Bank

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A bank is a financial institution licensed by a government. Its primary activity is to lend money.

Many other financial activities were allowed over time. For example banks are important players in financial markets and offer financial services such as investment funds. In some countries such as Germany, banks have historically owned major stakes in industrial corporations while in other countries such as the United States banks are prohibited from owning non-financial companies. In Japan, banks are usually the nexus of a cross-share holding entity known as the zaibatsu. In France, bancassurance is prevalent, as most banks offer insurance services (and now real estate services) to their clients.

The level of government regulation of the banking industry varies widely, with counties such as Iceland, the United Kingdom and the United States having relatively light regulation of the banking sector, and countries such as China having relatively heavier regulation (including stricter regulations regarding the level of reserves).

Here are the top 20 banks from the benchmark annual rankings by The Banker magazine of the world’s top 1,000 banks. Tier 1 capital in $ billions. Left column with government support and right column without government support.

Image:Top 20 banks.jpg

The top 10 bank losses for 2008 in $ billions from the benchmark annual rankings by The Banker magazine of the world’s top 1,000 banks.

Image:Top 10 bank losses.jpg


Contents

History

The first state deposit bank, Banco di San Giorgio (Bank of St. George), was founded in 1407 at Genoa, Italy.[1] [2](ISBN 978-0-275-96777-2)

Origin of the word

The name bank derives from the Italian word banco "desk/bench", used during the Renaissance by Florentine bankers, who used to make their transactions above a desk covered by a green tablecloth.[3] However, there are traces of banking activity even in ancient times.

In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders would set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are derived.

As a moneychanger, the merchant at the bancu did not so much invest money as merely convert the foreign currency into the only legal tender in Rome—that of the Imperial Mint. ("Ancient Rome on Five Denarii a Day", Thames & Hudson, 2007)

The earlierst evidence of money-changing activity is depicted on a silver drachm coin from ancient hellenic colony Trapezus on the Black Sea, modern Trabzon, c. 350-325 BC, presented in the British Museum in London. The coin shows a banker's table (trapeza) laden with coins, a pun on the name of the city.

In fact, even today in modern Greek the word Trapeza (Τράπεζα) means both a table and a bank.

Traditional banking activities

Banks act as payment agents by conducting checking or current accounts for customers, paying checks drawn by customers on the bank, and collecting checks deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and Automated teller machine.

Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending.

Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account.

Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings to.

Definition

The definition of a bank varies from country to country.

Under English common law, a banker is defined as a person who carries on the business of banking, which is specified as:

  • conducting current accounts for his customers
  • paying cheques drawn on him, and
  • collecting cheques for his customers.

In most English common law jurisdictions there is a Bills of Exchange Act that codifies the law in relation to negotiable instruments, including checks, and this Act contains a statutory definition of the term banker: banker includes a body of persons, whether incorporated or not, who carry on the business of banking' (Section 2, Interpretation). Although this definition seems circular, it is actually functional, because it ensures that the legal basis for bank transactions such as checks do not depend on how the bank is organised or regulated.

The business of banking is in many English common law countries not defined by statute but by common law, the definition above. In other English common law jurisdictions there are statutory definitions of the business of banking or banking business. When looking at these definitions it is important to keep in mind that they are defining the business of banking for the purposes of the legislation, and not necessarily in general. In particular, most of the definitions are from legislation that has the purposes of entry regulating and supervising banks rather than regulating the actual business of banking. However, in many cases the statutory definition closely mirrors the common law one. Examples of statutory definitions:

  • "banking business" means the business of receiving money on current or deposit account, paying and collecting cheques drawn by or paid in by customers, the making of advances to customers, and includes such other business as the Authority may prescribe for the purposes of this Act; (Banking Act (Singapore), Section 2, Interpretation).
  • "banking business" means the business of either or both of the following:
  1. receiving from the general public money on current, deposit, savings or other similar account repayable on demand or within less than [3 months] ... or with a period of call or notice of less than that period;
  2. paying or collecting cheques drawn by or paid in by customers(Banking Ordinance, Section 2, Interpretation, Hong Kong) Note that in this case the definition is extended to include accepting any deposits repayable in less than 3 months, companies that accept deposits of greater than HK$100 000 for periods of greater than 3 months are regulated as deposit taking companies rather than as banks in Hong Kong).

Since the advent of EFTPOS (Electronic Funds Transfer at Point Of Sale), direct credit, direct debit and internet banking, the check has lost its primacy in most banking systems as a payment instrument. This has led legal theorists to suggest that the cheque based definition should be broadened to include financial institutions that conduct current accounts for customers and enable customers to pay and be paid by third parties, even if they do not pay and collect cheques. e.g. Tyree's Banking Law in New Zealand, A L Tyree, LexisNexis 2003, page 70.

Accounting for bank accounts

Bank statements are accounting records produced by banks under the various accounting standards of the world. Under GAAP and IFRS there are two kinds of accounts: debit and credit. Credit accounts are Revenue, Equity and Liabilities. Debit Accounts are Assets and Expenses. This means you credit a credit account to increase its balance, and you debit a debit account to increase its balance.[4]

This also means you debit your savings account every time you deposit money into it (and the account is normally in deficit), while you credit your credit card account every time you spend money from it (and the account is normally in credit).

However, if you read your bank statement, it will say the opposite—that you credit your account when you deposit money, and you debit it when you withdraw funds. If you have cash in your account, you have a positive (or credit) balance; if you are overdrawn, you have a negative (or deficit) balance.

The reason for this is that the bank, and not you, has produced the bank statement. Your savings might be your assets, but the bank's liability, so they are credit accounts (which should have a positive balance). Conversely, your loans are your liabilities but the bank's assets, so they are debit accounts (which should have a also have a positive balance).

Where bank transactions, balances, credits and debits are discussed below, they are done so from the viewpoint of the account holder—which is traditionally what most people are used to seeing.

Wider commercial role

The commercial role of banks is not limited to banking, and includes:

  • issue of banknotes (promissory notes issued by a banker and payable to bearer on demand)
  • processing of payments by way of telegraphic transfer, EFTPOS, internet banking or other means
  • issuing bank drafts and bank cheques
  • accepting money on term deposit
  • lending money by way of overdraft, installment loan or otherwise
  • providing documentary and standby letters of credit (trade finance), guarantees, performance bonds, securities underwriting commitments and other forms of off-balance sheet exposures
  • safekeeping of documents and other items in safe deposit boxes
  • currency exchange
  • acting as a 'financial supermarket' for the sale, distribution or brokerage, with or without advice, of insurance, unit trusts and similar financial products

Economic functions

The economic functions of banks include:

  1. issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customer's order. These claims on banks can act as money because they are negotiable and/or repayable on demand, and hence valued at par. They are effectively transferable by mere delivery, in the case of banknotes, or by drawing a cheque that the payee may bank or cash.
  2. netting and settlement of payments – banks act as both collection and paying agents for customers, participating in interbank clearing and settlement systems to collect, present, be presented with, and pay payment instruments. This enables banks to economise on reserves held for settlement of payments, since inward and outward payments offset each other. It also enables the offsetting of payment flows between geographical areas, reducing the cost of settlement between them.
  3. credit intermediation – banks borrow and lend back-to-back on their own account as middle men
  4. credit quality improvement – banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from diversification of the bank's assets and capital which provides a buffer to absorb losses without defaulting on its obligations. However, banknotes and deposits are generally unsecured; if the bank gets into difficulty and pledges assets as security, to raise the funding it needs to continue to operate, this puts the note holders and depositors in an economically subordinated position.
  5. maturity transformation – banks borrow more on demand debt and short term debt, but provide more long term loans. In other words, they borrow short and lend long. With a stronger credit quality than most other borrowers, banks can do this by aggregating issues (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemptions of banknotes), maintaining reserves of cash, investing in marketable securities that can be readily converted to cash if needed, and raising replacement funding as needed from various sources (e.g. wholesale cash markets and securities markets).

Law of banking

Banking law is based on a contractual analysis of the relationship between the bank (defined above) and the customer—defined as any entity for which the bank agrees to conduct an account.

The law implies rights and obligations into this relationship as follows:

  1. The bank account balance is the financial position between the bank and the customer: when the account is in credit, the bank owes the balance to the customer; when the account is overdrawn, the customer owes the balance to the bank.
  2. The bank agrees to pay the customer's cheques up to the amount standing to the credit of the customer's account, plus any agreed overdraft limit.
  3. The bank may not pay from the customer's account without a mandate from the customer, e.g. a cheque drawn by the customer.
  4. The bank agrees to promptly collect the cheques deposited to the customer's account as the customer's agent, and to credit the proceeds to the customer's account.
  5. The bank has a right to combine the customer's accounts, since each account is just an aspect of the same credit relationship.
  6. The bank has a lien on cheques deposited to the customer's account, to the extent that the customer is indebted to the bank.
  7. The bank must not disclose details of transactions through the customer's account—unless the customer consents, there is a public duty to disclose, the bank's interests require it, or the law demands it.
  8. The bank must not close a customer's account without reasonable notice, since cheques are outstanding in the ordinary course of business for several days.

These implied contractual terms may be modified by express agreement between the customer and the bank. The statutes and regulations in force within a particular jurisdiction may also modify the above terms and/or create new rights, obligations or limitations relevant to the bank-customer relationship.

Entry regulation

Template:Main Currently in most jurisdictions commercial banks are regulated by government entities and require a special bank licence to operate.

Usually the definition of the business of banking for the purposes of regulation is extended to include acceptance of deposits, even if they are not repayable to the customer's order—although money lending, by itself, is generally not included in the definition.

Unlike most other regulated industries, the regulator is typically also a participant in the market, i.e. a government-owned (central) bank. Central banks also typically have a monopoly on the business of issuing banknotes. However, in some countries this is not the case. In the UK, for example, the Financial Services Authority licences banks, and some commercial banks (such as the Bank of Scotland) issue their own banknotes in addition to those issued by the Bank of England, the UK government's central bank.

Some types of financial institution, such as building societies and credit unions, may be partly or wholly exempt from bank licence requirements, and therefore regulated under separate rules.

The requirements for the issue of a bank licence vary between jurisdictions but typically include:

  1. Minimum capital
  2. Minimum capital ratio
  3. 'Fit and Proper' requirements for the bank's controllers, owners, directors, and/or senior officers
  4. Approval of the bank's business plan as being sufficiently prudent and plausible.

Banking channels

Banks offer many different channels to access their banking and other services:

  • A branch, banking centre or financial centre is a retail location where a bank or financial institution offers a wide array of face-to-face service to its customers.
  • ATM is a computerised telecommunications device that provides a financial institution's customers a method of financial transactions in a public space without the need for a human clerk or bank teller. Most banks now have more ATMs than branches, and ATMs are providing a wider range of services to a wider range of users. For example in Hong Kong, most ATMs enable anyone to deposit cash to any customer of the bank's account by feeding in the notes and entering the account number to be credited. Also, most ATMs enable card holders from other banks to get their account balance and withdraw cash, even if the card is issued by a foreign bank.
  • Mail is part of the postal system which itself is a system wherein written documents typically enclosed in envelopes, and also small packages containing other matter, are delivered to destinations around the world. This can be used to deposit cheques and to send orders to the bank to pay money to third parties. Banks also normally use mail to deliver periodic account statements to customers.
  • Telephone banking is a service provided by a financial institution which allows its customers to perform transactions over the telephone. This normally includes bill payments for bills from major billers (e.g. for electricity).
  • Online banking is a term used for performing transactions, payments etc. over the Internet through a bank, credit union or building society's secure website.

E-banking is the very popular in the world.

Types of banks

Banks' activities can be divided into retail banking, dealing directly with individuals and small businesses; business banking, providing services to mid-market business; corporate banking, directed at large business entities; private banking, providing wealth management services to high net worth individuals and families; and investment banking, relating to activities on the financial markets. Most banks are profit-making, private enterprises. However, some are owned by government, or are non-profit organizations.

Central banks are normally government-owned and charged with quasi-regulatory responsibilities, such as supervising commercial banks, or controlling the cash interest rate. They generally provide liquidity to the banking system and act as the lender of last resort in event of a crisis.

Types of retail banks

  • Commercial bank: the term used for a normal bank to distinguish it from an investment bank. After the Great Depression, the U.S. Congress required that banks only engage in banking activities, whereas investment banks were limited to capital market activities. Since the two no longer have to be under separate ownership, some use the term "commercial bank" to refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses.
  • Community Banks: locally operated financial institutions that empower employees to make local decisions to serve their customers and the partners.
  • Industrial loan company: (ILC) or industrial bank is a financial institution in the United States that lends money, and may be owned by non-financial institutions. Though such banks offer FDIC-insured deposits and are subject to FDIC and state regulator oversight, a debate exists to allow parent companies such as Wal-Mart to remain unregulated by the financial regulators. Industrial loan companies chart
  • Community development banks: regulated banks that provide financial services and credit to under-served markets or populations.
  • Postal savings banks: savings banks associated with national postal systems.
  • Private banks: banks that manage the assets of high net worth individuals.
  • Offshore banks: banks located in jurisdictions with low taxation and regulation. Many offshore banks are essentially private banks.
  • Savings bank: in Europe, savings banks take their roots in the 19th or sometimes even 18th century. Their original objective was to provide easily accessible savings products to all strata of the population. In some countries, savings banks were created on public initiative; in others, socially committed individuals created foundations to put in place the necessary infrastructure. Nowadays, European savings banks have kept their focus on retail banking: payments, savings products, credits and insurances for individuals or small and medium-sized enterprises. Apart from this retail focus, they also differ from commercial banks by their broadly decentralised distribution network, providing local and regional outreach—and by their socially responsible approach to business and society.
  • Narrow banks are institutions that are limited by regulation or choice in their investing activities to safe and liquid securities like US Treasuries and money market funds. These institutions have different incentives than large commercial/investment banks in the management of deposits.
  • Building societies and Landesbanks: institutions that conduct retail banking.
  • Ethical banks: banks that prioritize the transparency of all operations and make only what they consider to be socially-responsible investments.
  • Islamic banks: Banks that transact according to Islamic principles.

Types of investment banks

  • Investment banks "underwrite" (guarantee the sale of) stock and bond issues, trade for their own accounts, make markets, and advise corporations on capital market activities such as mergers and acquisitions.
  • Merchant banks were traditionally banks which engaged in trade finance. The modern definition, however, refers to banks which provide capital to firms in the form of shares rather than loans. Unlike venture capital firms, they tend not to invest in new companies.

Both combined

  • Universal banks, more commonly known as financial services companies, engage in several of these activities. For example, Citigroup is a large American bank involved in commercial and retail lending, with subsidiaries in tax havens offering offshore banking services to customers in other countries. Other large financial institutions are similarly diversified and engage in multiple activities. In Europe and Asia, big banks are very diversified groups that, among other services, also distribute insurance—hence the term bancassurance, a portmanteau word combining "banque or bank" and "assurance", signifying that both banking and insurance are provided by the same corporate entity.

Other types of banks

  • Islamic banks adhere to the concepts of Islamic law. This form of banking revolves around several well-established principles based on Islamic canons. All banking activities must avoid interest, a concept that is forbidden in Islam. Instead, the bank earns profit (markup) and fees on the financing facilities that it extends to customers.

Banks in the economy

Size of global banking industry

Worldwide assets of the largest 1,000 banks grew 16.3% in 2006/2007 to reach a record $74.2 trillion. This follows a 5.4% increase in the previous year. EU banks held the largest share, 53%, up from 43% a decade earlier. The growth in Europe’s share was mostly at the expense of Japanese banks, whose share more than halved during this period from 21% to 10%. The share of US banks remained relatively stable at around 14%. Most of the remainder was from other Asian and European countries.[1]

The United States has by far the most banks in the world, both in terms of institutions (7,540 at the end of 2005) and branches (75,000). This is an indicator of the geography and regulatory structure of the USA, resulting in a large number of small to medium-sized institutions in its banking system. Japan had 129 banks and 12,000 branches. In 2004, Germany, France, and Italy each had more than 30,000 branches—more than double the 15,000 branches in the UK.[1]

Bank crisis

Banks are susceptible to many forms of risk which have triggered occasional systemic crises. These include liquidity risk (where many depositors may request withdrawals beyond available funds), credit risk (the chance that those who owe money to the bank will not repay it), and interest rate risk (the possibility that the bank will become unprofitable, if rising interest rates force it to pay relatively more on its deposits than it receives on its loans).

Banking crises have developed many times throughout history, when one or more risks have materialized for a banking sector as a whole. Prominent examples include the bank run that occurred during the Great Depression, the U.S. Savings and Loan crisis in the 1980s and early 1990s, the Japanese banking crisis during the 1990s, and the subprime mortgage crisis in the 2000s.

Challenges within the banking industry

Template:Lgs Template:Unreferenced section The banking industry is a highly regulated industry with detailed and focused regulators. All banks with FDIC-insured deposits have the FDIC as a regulator; however, for examinations,Template:Clarify me the Federal Reserve is the primary federal regulator for Fed-member state banks; the Office of the Comptroller of the Currency (“OCC”) is the primary federal regulator for national banks; and the Office of Thrift Supervision, or OTS, is the primary federal regulator for thrifts. State non-member banks are examined by the state agencies as well as the FDIC. National banks have one primary regulator—the OCC.

Each regulatory agency has their own set of rules and regulations to which banks and thrifts must adhere.

The Federal Financial Institutions Examination Council (FFIEC) was established in 1979 as a formal interagency body empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions. Although the FFIEC has resulted in a greater degree of regulatory consistency between the agencies, the rules and regulations are constantly changing.

In addition to changing regulations, changes in the industry have led to consolidations within the Federal Reserve, FDIC, OTS and OCC. Offices have been closed, supervisory regions have been merged, staff levels have been reduced and budgets have been cut. The remaining regulators face an increased burden with increased workload and more banks per regulator. While banks struggle to keep up with the changes in the regulatory environment, regulators struggle to manage their workload and effectively regulate their banks. The impact of these changes is that banks are receiving less hands-on assessment by the regulators, less time spent with each institution, and the potential for more problems slipping through the cracks, potentially resulting in an overall increase in bank failures across the United States.

The changing economic environment has a significant impact on banks and thrifts as they struggle to effectively manage their interest rate spread in the face of low rates on loans, rate competition for deposits and the general market changes, industry trends and economic fluctuations. It has been a challenge for banks to effectively set their growth strategies with the recent economic market. A rising interest rate environment may seem to help financial institutions, but the effect of the changes on consumers and businesses is not predictable and the challenge remains for banks to grow and effectively manage the spread to generate a return to their shareholders.

The management of the banks’ asset portfolios also remains a challenge in today’s economic environment. Loans are a bank’s primary asset category and when loan quality becomes suspect, the foundation of a bank is shaken to the core. While always an issue for banks, declining asset quality has become a big problem for financial institutions. There are several reasons for this, one of which is the lax attitude some banks have adopted because of the years of “good times.” The potential for this is exacerbated by the reduction in the regulatory oversight of banks and in some cases depth of management. Problems are more likely to go undetected, resulting in a significant impact on the bank when they are recognized. In addition, banks, like any business, struggle to cut costs and have consequently eliminated certain expenses, such as adequate employee training programs.

Banks also face a host of other challenges such as aging ownership groups. Across the country, many banks’ management teams and board of directors are aging. Banks also face ongoing pressure by shareholders, both public and private, to achieve earnings and growth projections. Regulators place added pressure on banks to manage the various categories of risk. Banking is also an extremely competitive industry. Competing in the financial services industry has become tougher with the entrance of such players as insurance agencies, credit unions, check cashing services, credit card companies, etc.

As a reaction, banks have developed their activities in financial instruments, through financial market operations such as brokerage and trading and become big players in such activities.

Profitability

A bank generates a profit from the differential between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities. This difference is referred to as the spread between the cost of funds and the loan interest rate. Historically, profitability from lending activities has been cyclical and dependent on the needs and strengths of loan customers. In recent history, investors have demanded a more stable revenue stream and banks have therefore placed more emphasis on transaction fees, primarily loan fees but also including service charges on an array of deposit activities and ancillary services (international banking, foreign exchange, insurance, investments, wire transfers, etc.). Lending activities, however, still provide the bulk of a commercial bank's income.

Reference reading >> "The Impact of the Capital Markets Turbulence on Banks Funding costs"

Introduction -- "This article examines the main funding sources used by banks in Australia and provides some estimates of how the financial market turbulence has affected the costs of these sources. It notes that, while the cash rate still has a large influence on banks’ funding costs, changes in risk premia in markets over the past two years have weakened this relationship. In turn, this has also weakened the close relationship that has been experienced in the previous decade between the cash rate and banks’ interest rates on loans."

Source: The Reserve Bank of Australia, June 2009Part two of the study

In the past 10 years American banks have taken many measures to ensure that they remain profitable while responding to increasingly changing market conditions. First, this includes the Gramm-Leach-Bliley Act, which allows banks again to merge with investment and insurance houses. Merging banking, investment, and insurance functions allows traditional banks to respond to increasing consumer demands for "one-stop shopping" by enabling cross-selling of products (which, the banks hope, will also increase profitability). Second, they have expanded the use of risk-based pricing from business lending to consumer lending, which means charging higher interest rates to those customers that are considered to be a higher credit risk and thus increased chance of default on loans. This helps to offset the losses from bad loans, lowers the price of loans to those who have better credit histories, and offers credit products to high risk customers who would otherwise been denied credit. Third, they have sought to increase the methods of payment processing available to the general public and business clients. These products include debit cards, prepaid cards, smart cards, and credit cards. They make it easier for consumers to conveniently make transactions and smooth their consumption over time (in some countries with underdeveloped financial systems, it is still common to deal strictly in cash, including carrying suitcases filled with cash to purchase a home). However, with convenience of easy credit, there is also increased risk that consumers will mismanage their financial resources and accumulate excessive debt. Banks make money from card products through interest payments and fees charged to consumers and transaction fees to companies that accept the cards.

See also

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Country specific information

Types of institution

Terms and concepts

Related lists


Further reading

  • A Guide to the National Banking System(PDF), Office of the Comptroller of the Currency (OCC), Provides an overview of the national banking system of the USA, its regulation, and the OCC.
  • Murray Rothbard (1983). The Mystery of Banking. Richardson & Snyder. ISBN 9780943940045. 2008 edition (PDF) at Ludwig von Mises Institute. ISBN 9781933550282. Explains the modern fractional-reserve banking system, its origins, and—as Douglas E. French writes in his preface to the second edition—"its devastating effects on the lives of every man, woman, and child."


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