely of medium-term government securities, but also sometimes including industrial shares and participations) as rather less liquid than money-market assets (such as call money and treasury bills). Nevertheless, by staggering their maturities, they are able to ensure that a portion of their holdings is regularly approaching redemption, thereby constituting a secondary liquid reserve. Following redemption at maturity, the banks usually reinvest all or most of this money by purchasing longerterm securities that in due course themselves become increasingly shorter-term. (In Britain, the average maturity of a bank investment portfolio is about five years; it is usually rather less in the United States.) But selling before maturity is also quite common—in order to vary the spread of maturities, or to restore a bank’s liquidity, or to expand loans. Because market conditions may be variable and longer maturity dates give less opportunity to avoid loss by holding securities to maturity, banks tend for balance-sheet purposes to “write down” the value of their investments (and other assets) and thereby to create “hidden reserves.” The essential difference between money-market assets and bank investments is that as a rule the liquidity of investments depends primarily on marketability (although sometimes it depends on the readiness of the government or its agent to exchange its own securities for cash), whereas the liquidity of money-market assets depends partly on marketability and partly on eligibility at the central bank. For this reason, money-market assets are more liquid.
Long-term finance. Where special investment banks exist (like the French banques d’affaires, although these also undertake a sizable deposit banking business, especially for firms in which they hold shares or any other kind of capital interest), or where the commercial banks are accustomed to finance long-term industrial developments (as in West Germany), it is no more than ordinary business prudence both to operate on the basis of relatively large capital funds (plus long-term deposits) and to value the relevant investments most conservatively. The risk of error and therefore of loss tends to increase with the period of the commitment, which after the initial technical investigation may begin as an interim credit to be converted later into a participation. Since one of the functions of these banks (which frequently organize themselves in consortiums or syndicates) is to “nurse” investments until a venture is well established, it may be necessary to hold such participations for long periods. Then, if in the bank’s judgment market conditions are deemed favorable, the original investment can be converted into marketable securities by arranging an issue of shares to the public. Nevertheless, even assuming the ultimate success of the issue, a bank may on occasion be obliged to hold such shares for long periods before being able to liquidate the bulk of its holdings and begin the process all over again. In fact, a banque d’affaires will often retain a sufficient percentage of a firm’s shares to ensure a degree of continuing control.
In contrast with Continental tradition, the long-term provision of industrial finance is usually referred in the countries of the British Commonwealth (including the United Kingdom) to specialist institutions, with the commercial banks providing part of the necessary capital. Except in the United States, where the banks are active competitors for this business, installment credit (hire-purchase finance) is also provided in most countries largely by specialist houses. In Japan, the long-term financial needs of industry are met partly by special industrial banks (which supplement their capital with the proceeds of debenture issues) and partly by the ordinary commercial banks (on the basis of the large volume of time deposits they attract).
Since World War II, term lending has been systematically developed in the United States, largely for the purpose of financing industrial re-equipment and growth. This policy owes its origin to the poor loan demand of the 1930s, when the banks sought to induce additional borrowing, especially at times when stock markets were unfavorable for new issues, by offering finance for a period of years. These loans, the majority of which have an effective maximum maturity of little more than five years, are subject to a formal agreement between the customer and (usually) a group of lending banks, sometimes in cooperation with other institutions, such as insurance companies. More recently, banks in several other countries (including Britain and Australia) have instituted term loans to finance exports and capital expenditure, both in industry and in agriculture.
Loans and advances. Yet even in countries where commercial banks do lend long-term to industry, it is the self-liquidating loans and advances that constitute the core (and often the most profitable part) of earning assets. Traditionally, much of this accommodation is of the “seed-time to harvest” kind, that is, provision of working capital, although there may be some temporary financing of fixed capital development pending arrangements to raise long-term finance elsewhere. Overdrafts, whereby a borrower may overdraw his account (or go into debit) up to an agreed limit, are the common means of bank lending in the United Kingdom and in a number of other countries. In theory they are temporary but usually renewable annually or repayable after due and reasonable notice has been given; in practice they may run on for long periods, depending on the character of the business being financed. The advance is reduced or repaid when credits are paid into the account, and recreated when new checks are drawn. The “cash credit” employed in India and Pakistan to finance the holding of stocks is similar. Even in countries where the overdraft predominates (for example, in Britain and the Netherlands), the method of debiting a loan account for credit to a current account may sometimes be used; checks are drawn on the current account, with interest payable on the whole amount of the loan (itself usually for a fixed period) instead of only on the amount actually overdrawn.
Elsewhere (for example, on the Continent and in the United States and Japan), bank finance is often made available short-term on the basis of discountable paper—commercial bills or promissory notes, often subject to a line of credit similar to an overdraft limit. This accommodation is also self-liquidating as it matures, although such paper may be renewable at the discretion of the lender. If eligible for rediscount at the central bank, it becomes virtually a liquid asset, unlike a bank advance or loan. Under both systems, finance may be made available with or without formal security, depending on the reputation and financial strength of the borrower. In many countries the customer may seek finance (and other services) from a number of banks (to protect their own interests these institutions will usually freely exchange information about joint credit risks), but in Britain and in the Netherlands the tendency is for all but the largest concerns to use the services of a single institution to meet the bulk of their banking needs.
Finally, we must consider the relations between the commercial banks and other types of financial intermediary that undertake quasi-banking business. In the days of “cloakroom” banking (lending out mainly such money as had in fact been deposited in cash), banks were not in any important sense “creators of money,” except to the extent of their note issues. In a similar way, installment credit (or hire-purchase) finance companies, mortgage banks, and building societies (or savings and loan associations) in effect lend out only what they receive and, since money deposited with them usually and with little delay finds its way back to the banks themselves, the existence of such intermediaries cannot seriously affect the level of bank deposits. Other institutions, such as local governmental and other authorities, collect savings to spend; these, again, reappear in bank accounts. Yet, although they may not “create money” in the same way as the commercial banks, nonbank financial intermediaries can be the means of activating otherwise idle balances (accumulated from savings in earlier periods) and can thereby add to the intensity of the use made of monetary assets. In large measure what they do is merely gather savings together and direct these (by lending them) into the hands of those who will use them. In this event they lend no more than savers decide to place with them from their current income receipts. Only to the limited extent that these intermediaries invest in government securities may deposits be lost to the banking system, just as when commercial undertakings buy treasury bills. However, during times of credit restriction, when bank lending has been significantly curtailed, the nonbank financial intermediaries have been able to increase their share of the types of loans also made by the banks. In that way they seriously compete with the latter for business that once lost is difficult to regain. In addition, the competition for new loan business has certainly been intensified by the growth of lending institutions other than banks, and in a number of countries banks have been forced either to acquire capital interests in finance companies or themselves to develop installment credit or hire-purchase business.
J. S. G. Wilson
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Banking Industry. A monograph prepared for the Commission on Money and Credit. Englewood Cliffs, N.J.: Prentice-Hall.
Beckhart, Benjamin H. (editor) 1954 Banking Systems. New York: Columbia Univ. Press.
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Crick, W. F. (editor) 1965 Commonwealth Banking Systems. Oxford: Clarendon.
Diamond, William 1957 Development Banks. Published for the International Bank for Reconstruction and Development, Economic Development Institute. Baltimore: Johns Hopkins Press.
Great Britain, Committee on Finance and Industry 1931 a Report. Papers by Command, Cmd. 3897. London: H.M. Stationery Office. → Commonly known as the Macmillan Report.
Great Britain, Committee on Finance and Industry 1931b Minutes of Evidence Taken Before the Committee. Vol. 1. London: H.M. Stationery Office.
Great Britain, Committee on the Working of the Monetary System 1959 Report. Papers by Command, Cmd. 827. London: H.M. Stationery Office. → Commonly known as the Radcliffe Report.
Great Britain, Committee on the Working of the MONETARY SYSTEM 1960a Minutes of Evidence. London: H.M. Stationery Office.
Great Britain, Committee on the Working of the Monetary System 1960b Principal Memoranda of Evidence. 3 vols. London: H.M. Stationery Office.
Jacoby, Neil H.; and Saulnier, R. J. 1947 Business Finance and Banking. National Bureau of Economic Research, Financial Research Program. Princeton Univ. Press.
Plumptre, Arthur F. W. 1940 Central Banking in the British Dominions. Toronto Univ. Press; Oxford Univ. Press.
Reserve bank of India, Committee of Direction of the All-India Rural Credit Survey 1954 All-India Rural Credit Survey. Bombay. → Volume 1: The Survey Report. Parts 1 and 2. Volume 2: The General Report. Volume 3: The Technical Report.
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"Banking." International Encyclopedia of the Social Sciences. 1968. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1G2-3045000078.html
"Banking." International Encyclopedia of the Social Sciences. 1968. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1G2-3045000078.html
Banks and Banking
BANKS AND BANKING
Authorized financial institutions and the business in which they engage, which encompasses the receipt of money for deposit, to be payable according to the terms of the account; collection of checks presented for payment; issuance of loans to individuals who meet certain requirements; discount ofcommercial paper; and other money-related functions.
Banks have existed since the founding of the United States, and their operation has been shaped and refined by major events in U.S. history. Banking was a rocky and fickle enterprise, with periods of economic fortune and peril, between the 1830s and the early twentieth century. In the late nineteenth century, the restrained money policies of the U.S. treasury department, namely an unwillingness to issue more bank notes to eastern-based national banks, contributed to a scarcity of cash in many Midwestern states. A few states went so far as to charter local banks and authorize them to print their own money. The collateral or capital that backed these local banks was often of only nominal value. By the 1890s, there was a full-fledged bank panic. Depositors rushed to banks to withdraw their money, only to find in many cases that the banks did not have the money on hand. This experience prompted insurance reforms that developed during the next fifty years. The lack of a regulated money supply led to the passage of the Federal Reserve Act in 1913 (found in scattered sections of 12 U.S.C.A.), creating the Federal Reserve Bank System.
Even as the banks sometimes suffered, there were stories of economic gain and wealth made through their operation. Industrial enterprises were sweeping the country, and their need for financing was seized upon by men like J.P. Morgan (1837–1913). Morgan made his fortune as a banker and financier of various projects. His House of Morgan was one of the most powerful financial institutions in the world. Morgan's holdings and interests included railroads, coal, steel, and steamships. His involvement in what we now consider commercial banking and securities would later raise concern over the appropriateness of mixing these two industries, especially after the stock market crash of 1929 and the ensuing instability in banking. Between 1929 and 1933, thousands of banks failed. By 1933, President franklin d. roosevelt temporarily closed all U.S. banks because of a widespread lack of confidence in the institutions. These events played a major role in the Great Depression and in the future reform of banking.
In 1933, Congress held hearings on the commingling of the banking and securities industries. Out of these hearings, a reform act that strictly separated commercial banking from securities banking was created (12U.S.C.A. §§ 347a, 347b, 412). The act became known as the glass-steagall act, after the two senators who sponsored it, carter glass (DVA) and Henry B. Steagall (D-AL). The Glass-Steagall Act also created the federal deposit insurance corporation (FDIC), which insures money deposited at member banks against loss. Since its passage, Glass-Steagall has been the law of the land, with minor fine-tuning on several occasions.
Despite the Glass-Steagall reforms, periods of instability have continued to reappear in the banking industry. Between 1982 and 1987, about 600 banks failed in the United States. Over one-third of the closures occurred in Texas. Many of the failed banks closed permanently, with their customers' deposits compensated by the FDIC; others were taken over by the FDIC and reorganized and eventually reopened.
In 1999, Congress addressed many concerns on many involved in the financial industries with the passage of the Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338, also known as the Gramm-Leach Act. The act rewrote the banking laws from the 1930s and 1950s, including the Glass-Steagall Act, which had prevented commercial banks, securities firms, and insurance companies from merging their businesses. Under the act, banks, brokers, and insurance companies are able to combine and share consumer transaction records as well as other sensitive records. The act went into effect on November 12, 2000, though several of its provisions did not take effect until July 1,2001. Seven federal agencies were responsible for rewriting regulations that implemented the new law.
Gramm-Leach goes beyond the repeal of the Glass-Steagall Act and similar laws. One section streamlines the supervision of banks. It directs the federal reserve board to accept existing reports that a bank has filed with other federal and state regulators, thus reducing time and expenses for the bank. Moreover, the Federal Reserve Board may examine the insurance and brokerage subsidiaries of a bank only if reasonable cause exists to believe the subsidiary is engaged in activities posing a material risk to bank depositors. The new law contains many more similar provisions that restrict the ability of the Federal Reserve Board to regulate the new type of bank that the law contemplates. The Gramm-Leach Act also breaks down barriers of foreign banks wishing to operate in the United States by allowing foreign banks to purchase U.S. banks.
Categories of Banks
There are two main categories of banks: federally chartered national banks and state-chartered banks.
A national bank is incorporated and operates under the laws of the United States, subject to the approval and oversight of the comptroller of the currency, an office established as a part of the Treasury Department in 1863 by the National Bank Act (12 U.S.C.A. §§ 21, 24, 38, 105, 121, 141 note).
All national banks are required to become members of the Federal Reserve System. The Federal Reserve, established in 1913, is a central bank with 12 regional district banks in the United States. The Federal Reserve creates and implements national fiscal policies affecting nearly every facet of banking. The system assists in the transfer of funds, handles government deposits and debt issues, and regulates member banks to achieve uniform commercial procedure. The Federal Reserve regulates the availability and cost of credit, through the buying and selling of securities, mainly government bonds. It also issues Federal Reserve notes, which account for almost all the paper money in the United States.
A board of governors oversees the work of the Federal Reserve. This board was approved in 1935 and replaced the Federal Reserve Board. The seven-member board of governors is appointed to 14-year terms by the President of the United States with Senate approval.
Each district reserve bank has a board of directors with nine members. Three nonbankers and three bankers are elected to each board of directors by the member bank, and three directors are named by the Federal Reserve Board of Governors.
A member bank must keep a reserve (a specific amount of funds) deposited with one of the district reserve banks. The reserve bank then issues Federal Reserve notes to the member bank or credits its account. Both methods provide stability in meeting customers' needs in the member bank. One major benefit of belonging to the Federal Reserve System is that deposits in member banks are automatically insured by the FDIC. The FDIC protects each account in a member bank for up to $100,000 should the bank become insolvent.
A state-chartered bank is granted authority by the state in which it operates and is under the regulation of an appropriate state agency. Many state-chartered banks also choose to belong to the Federal Reserve System, thus ensuring coverage by the FDIC. Banks that are not members of the Federal Reserve System can still be protected by the FDIC if they can meet certain requirements and if they submit an application.
The Interstate Banking and Branching Efficiency Act of 1994 (scattered sections of 12U.S.C.A.) elevated banking from a regional enterprise to a more national pursuit. Previously, a nationally chartered bank had to obtain a charter and set up a separate institution in each state where it wished to do business; the 1994 legislation removed this requirement. Also, throughout the 1980s and the early 1990s, a number of states passed laws that allowed for reciprocal interstate banking. This trend resulted in a patchwork of regional compacts between various states, most heavily concentrated in the New England states.
Types of Banks
The term bank is generally used to refer to commercial banks; however, it can also be used to refer to savings institutions, savings and loan associations, and building and loan associations.
A commercial bank is authorized to receive demand deposits (payable on order) and time deposits (payable on a specific date), lend money, provide services for fiduciary funds, issue letters of credit, and accept and pay drafts. A commercial bank not only serves its depositors but also can offer installment loans, commercial long-term loans, and credit cards.
A savings bank does not offer as wide a range of services. Its primary goal is to serve its depositors through providing loans for purposes such as home improvement, mortgages, and education. By law, a savings bank can offer a higher interest rate to its depositors than can a commercial bank.
A savings and loan association (S&L) is similar to a savings bank in offering savings accounts. It traditionally restricts the loans it makes to housing-related purposes including mortgages, home improvement, and construction, although, some S&Ls have entered into educational loans for their customers. An S&L can be granted its charter by either a state or the federal government; in the case of a federal charter, the organization is known as a federal savings and loan. Federally chartered S&Ls have their own system, which functions in a manner similar to that of the Federal Reserve System, called the Federal Home Loan Banks System. Like the Federal Reserve System, the Federal Home Loan Banks System provides an insurance program of up to $100,000 for each account; this program is called the Federal Savings and Loan Insurance Corporation (FSLIC). The Federal Home Loan Banks System also provides membership options for state-chartered S&Ls and an option for just FSLIC coverage for S&Ls that can satisfy certain requirements.
A building and loan association is a special type of S&L that restricts its lending to home mortgages.
The distinctions between these financial organizations has become narrower as federal legislation has expanded the range of services that can be offered by each type of institution.
Bank Financial Structure
Banks are usually incorporated, and like any corporation must be backed by a certain amount of capital (money or other assets). Banking laws specify that banks must maintain a minimum amount of capital. Banks acquire capital by selling capital stock to shareholders. The money shareholders pay for the capital stock becomes the working capital of the bank. The working capital is put in a trust fund to protect the bank's depositors. In turn, shareholders receive certificates that prove their ownership of stock in the bank. The working capital of a bank cannot be diminished. Dividends to shareholders must be paid only from the profits or surplus of the bank.
Shareholders have their legal relationship with a bank defined by the terms outlined in the contract to purchase capital stock. With the investment in a bank comes certain rights, such as the right to inspect the bank's books and records and the right to vote at shareholders' meetings. Shareholders may not personally sue a bank, but they can, under appropriate circumstances, bring a stockholder's derivative suit on behalf of the bank (sue a third party for injury done to the bank when the bank fails to sue on its own). Shareholders also are not usually personally liable for the debts and acts of a bank, because the corporate form limits their liability. However, if shareholders have consented to or accepted benefits of unauthorized banking practices or illegal acts of the board of directors, they are not immune from liability.
The election and term of office of a bank's board of directors are governed by statute or by the charter of the bank. The liabilities and duties of bank officials are prescribed by statute, charter, bylaws, customary banking practices, and employment contracts. Directors and bank officers are both responsible for the conduct and honorable management of a bank's affairs, although their duties and liabilities are not the same.
Officers and directors are liable to a bank for losses it incurs as a result of their illegal, fraudulent, or wrongful conduct. Liability is imposed for embezzlement, illegal use of funds or other assets, false representation about the bank's condition made to deceive others, or fraudulent purchases or loans. The failure to exercise reasonable care in the execution of their duties also renders officials liable if such failure brings about bank losses. If such losses result from an error in judgment, liability will not be imposed so long as the officials acted in good faith with reasonable skill and care. Officers and directors will not be held liable for the acts of their employees if they exercise caution in hiring qualified personnel and supervise them carefully. Civil actions against bank officials are maintained in the form of stockholders' derivative suits. Criminal statutes determine the liability of officers and directors for illegal acts against their bank.
The powers and duties of a bank are determined by the terms of its charter and the legislation under which it was created (either federal or state regulations). A bank can, through its governing board, enact reasonable rules and regulations for the efficient operation of its business.
Deposits A deposit is a sum of money placed in an account to be held by a bank for the depositor. A customer can deposit money by cash or by a check or other document that represents cash. Deposits are how banks survive. The deposited money establishes a debtor and creditor relationship between the bank and the depositor. Most often, the bank pays the depositing customer interest for its use of the money until the customer withdraws the funds. The bank has the right to impose rules and regulations managing the deposit, such as restrictions governing the rate of interest the deposited money will earn and guidelines for its withdrawal.
Collections A primary function of a bank is to make collections of items such as checks and drafts deposited by customers. The bank acts as an agent for the customer. Collection occurs when the drawee bank (the bank ordered by the check to make payment) takes funds from the account of the drawer (its customer who has written the check) and presents it to the collecting bank.
Checks A check is a written order made by a drawer to her or his bank to pay a designated person or organization (the payee) the amount specified on the check. Payment pursuant to the check must be made in strict compliance with its terms. The drawer's account must be reduced by the amount specified on the check. A check is a demand instrument, which means it must be paid by the drawee bank on the demand of, or when presented by, the payee or the agent of the payee, the collecting bank.
A payee usually receives payment of a check upon endorsing it and presenting it to a bank in which the payee has an account. The bank can require the payee to present identification to prove a relationship with the bank, before cashing the check. It has no obligation to cash a check for a person who is not a depositor, since it can refuse payment to a stranger. However, it must honor (pay) a check if the payee has sufficient funds on deposit with the bank to cover the amount paid if the drawer of the check does not have adequate funds in his or her account to pay it.
A certified check is guaranteed by a bank, at the request of its drawer or endorser, to be cashable by the payee or succeeding holder. A bank is not obligated to certify a check, but it usually will do so for a customer who has sufficient funds to pay it, in exchange for a nominal fee. A certified check is considered the same as cash because any bank must honor it when the payee presents it for payment.
A drawer can revoke a check unless it has been certified or has been paid to the payee. The notice of revocation is often called a stop payment order. A check is automatically revoked if the drawer dies before it is paid or certified, since the drawer's bank has no authority to complete the transaction under that circumstance. However, if the drawer's bank does not receive notice of the drawer's death, it is not held liable for the payment or certification of that drawer's checks.
Upon request, a bank must return to the drawer all the checks it has paid, so that the drawer can inspect the canceled checks to ensure that no forgeries or errors have occurred, in adjusting the balance of her or his checking account. This review of checks is usually completed through the monthly statement. If the drawer finds an error or forgery, it is her or his obligation to notify the bank promptly or to accept full responsibility for whatever loss has been incurred.
Bank liabilities A bank has a duty to know a customer's signature and therefore is generally liable for charging the customer's account with a forged check. A bank can recover the loss from the forger but not from the person who in good faith and without knowledge of the crime gave something in exchange for the forged check. If the depositor's negligence was a factor in the forgery, the bank can be excused from the liability.
A bank is also responsible for determining the genuineness of the endorsement when a depositor presents a check for payment. A bank is liable if it pays a check that has been materially altered, unless the alteration was due to the drawer's fault or negligence. If a bank pays a check that has a forged endorsement, it is liable for the loss if it is promptly notified by the customer. In both cases, the bank is entitled to recover the amount of its loss from the thief or forger.
A drawee bank that is ordered to pay a check drawn on it is usually not entitled to recover payment it has made on a forged check. If, however, the drawee bank can demonstrate that the collecting bank was negligent in its collection duties, the drawee bank may be able to establish a right of recovery.
A bank can also be liable for the wrongful dishonor or refusal to pay of a check that it has certified, since by definition of certification it has agreed to become absolutely liable to the payee or holder of the check.
If a bank has paid a check that has been properly revoked by its drawer, it must reimburse the drawer for the loss.
Drawer liabilities A drawer who writes a check for an amount greater than the funds on deposit in his or her checking account is liable to the bank. Such a check, called an overdraft, sometimes results in a loan from the bank to the drawer's account for the amount by which the account is deficient, depending on the terms of the account. In this case, the drawer must repay the bank the amount lent plus interest. The bank can also decide not to provide the deficient funds and can refuse to pay the check, in which case the check is considered "bounced." The drawer then becomes liable to the bank for a handling fee for the check, as well as remaining liable to the payee or subsequent holder of the check for the amount due. Many times, the holder of a returned, or bounced, check will impose another fee on the drawer.
Loans and Discounts A major function of a bank is the issuance of loans to applicants who meet certain qualifications. In a loan transaction, the bank and the debtor execute a promissory note and a separate agreement in which the terms and conditions of the loan are detailed. The interest charged on the amount lent can differ based on many variables. One variable is a benchmark interest rate established by the Federal Reserve Bank Board of Governors, also known as the prime rate, at the time the loan is made. Another variable is the length of repayment. The collateral provided to secure the loan, in case the borrower defaults, can also affect the interest rate. In any case, the interest rate must not exceed that permitted by law. The loan must be repaid according to the terms specified in the loan agreement. In case of default, the agreement determines the procedures to be followed.
Banks also purchase commercial papers, which are commercial loans, at a discount from creditors who have entered into long-term contracts with debtors. A creditor sells a commercial paper to a bank for less than its face value because it seeks immediate payment. The bank profits from the difference between the discount price it paid and the face value of the bond, which it will receive when the debtor has finished repaying the loan. Types of commercial paper are educational loans and home mortgages.
Many banks are replacing traditional checks and deposit slips with electronic fund transfer (EFT) systems, which utilize sophisticated computer technology to facilitate banking and payment needs. Routine banking by means of EFT is considered safer, easier, and more convenient for customers.
Many types of EFT systems are available, including automated teller machines; pay-by-phone systems; automatic deposits of regularly received checks, such as paychecks; automated payment of recurring bills; point-of-sale transfers or debit cards, where a customer gives a merchant a card and the amount is automatically transferred from the customer's account; and transfer and payment by customers' home computers.
When an EFT service is arranged, the customer receives an EFT card that will activate the system and the bank is legally required to disclose the terms and conditions of the account. These terms and conditions include the customer's liability and the notification process to follow if an EFT card is lost or stolen; the type of transactions in which a customer can take part; the procedure for correction of errors; and the extent of information that can be disclosed to a third party without improper infringement on the customer's privacy. If a bank is planning to change the terms of an account—for example, by imposing a fee for transactions previously conducted free of charge—the customer must receive written notice before the change will be effective.
Banks must send account statements for EFT transactions on a monthly basis. The statements must have the amount, date, and type of transaction; the customer's account number; the account's opening and closing balances; charges for the transfers or for continuation of the service; and an address and telephone number for referral of account questions or mistakes.
EFT transactions have become a highly competitive area of banking, with banks offering various bonuses such as no fee for the use of a card when the account holder meets certain provisions such as maintaining a minimum balance. Also, the rapid growth of personal and home office computing has increased pressure on banks to provide services on-line. Several computer software companies produce technology that can complete many routine banking services, like automatic bill paying, at a customer's home.
Banks have a wide range of options available for notifying a customer that a check has been directly deposited into her or his account.
If a customer has arranged for automatic payment of regularly recurring bills, like mortgage or utility bills, the customer has a limited period of time, usually up to three days before the payment is made, in which to order the bank to stop payment. When the amounts of such bills vary, as with utility bills, the bank must notify the customer of the payment date in sufficient time so that there will be enough funds in the account to cover the debt.
If the customer discovers a mistake in an account, the bank must be notified orally or in writing after the erroneous statement is received. The bank must investigate the claim.
Often, after several days, the customer's account will be temporarily recredited with the disputed amount. After the investigation is complete, the bank is required to notify the customer in writing if it concludes that no error occurred. It must provide copies of its decision and explain how it reached its findings. Then the customer must return the amount of the error if it was recredited to his or her account.
A customer is liable if an unauthorized transfer is made because an EFT card or other device is stolen, lost, or used without permission. This liability can be limited if the customer notifies the bank within two business days of the discovery of the misdeed; it is extended to $500 if the customer fails to comply with the notice requirement. A customer can assume unlimited liability if she or he fails to report any unauthorized charges to an account within a specified period after receiving the monthly statement.
A customer is entitled to sue a bank for compensatory damages caused by the bank's wrongful failure to perform the terms and conditions of an EFT account, such as refusing to pay a charge if the customer's account has more than adequate funds to do so. The customer can also recover a maximum penalty of $1,000, attorneys' fees, and costs in an action based upon violation of this law.
The expansion of the internet in the mid 1990s allowed banks to offer many more electronic services to their customers. Although this form of business with banks is certainly convenient, it has also caused a considerable amount of concern regarding the security of transactions conducted in this manner. Although laws designed to prevent fraud in traditional banking also apply to electronic banking, identifying individuals engaged in fraud can be more difficult when electronic transactions are concerned. On the federal level, the Electronic Funds Transfers Act, 15 U.S.C.A. §§ 1693a et seq., provides protection to consumers who are the subject of an unauthorized electronic funds transfer.
The Gramm-Leach-Bliley Financial Modernization Act, PL 106-102 (S 900) November 12, 1999. also modified federal statutory provisions related to electronic banking. Under this act, banks must now disclose the fees they charge for use of their automated teller machines. If the consumer is not provided with proper fee disclosure, an ATM operator cannot impose a service fee concerning any electronic fund transfer initiated by the consumer. Furthermore, the act requires that possible fees be disclosed to a consumer when an ATM card is issued.
Interstate Banking and Branching
In late 1994, the 103d Congress authorized significant reforms to interstate banking and branching law. The Interstate Banking Law (Pub. L. No. 103-328), also referred to as the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, provided the banking industry with major legislative changes. The Interstate Banking Act was expected to accelerate the trend of bank mergers. These mergers are a benefit to the nation's largest banks, which will likely see savings of millions of dollars resulting from streamlining.
Adler, Joseph. 1995. "Banking without Glass-Steagall? Look Overseas." American Banking Association Journal (May).
Bunditz, Mark. 2002. Consumer Banking and Payments Law. Boston: National Computer Law Center.
Lovett, William A. 2001. Banking and Financial Institutions in a Nutshell. St. Paul, Minn.: West. Timberlake, Richard H., Jr. 1993. Monetary Policy in the United States: An Intellectual and Institutional History. Chicago: Univ. of Chicago Press.
"Banks and Banking." West's Encyclopedia of American Law. 2005. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1G2-3437700458.html
"Banks and Banking." West's Encyclopedia of American Law. 2005. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1G2-3437700458.html
Banking and finance issues in the context of the modern Middle East.
Commercial banks are especially strategic intermediaries between enterprises and investors in most countries of the Middle East and Africa, where alternative sources of private capital, such as stock markets, are relatively underdeveloped. In most of these countries, the banks are also important instruments of political control and patronage. Structural adjustment, undertaken on the advice of international financial institutions since the mid-1980s, has not significantly altered the patterns of political control discussed in this article.
Although the basic instruments of European finance were probably imported from Egypt to Italy (and from there to the rest of Europe) in the early Middle Ages, Britain, followed by France, Germany, and other European powers, introduced modern banking into the region in the nineteenth century. European trading houses founded banks in Alexandria, Egypt, as early as 1842, shortly after the British obliged Muhammad Ali to dismantle his state monopolies. The British opened a bank in rİzmir, Turkey, in the same year. Moses Pariente, a Moroccan Jew operating under British consular protection out of Europe's trading entrepôt of Tangier, opened Morocco's first bank, a trading house tied to the Anglo-Egyptian Bank based in London and Gibraltar, in 1844.
Although Britain's İzmir venture failed, the Ottoman authorities took up the challenge to modernize their finances. The Porte (the Ottoman authorities) prevailed upon two sarraflar (money changers) to establish the Bank of Istanbul in 1847 to trade in sehim kaimesi (treasury bond documents), and Tunisia's infamous finance minister, Mahmud Bin Ayad, immediately followed suit with a central bank, Dar al-Mal, to issue treasury bills. But these experiments in central banking were short lived: Bin Ayad looted his bank and fled the country in 1852. Virtually all of the other commercial banks founded in the nineteenth century were European, and they displaced the moneychangers or, like the National Bank of Egypt, subcontracted with them for business in the informal agricultural sector. The oldest survivor into the twenty-first century is the Osmanli Bankasi (Ottoman Bank), originally founded in London in response to the Ottoman decree of 1856, inspired by Her Majesty's Government, calling for "banks and other similar institutions" to promote and monitor overseas loans to the Ottoman treasury. The Ottoman Bank acquired a distinctly French look after 1863, when a consortium led by Crédit Mobilier doubled its shares and renamed it the Banque Impériale Ottomane (Ottoman Imperial Bank). As the result of a merger in 2001, it became Turkey's ninth largest bank but is wholly owned by an even larger Turkish private sector bank. The National Bank of Egypt, founded in 1898 and nationalized by Gamal Abdel Nasser in 1964, is one of Egypt's two most powerful state banks. The only other recognizable remnant of nineteenth-century European imperialism is the Banque Franco-Tunisienne, founded in 1878 but barely surviving in the twenty-first century after years of mismanagement by a leading Tunisian public sector bank.
National Banking Systems
Banking was too strategic an industry to escape the control of national governments once they achieved a degree of economic and political independence from their foreign sponsors. The patterns of control varied with the political and economic strategies of the respective regimes. The monarchies tended to prefer indirect family control through their business interests, whereas the single-party states, such as Turkey in the 1930s, and Algeria, Egypt, Iraq, Syria, and Tunisia in the 1960s, established public sectors for absorbing most or all of the banks, whether they were foreign or locally owned. Iran followed suit after the revolution of 1979. Israel had to bail out its big banks in 1983 but succeeded in selling off the government's share in some of them. The only republic in the region to support a privately owned banking system is Lebanon. Until the Civil War broke out in 1975, Lebanon was the financial center and trading entrepôt for much of the Middle East. Its Bank Control Commission regulates the eighty or so commercial banks on behalf of the Banque du Liban, the country's central bank, and remains a model in the region for the professional supervision of banks.
Like Lebanon, the monarchies that survived the revolutions sweeping the Arab world in the 1950s and 1960s tended to conserve their banks as well as their ruling families, and they encouraged local businesspeople to gain control of the banks in the 1970s and 1980s, usually continuing a close association with their foreign founders. Until 2003, for instance, Citibank not only had a 30 percent interest in the Saudi American Bank but also a management contract. The leading Moroccan banks, despite the Moroccanization of commerce in 1973, have kept close ties with the French banks that founded them. In Jordan, the Arab Bank deserves special mention: Founded by Abd al-Hamid Shoman in Jerusalem in 1930, the bank survived the creation of Israel in 1948 and Jordan's subsequent takeover of the West Bank and East Jerusalem. It is not only the oldest locally owned bank but also one of the largest international ones to be based in an Arab country. The other large international players, such as Arab Banking Corporation, are based in the Persian Gulf states (see Table 1). Bahrain, a money-market center for offshore international banking since the mid 1970s, became the center for Islamic finance in the twenty-first century as well.
Many Muslims tend to distrust banks, either out of a general distrust of public institutions or because they object to interest on religious grounds. The banking systems that preserved continuity with their foreign origins tended to be more in touch with local depositors than the public sector monopolies that broke with the foreign banks. The percentage of money held in banks, rather than as cash under people's mattresses, was high in the Gulf Cooperation Council (GCC) city states and also in Israel, Lebanon, Turkey, and Iran—countries that had delayed or never gotten around to nationalizing their respective banking systems.
The small size of a country may ease the penetration of banks into household finance, but the banks of large countries like Turkey and Iran also substantially outperformed those in all Arab countries except Lebanon. Lebanon had always encouraged commercial banking, which became its virtual
|Country||Bank||Capital (US $m)||Total assets (US $m)||Capital assets ratio (%)||Return on assets (%)|
|Syria||Commercial Bank of Syria||730||66,215||1.1||0.2|
|Bahrain||Arab Banking Corporation||2,110||26,586||7.94||0.6|
|Saudi Arabia||National Commercial Bank||2,275||26,569||8.56||na|
|Egypt||National Bank of Egypt||1,027||22,631||4.54||0.61|
|Saudi Arabia||Saudi American Bank||2,243||20,623||10.87||2.91|
|Saudi Arabia||Riyad Bank||2,139||17,933||11.93||2.01|
|Bahrain||Gulf International Bank||1,236||15,232||8.11||0.61|
|Kuwait||National Bank of Kuwait||1,421||14,551||9.77||2.52|
|Saudi Arabia||Al Rajhi Banking & Investment Corporation||1,794||13,816||12.99||2.98|
|Saudi Arabia||Saudi British Bank||1,055||11,194||9.42||1.98|
|Saudi Arabia||Arab National Bank||887||10,785||8.23||1.2|
|Saudi Arabia||Al Bank Al Saudi Al Fransi||1,075||10,683||10.06||2.11|
|Egypt||Banque du Caire||358||9,422||3.8||0.39|
|U.A.E.||National Bank of Dubai||1,133||8,893||12.74||1.38|
|U.A.E.||National Bank of Abu Dhabi||878||8,782||10||1.96|
|Libya||Libyan Arab Foreign Bank||445||8,769||5.08||1.52|
|Qatar||Qatar National Bank||1,294||7,797||16.6||1.86|
|Kuwait||Kuwait Finance House||685||7,674||8.93||2.26|
|U.A.E.||Abu Dhabi Commercial Bank||1,035||7,241||14.3||2.35|
|Algeria||Banque Extérieure d'Algérie||244||7,116||3.43||0.11|
|Saudi Arabia||Saudi Hollandi Bank||550||6,721||8.18||1.96|
|Morocco||Crédit Populaire du Maroc||536||6,716||7.99||1.63|
|U.A.E.||Emirates Bank International||1,075||6,406||16.78||2.38|
|Egypt||Bank of Alexandria||322||6,225||5.18||0.55|
|Algeria||Banque Nationale d'Algérie||312||5,944||5.25||0.6|
|Algeria||Crédit Populaire d'Algérie||273||5,557||4.91||0.02|
|Kuwait||Commercial Bank of Kuwait||618||5,503||11.22||2.12|
|Lebanon||Banque de la Méditerranée||470||4,659||10.09||0.64|
|Morocco||Banque Commerciale du Maroc||441||4,313||10.23||2.14|
|Morocco||Banque Marocaine du Commerce Extérieur||449||4,199||10.7||1.11|
|U.A.E.||Dubai Islamic Bank||310||4,175||7.41||1.02|
|Egypt||Commercial International Bank (Egypt)||351||4,143||8.47||2.43|
|Bahrain||Ahli United Bank||542||4,103||13.22||1.34|
|Saudi Arabia||Saudi Investment Bank||594||4,073||14.59||1.99|
|Kuwait||Al-Ahli Bank of Kuwait||518||3,859||13.42||1.18|
|U.A.E.||Union National Bank||401||3,613||11.11||1.83|
|Kuwait||Bank of Kuwait & the Middle East||445||3,519||12.64||1.47|
|Bahrain||Bank of Bahrain & Kuwait||299||2,929||10.21||1.52|
|Egypt||Misr International Bank||232||2,910||7.99||1.92|
|Bahrain||National Bank of Bahrain||330||2,868||11.5||1.68|
|Egypt||Arab International Bank||405||2,746||14.75||0.38|
|Tunisia||Société Tunisienne de Banque||235||2,668||8.8||1.17|
|Oman||National Bank of Oman||245||2,472||9.89||-0.64|
|Egypt||Suez Canal Bank||166||2,450||6.77||0.94|
|Jordan||The Housing Bank for Trade and Finance||362||2,410||15.01||1.76|
|Tunisia||Banque Nationale Agricole||243||2,242||10.84||0.97|
|Country||Bank||Capital (US $m)||Total assets (US $m)||Capital assets ratio (%)||Return on assets (%)|
|Table by GGS Information Services, The Gale Group.|
|Egypt||Faisal Islamic Bank of Egypt||77||2,221||3.45||0.39|
|U.A.E.||Commercial Bank of Dubai||333||2,002||16.63||2.94|
|Jordan||Jordan National Bank||98||1,910||5.12||-0.03|
|Tunisia||Banque Internationale Arabe de Tunisie||156||1,810||8.62||1.55|
|Oman||Oman International Bank||229||1,749||13.08||0.38|
|Lebanon||Bank of Beirut & the Arab Countries||78||1,682||4.64||0.79|
|U.A.E.||Arab Bank for Investment & Foreign Trade||336||1,573||21.35||0.7|
|Egypt||National Bank for Development||95||1,567||6.05||0.89|
|Egypt||Egyptian American Bank||116||1,537||7.56||1.06|
|Egypt||National Société Générale Bank||125||1,487||8.41||2.27|
|Qatar||Commercial Bank of Qatar||182||1,431||12.71||1.94|
|Morocco||Crédit du Maroc||128||1,417||9.04||1.13|
|Saudi Arabia||Bank Al-Jazira||185||1,365||13.53||1.12|
|Jordan||Jordan Islamic Bank for Finance & Investment||76||1,280||5.9||0.15|
|Bahrain||Shamil Bank of Bahrain||258||1,242||20.8||1.69|
|Qatar||Qatar Islamic Bank||102||1,213||8.4||1.52|
|Tunisia||Banque du Sud||101||1,079||9.35||1.55|
|Jordan||Bank of Jordan||75||1,040||7.18||2.52|
|Egypt||Arab African International Bank||142||1,029||13.84||1.01|
|Tunisia||Banque de Tunisie||116||945||12.28||2.59|
|U.A.E.||First Gulf Bank||141||938||15.08||1.79|
|Bahrain||United Gulf Bank||214||931||23.01||0.43|
|Bahrain||Bahrain International Bank||176||888||19.78||-5.29|
|Egypt||Cairo Barclays Bank||64||877||7.3||1.49|
|Oman||Oman Arab Bank||100||832||12.01||2.14|
|Jordan||Jordan Kuwait Bank||76||804||9.44||1.78|
|U.A.E.||National Bank of Fujairah||151||718||21.1||2.66|
|Bahrain||Bahraini Saudi Bank||88||595||14.82||2|
|U.A.E.||National Bank of Sharjah||188||557||33.8||3.73|
|Egypt||Delta International Bank||108||544||19.88||5.9|
|U.A.E.||Bank of Sharjah||93||525||17.78||2.6|
|Egypt||Société Arabe Internationale de Banque||85||500||16.89||2.1|
|U.A.E.||United Arab Bank||117||484||24.08||4.04|
|U.A.E.||National Bank of Umm Al-Qaiwain||126||466||27.04||3.45|
|Bahrain||Albaraka Islamic Bank||62||260||23.83||1.06|
government during the anarchy of 1975 through 1990. Turkey systematically encouraged a Turkish private sector after 1924, and Iran delayed its revolutionary attack on privately owned banks until 1979, when the banks had already acquired substantial control over the country's money—a control that would be recovered in the 1990s (see Table 2).
Under the gun of international debt workouts after 1982 (but this time by international financial institutions rather than the nineteenth-century imperialists), most of the commercial banking systems in the region were partially liberalized in the 1990s. In the predominantly state-owned banking systems of Algeria, Egypt, and Tunisia, liberalization meant adding a satellite private sector, whereas reform in the monarchies tended to strengthen privately owned oligopolies in defense of their respective ruling families. The different regimes of the Middle East and North Africa were able to parry the international pressures for reform so as to reinforce rather than undermine their enduring authoritarian
|Table by GGS Information Services, The Gale Group.|
traits. Neither in Egypt nor Tunisia, for example, were the patronage operations of their respective state banks seriously threatened, nor has the Moroccan private sector escaped a business oligopoly that is partly owned by the Makhzan (royal treasury). But foreign competition may pose new challenges under measures that break down national barriers to financial services.
One response to global economic pressures is Islamic finance, designed to attract the savings of people who distrust conventional banks. Islamic banking emerged officially for the first time in Dubai in 1974, and two Saudi entrepreneurs, Prince Muhammad al-Faisal (son of the late King Faisal ibn Abd al-Aziz Al Saʿud) and Shaykh Salih Kamil, then projected such banks to over twenty countries, including the United Kingdom and Denmark, in the subsequent decade. In some of the less developed countries, such as Sudan and Yemen, the Islamic banking movement made important inroads. The Faisal Islamic Bank of Sudan enabled Hasan al-Turabi to cultivate new business networks that supported his seizure of power in 1989 (but then deserted him in 1999 when his military allies removed him). The wealthy Gulf countries, however, fuel most of the steady growth of these new institutions. In Saudi Arabia in particular, conventional banks have opened up Islamic windows to satisfy customers who reject interest as a matter of Islamic principle but who are eager to receive legitimate returns on investment. Most of the savings attracted by Islamic banks are just as likely, however, to be reinvested abroad, in the United States or Europe, as those of the conventional banks.
The international crackdown on money laundering after 11 September 2001 adversely affected Islamic banks because the Al-Baraka group of Shaykh Salih Kamil was confused with a company called AlBaraka in Somalia, which transferred workers' remittances but was also suspected by the U.S. Treasury of being associated with international terrorists. The United States, however, has put only one very marginal Sudanese Islamic bank on its blacklist, and the Islamic banks not only recovered after the shock of 11 September but increased their share in the wealthy Gulf markets to well over 10 percent of their respective commercial banking assets.
see also faisal ibn abd al-aziz al saʿud; lebanese civil war (1975–1990); nasser, gamal abdel; turabi, hasan al-.
Bistolfi, Robert. Structures économiques et indépendance monétaire. Paris: Editions Cujas, 1967.
Davison, Roderic H. Essays in Ottoman and Turkish History, 1774–1923. Austin: University of Texas Press, 1990.
Feis, Herbert. Europe: The World's Banker, 1970–1914. New Haven, CT: Yale University Press, 1930.
Fieldhouse, D. K. Economics and Empire, 1830–1914. London: Weidenfeld and Nicolson, 1973.
Henry, Clement M. The Mediterranean Debt Crescent: Money and Power in Algeria, Egypt, Morocco, Tunisia, and Turkey. Gainesville: University Press of Florida, 1996.
Henry, Clement M., and Wilson, Rodney, eds. The Politics of Islamic Finance. Edinburgh, U.K.: Edinburgh University Press, 2004.
Landes, David. Bankers and Pashas: International Finance and Economic Imperialism in Egypt. Cambridge, MA: Harvard University Press, 1958.
Snider, Lewis W. Growth, Debt, and Politics: Economic Adjustment and the Political Performance of Developing Countries. Boulder, CO: Westview, 1996.
Udovitch, Abraham L. Partnership and Profit in Medieval Islam. Princeton, NJ: Princeton University Press, 1970.
Warde, Ibrahim A. Islamic Finance in the Global Economy. Edinburgh, U.K.: Edinburgh University Press, 2000.
Clement Moore Henry
Henry, Clement Moore. "Banking." Encyclopedia of the Modern Middle East and North Africa. 2004. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1G2-3424600447.html
Henry, Clement Moore. "Banking." Encyclopedia of the Modern Middle East and North Africa. 2004. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1G2-3424600447.html
Banks and Banking
Banks and Banking
The banking sector of the economy can be viewed bottom-up or top-down. The top-down view shows central banks overseeing financial activities for the entire nation. Beneath them full-service national commercial banks conduct business. At the bottom of the system are small full-service community banks and specialized savings and loan institutions. Other specialized institutions, some regional, some local, fill in the fabric of banking. These include trusts and credit unions. Of greatest interest to the small business is the local community bank or the local branch of a national commercial bank.
THE FEDERAL RESERVE
Our central bank, the U.S. Federal Reserve, operates through 12 regional banks. The Fed, as it is known, provides services like check clearing; more importantly, it regulates the banking sector and sets monetary policy by managing credit and the money supply. Its principal aim is to hold inflation in check. The Fed uses three major tools to do this job. First, it sets the rate at which banks can borrow from the Federal Reserve. High rates discourage and low rates encourage economic activity. Second, under law the Federal Reserve sets "reserve requirements." The nation's banks must place a portion of their deposits with the Federal Reserve, e.g., 20 percent; they may only lend out the remainder. If the Fed increases the reserve requirement, that takes money out of the economy. Lowering reserve requirements makes money available. Third, the Federal Reserve engages in open market operations that indirectly affect reserves. It either sells or buys Treasury securities on the open market. Holding a Treasury bill is, in effect, a savings: it takes money out of circulation. Thus the Fed sells securities to "cool" and buys securities to "heat up" a sluggish economy. The Fed thus decreases or increases the money supply. Such activities are reflected in interest rate levels which, of course, affect the small business. In this manner even a very small business feels the activity of the Fed's activities.
Full-service commercial banks accept deposits from customers; the interest paid on such deposits is relatively low, but the funds up to a maximum of $100,000 are insured by the Federal Deposit Insurance Corporation, an entity created by Congress in 1933 to restore faith in the banking system during the Depression. The bank places a portion of its deposits with the Fed (the "reserve requirement," see above) and lends the rest to others at a higher rate of interest—be these loans to purchase cars, homes, or to finance business activities. Commercial banks also generate revenues from services such as asset management, investment sales, and mortgage loan maintenance. By their very nature, banks are conservative. Most of their lending is secured. So-called "investment bankers" that finance start-ups are not to be confused with commercial banks. They are other types of financial entities. A commercial bank may operate an investment banking business, but not as part of its regulated activities. Small businesses should not look to banks to obtain start-up capital.
Most commercial banks are operated as corporate holding companies that own one or several banks. Because of regulatory constraints, banks that are not associated with holding companies must operate under restrictions that often put them at a disadvantage compared with other financial institutions. Holding companies are often used as vehicles to circumvent legal restrictions and to raise capital by otherwise unavailable means. For instance, many banks can indirectly operate branches in other states by organizing their entity as a holding company. Banks are also able to enter, and often effectively compete in, related industries through holding company subsidiaries. In addition, holding companies are able to raise capital using methods from which banks are restricted, such as issuing commercial paper. Multibank holding companies may also create various economies of scale related to advertising, bookkeeping, and reporting.
Commercial banking in the United States has been characterized by: 1) a proliferation of competition from other financial service industries, such as mutual funds and leasing companies; 2) the growth of multibank holding companies; and 3) new technology that has changed the way that banks conduct business. The first two developments are closely related. Indeed, as new types of financial institutions have emerged to meet specialized needs, banks have increasingly turned to the holding company structure to increase their competitiveness. In addition, a number of laws passed since the 1960s have favored the multibank holding company format. As a result the U.S. banking industry had become highly concentrated in the hands of bank holding companies by the early 1990s.
Electronic information technology, the third major factor in the recent evolution of banking, is evidenced most visibly by the proliferation of electronic transactions. Electronic fund transfer systems, automated teller machines (ATMs), and computerized home-banking services all combined to transform the way that banks conduct business. Such technological gains have served to reduce labor demands and intensify the trend toward larger and more centralized banking organizations. They have also diminished the role that banks have traditionally played as personal financial service organizations. Finally, electronic systems have paved the way for national and global banking systems.
THRIFTS AND OTHER BANK-LIKE INSTITUTIONS
Savings banks, savings and loan associations (S&Ls), and credit unions are known as thrift institutions or simply as "thrifts." Like commercial banks, they are depository institutions but, under law, deal with individuals rather than businesses. Small businesses are unlikely to do business with thrifts.
Trust companies act as trustees, managing assets that they transfer between two parties according to the wishes of the trustor. Trust services are often offered by departments of commercial banks. Insurance companies and pension funds, which are really outside the banking sector strictly viewed, fulfill some bank-like functions such as the management of savings. They typically invest their assets but are not good sources of small business financing.
BANKS AND SMALL BUSINESSES
Small business is the fastest-growing segment of the American business economy. As a result, more and more commercial banks are creating special products and programs designed to attract small business customers. The small business owner looking for funds is best advised to seek out a local community bank. Tom Henderson, writing in Crain's Detroit Business, sums up the situation: "Name changes and consolidations among the area's biggest banks capture headlines, but industry and government analysts say the activity also creates big opportunities for community banks. Those banks continue to carve out a niche by providing loans and lines of credit to small and medium-sized businesses." Citing a 2004 report by the Federal Deposit Insurance Corporation, Henderson says that "small banks have an advantage in small-business lending because it requires 'local expertise that is both characteristic of community banks and more favorable to some small-business borrowers, such as new or young firms with limited credit history.'"
There are a number of factors a small business owner should consider when selecting a bank, including its accessibility, compatibility, lending limit, loan approval process, general services provided, and fees charged. Perhaps the best way to approach banks is to obtain referrals to business representatives or loan officers at three to five banks. This approach aids the small business owner by providing a recommendation or association from a known customer, and also by providing the name of a specific banker to talk to. The company's accountant, business advisors, and professional contacts will most likely be good sources of referrals.
The next step in forming a positive banking relationship is to arrange for a preliminary interview at each bank to get a feel for its particular personnel and services. It may be helpful to bring a brief summary of the business and a list of questions. The small business owner should also be prepared to answer the bankers' questions, including general information about the business, its primary goods/services, its financial condition, its banking needs, and the status of the industry in which it operates. All of these queries are designed to solicit information that will enable the institution to evaluate the small business as a potential client. After all the face-to-face meetings have taken place, the small business owner should compare each bank to the list of preferred criteria, and consult with his or her business advisors as needed. It is important to notify all the candidates once a decision has been made.
Ideally, a small business's banking relationship should feature open communication. Consultants recommend regular appointments to keep the banker updated on the business's condition, including potential problems on the horizon, as well as to give the banker an opportunity to update the small business owner on new services. The banker can be a good source of information about financing, organization, and record keeping. He or she may also be able to provide the small business owner with referrals to other business professionals, special seminars or programs, and networking opportunities.
The Federal Reserve Bank of St. Louis. "In Plain English: Making Sense of the Federal Reserve." Available from http://www.stls.frb.org/publications/pleng/default.html. Retrieved on 4 January 2006.
Henderson, Tom. "Banking on Small Business; Increased Lending to Small Business Lays the Groundwork for Growth of Community Banking." Crain's Detroit Business. 12 December 2005.
Koehler, Dan M. Insider's Guide to Small Business Loans. PSI Research, 2000.
Hillstrom, Northern Lights
updated by Magee, ECDI
"Banks and Banking." Encyclopedia of Small Business. 2007. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1G2-2687200050.html
"Banks and Banking." Encyclopedia of Small Business. 2007. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1G2-2687200050.html
banking, primarily the business of dealing in money and instruments of credit. Banks were traditionally differentiated from other financial institutions by their principal functions of accepting deposits—subject to withdrawal or transfer by check—and of making loans.
Types of Banks
Banks have traditionally been distinguished according to their primary functions. Commercial banks, which include national- and state-chartered banks, trust companies, stock savings banks, and industrial banks, have traditionally rendered a wide range of services in addition to their primary functions of making loans and investments and handling demand as well as savings and other time deposits. Mutual savings banks, until recently, accepted only savings and other time deposits, and offered limited types of loans and services. The fact that commercial banks were able to expand or contract their loans and investments in accordance with changes in reserves and reserve requirements further differentiated them from mutual savings banks, where the volume of loans and investments was governed by changes in customers' deposits. Membership in the Federal Deposit Insurance Corporation is compulsory for all Federal Reserve member banks but optional for other banks.
Other Financial Institutions
Types of financial institutions that have not traditionally been subject to the supervision of state or federal banking authorities but that perform one or more of the traditional banking functions are savings and loan associations, mortgage companies, finance companies, insurance companies, credit agencies owned in whole or in part by the federal government, credit unions, brokers and dealers in securities, and investment bankers. Savings and loan associations, which are state institutions, provide home-building loans to their members out of funds obtained from savings deposits and from the sale of shares to members. Finance companies make small loans with funds obtained from invested capital, surplus, and borrowings. Credit unions, which are institutions owned cooperatively by groups of persons having a common business, fraternal, or other interest, make small loans to their members out of funds derived from the sale of shares to members. The primary functions of investment bankers are to act as advisers to governments and corporations seeking to raise funds, and to act as intermediaries between these issuers of securities, on the one hand, and institutional and individual investors, on the other.
The International Bank for Reconstruction and Development (World Bank) was organized (1945) to make loans both to governments and to private investors. The discharge of debts between nations has been simplified and facilitated through the International Monetary Fund (IMF), which also provides members with technical assistance in international banking. The former European Monetary Agreement also made possible the rapid discharge of debts and balance of payments obligations between nations. The European Central Bank (see European Monetary System) was established in 1998 to help formulate the joint monetary policy of those European Union nations adopting a single currency.
A simple form of banking was practiced by the ancient temples of Egypt, Babylonia, and Greece, which loaned at high rates of interest the gold and silver deposited for safekeeping. Private banking existed by 600 BC and was considerably developed by the Greeks, Romans, and Byzantines. Medieval banking was dominated by the Jews and Levantines because of the strictures of the Christian Church against interest and because many other occupations were largely closed to Jews. The forerunners of modern banks were frequently chartered for a specific purpose, e.g., the Bank of Venice (1171) and the Bank of England (1694), in connection with loans to the government; the Bank of Amsterdam (1609), to receive deposits of gold and silver. Banking developed rapidly throughout the 18th and 19th cent., accompanying the expansion of industry and trade, with each nation evolving the distinctive forms peculiar to its economic and social life.
History in the United States
Early Years to the Federal Reserve
In the United States the first bank was the Bank of North America, established (1781) in Philadelphia. Congress chartered the first Bank of the United States in 1791 to engage in general commercial banking and to act as the fiscal agent of the government, but did not renew its charter in 1811. A similar fate befell the second Bank of the United States, chartered in 1816 and closed in 1836.
Prior to 1838 a bank charter could be obtained only by a specific legislative act, but in that year New York adopted the Free Banking Act, which permitted anyone to engage in banking, upon compliance with certain charter conditions. Free banking spread rapidly to other states, and from 1840 to 1863 all banking business was done by state-chartered institutions. In many Western states it degenerated into "wildcat" banking because of the laxity and abuse of state laws. Bank notes were issued against little or no security, and credit was overexpanded; depressions brought waves of bank failures. In particular, the multiplicity of state bank notes caused great confusion and loss. To correct such conditions, Congress passed (1863) the National Bank Act, which provided for a system of banks to be chartered by the federal government.
In 1865, by granting national banks the authority to issue bank notes and by placing a prohibitive tax on state bank notes, an amendment to the act brought all banks under federal supervision. Most banks in existence did take out national charters, but some, being banks of deposit, were unaffected by the tax and continued under their state charters, thus giving rise to what is generally known as the "dual banking system." The number of state banks expanded rapidly with the increasing use of bank checks.
Recurrent banking panics caused by overexpansion of credit, inadequate bank reserves, and inelastic currency prompted Congress in 1908 to create the National Monetary Commission to investigate the banking and currency fields and to recommend legislation. Its suggestions were embodied in the Federal Reserve Act (1913), which provided for a central banking organization, the Federal Reserve System (see also central bank).
Since the establishment of the Federal Reserve system, federal banking legislation has been limited largely to detailed amendments to the National Bank and Federal Reserve acts. The Glass-Steagall Act of 1932 and the Banking Act of 1933 together formed an extensive reform measure designed to correct the abuses that had led to numerous bank crises in the years following the stock market crash of 1929. The Glass-Steagall Act prohibited commercial banks from involvement in the securities and insurance businesses. The Banking Act strengthened the powers of supervisory authorities, increased controls over the volume and use of credit, and provided for the insurance of bank deposits under the Federal Deposit Insurance Corporation (FDIC). The Banking Act of 1935 strengthened the powers of the Federal Reserve Board of Governors in the field of credit management, tightened existing restrictions on banks engaging in certain activities, and enlarged the supervisory powers of the FDIC.
Deregulation, Bank Failures, and New Technology
Several deregulatory moves made by the federal government in the 1980s diminished the distinctions among various financial institutions in the United States. Two major changes were the Depository Institutions Deregulation and Monetary Control Act (1980) and the Depository Institutions Act (1982), which allowed savings and loan associations to engage in often-risky commercial loans and real estate investments, and to receive checking deposits. By 1984, banks had federal support in buying discount brokerage firms, and commercial banks were beginning to acquire failed savings banks; in 1985 interstate banking was declared constitutional.
Such deregulation was blamed for the unprecedented number of bank failures among savings and loan associations, with over 500 such institutions closing between 1980 and 1988. The Federal Savings and Loan Insurance Corporation (FSLIC), until it became insolvent in 1989, insured deposits in all federally chartered—and in many state-chartered—savings and loan associations. Its outstanding insurance obligations in connection with savings and loan failures, over $100 billion, were transferred (1989) to the FDIC.
Further deregulation occurred in 1999, when Congress overhauled the entire U.S. financial system. Among other actions, the legislation repealed the Glass-Steagall Act, thus allowing banks to enter the insurance and securities businesses. Supporters predicted that the measure would permit U.S. banks to diversify and compete more effectively on an international scale. Opponents warned that this deregulation could lead to failures of many financial institutions, as had occurred with the savings and loans, and many blamed banking deregulation for the financial crisis that began in 2007. Extensive government intervention was required to maintain financial stability, and the crisis nonetheless resulted in an increase in failed and troubled banks, with the number of troubled banks higher than it had been in 15 years by 2009.
In the last decades of the 20th cent., computer technology transformed the banking industry. The wide distribution of automated teller machines (ATMs) by the mid-1980s gave customers 24-hour access to cash and account information. On-line banking through the Internet and banking through automated phone systems now allow for electronic payment of bills, money transfers, and loan applications without entering a bank branch.
See L. Schweikart, ed., Banking and Finance, 1913–1989 (1990); C. J. Woelfel, ed., Encyclopedia of Banking and Finance (10th 1994); C. W. Calomiris and S. H. Haber, Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (2014).
"banking." The Columbia Encyclopedia, 6th ed.. 2016. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1E1-banking.html
"banking." The Columbia Encyclopedia, 6th ed.. 2016. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1E1-banking.html
Banking is the name given to the activities of banks. The word bank is derived from the Italian banca, which means bench. Moneylenders in Northern Italy originally did business in open rooms or areas, with each lender working from his own bench or table. In the modern era banks are financial firms that simultaneously issue deposits, make loans, and create money.
A deposit is issued when a household or a business brings cash or currency to a bank in exchange for an equivalent amount of stored value, which can either be used to meet payment obligations or saved for future expenditure needs. Loan making is a form of credit. Credit comes into being when one economic unit (the creditor) authorizes another (the debtor) to acquire goods prior to paying for the goods received. A bank makes a loan when it authorizes a borrower to make expenditures on the bank’s account up to a contractually agreed maximum level, in exchange for repayment of these advances later in time. Loans are usually made for expenditure purposes that are agreed on in advance (for example, the purchase of housing or of education services). Borrowers are normally authorized to use loan funds for a certain period of time and are required to repay the amount of the loan plus some amount of interest, which reflects the cost of the loaned funds. Common types of loans are workingcapital loans, used by businesses primarily for buying supplies and making wage payments, and mortgage loans, which provide long-term funds (often for a duration of thirty years) for purchasing residences.
There are two principal types of bank deposits. Demand deposits are used primarily to handle transaction needs. They are completely liquid, as they can be withdrawn at will and without notice by the deposit holder. Time deposits are used primarily to store savings. They are less liquid than demand deposits, as they are normally contracted for fixed time periods (often six months or one year). In compensation for this loss of liquidity, those holding time deposits receive compensation in the form of (higher) interest payments.
The process of making loans may create money. A financial institution creates money in making loans when it creates demand deposits that can be spent by its borrowers. These borrowers did not possess these deposits before receiving loans, nor were these deposits taken from any of the bank’s deposit customers. The ability to create money by making loans makes banks’ behavior procyclical: Their loan making tends to expand when the economy is growing, further accelerating growth, and to slow when the economy does.
Banking is heavily regulated for two reasons. First, maintaining an orderly economy requires maintaining reliable transaction processes and financial markets, and banks are at the heart of these processes and markets. Second, banks are a source of instability within the economy. The default risks inherent in loan making interact with banks’ ability to expand the money supply through loan making. In a worst-case scenario, unsound bank loan making (or choices of other assets) can weaken an economy and subject it to bank or currency runs, and/or expose an economy to stagnation, deflation, and even recession.
Banking has always been a heavily regulated field of activity. For one, banks typically require a bank charter issued by regulators. Moreover, every economy normally has a central bank, which attempts to control money and credit growth and which is responsible for rescuing the banking system in times of acute crisis. Regulation is especially important at the beginning of the twenty-first century, because banks’ behavior in loan making has changed so much over time. From the 1930s to the 1960s, banks were relatively cautious. They made loans up the amount of their excess reserves, that is, the amount of currency on hand beyond that needed to meet its deposit customers’ normal withdrawal demands. Over time, banks became more aggressive in finding funds to lend. Banks evolved the practice of liability management, in which they set targets for asset and loan growth and reach those targets by borrowing reserves, primarily from other banks in the interbank market.
Banks have also become more aggressive in loan making, as a result in part of their deepening links to financial centers such as Fleet Street and Wall Street. Since the late 1970s, banks have competed to make loans in hot markets, including overseas borrowers. This has led to severe crises of loan repayment and refinancing, the most spectacular cases being the Latin American debt crisis of the 1980s and the East Asian financial crisis of 1997–1998 (Stiglitz 2003). Despite these recurring crises, banks continually push into new areas of loan making, searching for new ways to earn revenue. In the 1990s and 2000s, banks have increasingly extended personal credit (often via credit cards), and have gotten involved in such nonbanking activities as derivatives and options, mutual funds and insurance.
The recurring problems in loan markets have made banking behavior a central topic in economic research. One key question is why lending booms and busts occur; another is why borrowers default (that is, are unable to repay loans according to their contractual obligations). Economists focusing on the first question have emphasized that banks are driven by competition to overlend in boom periods, leading to rising financial fragility (more debt obligations relative to available income), which eventually triggers a downturn (Minsky 1982). Economists addressing the second question focus on the distribution of information in credit markets; they emphasize that borrowers may seek to cheat lenders, and that banks may not accurately determine which potential borrowers are competent and which are not (Freixas and Rochet 1997). Banks can avoid default by extracting timely information about borrowers, their competence, and their intentions. Yet the social neutrality of the criteria that banks use to decide which borrowers are creditworthy has been called into question. Economic studies have generated substantial evidence that banks sometimes treat racial minorities, residents of minority and lower-income communities, and even disadvantaged regions unfairly in their credit-market decisions (Austin Turner and Skidmore 1999).
SEE ALSO Financial Markets; Loans; Overlending
Austin Turner, Margery, and Felicity Skidmore, eds. 1999. Mortgage Lending Discrimination: A Review of Existing Evidence. Washington, DC: Urban Institute.
Freixas, Xavier, and Jean-Charles Rochet. 1997. The Microeconomics of Banking. Cambridge, MA: MIT Press.
Minsky, Hyman. 1982. Can “It” Happen Again? Armonk, NY: M. E. Sharpe.
Stiglitz, Joseph E. 2003. Globalization and Its Discontents. New York: Norton.
Gary A. Dymski
"Banking." International Encyclopedia of the Social Sciences. 2008. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1G2-3045300158.html
"Banking." International Encyclopedia of the Social Sciences. 2008. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1G2-3045300158.html
Monarchs had borrowed from merchants and landowners for centuries. By the late 17th cent., constitutional changes, particularly the growth of parliamentary power over government expenditures, required a more regulated framework. The Bank of England, founded in 1694, gave the government and other users of credit access to English funds. Similar developments occurred in Scotland and Ireland. These banks remained without serious competition until the later 18th cent., when expanding commercial and manufacturing activities gave scope to merchants, brewers, and landowners to establish banks based on their own cash reserves. These commercial banks took deposits, made loans, usually for limited periods, and issued promissory notes whose value was backed by bullion in the vaults combined with a fiduciary issue which depended on the likely scale of withdrawals. Errors of judgement sometimes occurred and ‘runs on the bank’ took place when depositors feared for the security of their money and demanded its return.
Fluctuations in the value of money because of the return to a gold-based currency after the end of the Napoleonic wars (1815) precipitated a series of crises. To stabilize the currency the government eventually introduced the 1844 Bank Charter Act, which gave the Bank of England two functions, that of supervising the note issue as part of the currency and that of monitoring the activities of the banking system. Regulatory powers were put in place in 1845 to control banking in Scotland and Ireland.
From their earliest days, banks required loyal staff who did not accept bribes, steal money, or give information about accounts to unauthorized persons. Literate and numerate staff received high salaries, retirement pensions, and various privileges including holidays and social facilities. Their work required systematic record keeping which grew in volume and complexity during the 19th cent. when cheques replaced banknotes for many business transactions. In 1773 banks established the London Clearing House to process cheques rapidly.
In the 19th cent., overseas trade and the expanding British empire reinforced the place of London as a centre of merchant banking. The probity, knowledge, and skills of these specialist bankers attracted business from foreign firms and governments seeking loans in Britain. Some British firms employed merchant banks to arrange their supply of capital finance. This usually involved share or bond issues which were traded on the stock markets. Such arrangements made possible the rapid development of railways, heavy engineering, mines, and large commercial developments. Many of these merchant banks survive, including Rothschilds, Lazard Brothers, Baring, Kleinwort Benson, and Schroders. Internal commerce and trade were funded mainly by a larger number of separate local banks which, after the middle of the 19th cent., became consolidated into a much smaller number of banks covering much of England. Numbers continued to diminish so that by 1980 banking was dominated by four companies: Barclays, Lloyds, Midland, and National Westminster.
London's dominance as the banking centre, not only of Britain but of the financial world, was not challenged until the 20th cent. with the growth of competing international economies such as the USA and Japan. None the less, London remains a major centre of merchant banking.
Within Britain, banking has been characterized, largely because of technological innovation, by an increasingly sophisticated provision of traditional banking services and an expansion of services associated with consumer credit. The business of safeguarding and lending money is often arranged through machine-readable cards and continuous access by telephone. Since the Financial Services Act of 1986, banks face more competition with many banking services being provided by building societies, trustee savings banks, and the Post Office.
Ian John Ernest Keil
JOHN CANNON. "banking." The Oxford Companion to British History. 2002. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1O110-banking.html
JOHN CANNON. "banking." The Oxford Companion to British History. 2002. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O110-banking.html
"banking." World Encyclopedia. 2005. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1O142-banking.html
"banking." World Encyclopedia. 2005. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O142-banking.html
bank·ing / ˈbangking/ • n. the business conducted or services offered by a bank: with this account, you are entitled to free banking. ∎ the occupation of a banker: [as adj.] to pursue a banking career.
"banking." The Oxford Pocket Dictionary of Current English. 2009. Encyclopedia.com. (May 25, 2016). http://www.encyclopedia.com/doc/1O999-banking.html
"banking." The Oxford Pocket Dictionary of Current English. 2009. Retrieved May 25, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O999-banking.html