Bank practice and

procedures (AcFn2113)
CHAPTER 1
AN OVERVIEW OF BANKS AND THEIR
FUNCTION

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 1.1. INTRODUCTION
1.1.1. World Banking History
 There are different assumptions
 as to the origin of the word “BANK”.
 One assumption is that
 it is derived from the French word ‘Banque’ or
 it is derived from the Italian word “Banco”

which means in English a bench.



 It is derived from the experience of the merchants of Greece

and Rome.
 They used to sit
on a bench in the center of the market and
receive deposits from the public and pay to the public
from the deposit.
 They were referred as ‘benchers’.
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 1.1. INTRODUCTION
…Cont’d
 Mainly concerned with currency exchange,”

? Who are the ancestors of present day bankers

Ans. Merchants, Gold smiths and money lenders.

 Then they started Safe keeping of gold’s and coin at

templets and granting loans on interest.

 Bank of Venice(1157) is the first public bank(Rome &

Greek)

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 1.1. INTRODUCTION
…Cont’d

 Public Bank established in Barcelona in 1401( money

exchange, deposit receiving, discounting of bills of
exchanges for both the citizens and foreigners.

 Bank of England was established in 1694.

London goldsmiths, money lenders, merchants and
money exchangers were the most of the private
bankers.

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 1.1.2. Development of Banking in
Ethiopia
The first bank in Ethiopia was bank of Egypt
( around 1896)
 It was established and owned by the National Bank of
Egypt,
 an affiliate of the Bank of England

Turned to the establishment of Bank of Abyssinia

in March 1905( Ras Mekonnen/AAU main campus.)

Bank of Abyssinia has opened

 branches at Dire Dawa, Gore and Dessie and
 agencies at Harrar and Gambella with the
construction of Franco-Ethiopia railway

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 1.1.2. Development of Banking ….
Bank of Ethiopia (29th August 1931)
During Itallian Occupation,Branches of
different Italian Banks, Barclays Bank
They withdrew in 1943 with the Britsh
troop and Banko di Indo china
established.
 August 1942 National and Commercial
Bank proclamation has issued-State
Bank of Ethiopia
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 1.1.2. Development of Banking ….
1945 Agricultural Bank established
1949 Changed to Agricultural and Commercial
Bank
1951 changed in to Development Bank of
Ethiopia.
1961 Imperial Saving and Home ownership
public association has established
1963 split of central Banking and Commercial
Banking Activities.

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 1.1.2. Development of Banking ….
Events of 1963
 Commercial bank of Ethiopia established as share
company for the objective of:
 Carrying out all banking activities,
 Attracting public deposits,
 Promoting banking habit and facilitating transactions.
 DBE for:
 Agricultural banking and commercial banking activities.
 Ethiopian Investment Corporation for:
 General investment banking business.

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 1.1.2. Development of Banking ….

 Addis Ababa Share Company first private domestic

bank established in October 1964.
 Mortgage company of Ethiopia (1965):
 the construction of commercial, industrial and residential
buildings against mortgage of immoveable properties.
 1974 all banks nationalized . Three Government
owned banks:
i. Commercial Bank of Ethiopia
ii. Agricultural and Industrial Bank and
iii. Mortgage Bank of Ethiopia,
 After Derg Regim many private banks has been established:
 BOAS.C., AIBS.C., Dashen Bank S.C.,UB S.C., Wogagen Bank S.C etc

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 Take Home Assignment # 1
(10%)
 Discuss the World Banking
History & Development of
Banking in Ethiopia.
 Deadline: March 24, 2014 G.C.
 Presentation: 5% out of 10%
 Paper: 5% out of 10%

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 1.2. MEANING OF BANK
Definition
A bank is a financial intermediary that accepts
deposits and channels those deposits into lending
activities, either directly by loaning or indirectly
through capital markets.

It links customers that have capital deficits and

customers with capital surpluses.

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 1.2. MEANING OF BANK (CONT’D)
The term BANK in the modern times refers to an
institution which:
 deals with money; it accepts deposits and advance
loans
 plays a significant role by facilitating international trades
 Connects international markets.
 deals withcredit; it has the ability to create credit,
 is a commercial institution; it aims at earning
profits, and
 creates a demand deposits which serve as a
medium of exchange, and as a result,
 the bank manages the payment system of the
country.

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 Activity 1 (15 Minutes)
 List and Discuss the classification
and functions of banking

Instruction:
 Make a group of three members
and discuss thoroughly.

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 1.3. CLASSIFICATIONS & FUNCTIONS
OF BANKING

1.3.1. CLASSIFICATIONS OF
BANKING
1)
BASED
On theON OWNERSHIP
basis of ownership, banks can
be classified into three
i. Public Sector Banks:-These are
owned and controlled by the
government.(CBE,DBE,NBE,& CBB)
ii. Private Sector Banks:-These are
owned and controlled by the
private individuals or corporations
14 and not by the government or co-
 1.3. CLASSIFICATIONS & FUNCTIONS
OF BANKING

1.3.1. CLASSIFICATIONS OF
BANKING
2) BASED
On ON DOMICILE
the basis (Residence)
of domicile the banks
are divided into two
i. Domestic Banks:-They are
registered and incorporated within a
country.(e.g all Banks in Ethiopia)
ii. Foreign Banks:- These are foreign
in origin and have their head offices
in the country of origin.(City Bank,
Commercial Bank of Dubai etc)
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 1.3. CLASSIFICATIONS & FUNCTIONS
OF BANKING
1.3.1. CLASSIFICATIONS OF BANKING
3) BASED ON THEIR FUNCTIONS
a) Commercial Banks
b) Industrial Banks (or Development Bank)
c) Agricultural Banks
d) Exchange Banks ( or Foreign Exchange
Banks)
e) Savings Banks
f) Cooperative Banks
g) Central Bank/National Bank
h) Indigenous Bank
i) Consumer Banks

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 a) Commercial Banks
 They perform all kinds of banking business.
 They generally finance trade and commerce.
 They usually
 accept Short-Term Deposits and
Advance Short-Term Loans to the
businesspersons and traders and
 avoid medium- term and long term
loans.

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 b) Industrial Banks
( Investment Banks)
 They collect cash by issuing shares &
debentures and providing long-term
loans to industries.

 Their main objective is to provide long-

term loans for expansion and
modernization of industries.

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 c) Agricultural Banks

 Provide credit to farmers for short-

term, medium-term and long-term
needs.
 Here also, an example of agricultural
bank could be Development Bank of
Ethiopia.

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 d) Exchange Banks (Foreign
Exchange
 deal Banks)
in foreign exchange and
specialize in Financing Foreign
Trade.

 Functions of Exchange Banks :-

Remitting money from one country to
another country,
Discounting of foreign bills,
Buying and Selling Gold and Silver,
and
Helping Import and Export Trade.

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 e) Savings Banks
 Promote saving habits among the general
public and mobilize their small savings.
 They are helpful for salaried people and low
income groups.
 The deposits collected from customers are
invested in bonds, securities, etc.
 At present most of the commercial banks
carry the functions of savings banks.
 Postal department also performs the
functions of saving bank.

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 f) Cooperative Banks
 Cooperative banks are those financial
institutions which are organized on the
principle of cooperatation.
 The functions of these banks are just
similar to commercial banks.
 They provide short-term and medium-
term loans to their members only

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 g) Central Banks (National
Bank)

 Every country of the world has a central

bank.
 They are the bankers of the other banks.
 They provide specialized functions i.e.
issue of paper currency, working as
bankers of government, supervising
and controlling foreign exchange.
 It is a non-profit making institution.
 It does not deal with the public but it
deals with other banks.
 The principal responsibility of Central
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Bank is thorough control on currency
of a country.
 h) Indigenous Banks

 Indigenous banks means Money Lenders.

 They collect deposits from general public and
grant loans to the needy persons out of their
own funds as well as from deposits. These
indigenous banks are popular in villages and
small towns. They perform combined
functions of trading and banking activities

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 i) Consumer Banks
 Consumers bank is a new addition to the existing type of

banks.
 Usually found only in advanced countries like U.S.A. and

Germany.
 The main objective of this bank is to give loans to
consumers for purchase of the durables like Motor car,
television set, washing machine, furniture, etc.
 The consumers have to repay the loans in easy
installments.

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 1.3.2. FUNCTIONS OF
BANKING
 A modern bank performs a variety of
functions.
some basic functions performed by
the banks are discussed as follows:
1) Accepting Deposit
2) Advancing Loan
3) Credit Creation
4) Facilitating payment
5) Agency Service
6) General Utility Function

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 1)ACCEPTING DEPOSITS
Accepting deposits is the
primary functions of a
bank.
 To attract savings from all
sorts of individuals, the
banks maintain different
types of accounts:
i. Fixed deposit account
ii. Current deposit
account
iii. Saving deposit
account(Different
types)

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 i. Fixed Deposit Account
 They are money deposited for a specific
period of time.
 Interest is calculated for the whole
amount for the same period.
 If the depositor withdraws the deposit
before the expiry date, the depositor will
ii. pay
Current Deposit
penalty rate plus the Accounts
banker should
 be willing
Current to pay are
accounts before the expiry
checking date. or
accounts
demand deposit accounts.
 Current accounts are operated through
cheques.
 Current account is owned by
28 businesspersons and firms.
No interest income on the amount mentioned
 iii. Saving Deposit Account
 Are different in type.
 are opened by individual savers and
small business owners.
 it is opened for saving purpose
 Interest is generally calculated on
monthly/weekly/daily basis on the
minimum balances that remains in
the account
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 2) ADVANCING LOANS
The various types of
LOANS granted by the
bank are:
a) Term loan
b) Merchandise loan
c) Overdraft facility
d) Reshipment Export
Facility
e) Letter of credit
facility
f) Letter of Guarantee

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 a) Term loan
Term Loans are loans granted for a
fixed period of time.
The time period may be short-term,
intermediate and long-term loans.
 SHORT-TERM LOAN is usually a loan granted up
to one year,
 INTERMEDIATE LOANS are from one to five
years and
 LONG TERM LOAN is a loan granted for above
five years.
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 a) Term Loan (….cont’d)
Types of term loan
i. Project loan
ii. Working capital loan
iii.Motor vehicle loan
iv.Consumer loan,
v. Mortgage loan
vi.Partial financing loan,
vii.Agricultural loan
viii.Industrial loan etc.

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 b) Merchandise loan
 A short term credit facility provided by a
bank against which the merchandise or
documentary evidence(rail way receipt,
warehouse receipt or air way bill.) is held
as collateral for the loan.
 It could be revolving or one time.

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 c) Overdraft Facility

 Is a form of credit by which a customer allowed

to draw beyond the deposit of its current
account for the sol purpose of its day-to-day
operation needs of viable and ongoing business.
 It is a renewable facility ( every six month or
annually)
 It may be granted either on clean basis, or
against collateral.

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 d) Pre-shipment Export Facility

 A loan granted for the purpose of raw

material processing and converting in
to finished goods,purchasing,
warehousing ,packaging and
transporting the goods until shipment.
It could be revolving or one time,
Must be settled with in ninety days
from the advance of the loan.

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 e) Letter of Credit Facility

It is the credit facility in which the bank

extends the business to engage in import
and export activities.
It is granted on percentage of the value of
the document based on the credit
worthiness of the business,
It could be revolving(renewable
annually/semi-annually or one time).

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 There are different types of letters of
credit, which can be discussed as
follows;
a) Clean letter of credit: Under this
form acceptance of bills is unconditional
b)Documentary L.C: Bills acceptance is
conditional on the receipt of the
documents of title to goods.
c) Revocable L.C: The bill can be
canceled at any time by the issuing banker
d)Irrevocable L.C: The bill can’t be
canceled before expiry of the period.

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 Class Activity
 Identify the parties involved in Letter of credit of the following
transaction:
 Ato Zeberga wants to import goods on credit from an Italian
exporter known as Maldini. Now Mr. Maldini may not be willing
to sell his goods on credit to an Ethiopian importer, Ato Zeberga,
he rather prefers the credit to be guaranteed by a known bank
in Ethiopia. Here Commercial Bank of Ethiopia, who is the
banker to Ato Zeberga, writes a letter to another banker in Italy,
may be Bank of Italy, to pay the agreed sum of money in the
transaction, when the goods are arrived to the buyer, which
might be communicated as it is realized. Then, the Italian bank
will advice Mr. Maldini to deliver goods according to the
agreement with Ato Zeberga. As the arrival of the goods is
reported to Bank of Italy through Commercial Bank of Ethiopia,
Bank of Italy will pay the amount or credit Mr. Maldini’s account,
if he has an account in the same bank, or may transfer to
another bank where he has an account, if it is instructed to do
so.

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 Answer
Here,
 Ato Zeberga is the customer,
 Commercial Bank of Ethiopia is the
issuing bank,
 Bank of Italy is the advisory bank
and
 Mr. Madini is the seller or creditor
or beneficiary in the instrument

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 e) Letter of Guaranty

It is written promise /irrevocable

obligation by the bank to compensate(pay
sum of money) to the beneficiary(local or
foreign)in the event that the obligator fails
to honor its obligation in accordance with
the terms and conditions the
guarantee/agreement/contract.

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 3.Credit creation
 It is a unique function of the bank.
 When a bank advances loan to its customer, it does not
lend cash
o opens an account in the borrower's
but
name and
o credits the amount of loan to this account.
 Thus, whenever a bank grants a loan, it creates an equal
amount of bank deposit.

4. Facilitating Payment
 Through a check, the depositor directs
the bankers to make payment to the payee.
 Check is the most developed credit
instrument in the money market.
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 5.Agency Service
 Banks perform certain AGENCY FUNCTIONS for and
on behalf of their customers on top of their
main functions such as:
a) COLLECTION and PAYMENT of credit instruments
like Check, Bills of Exchange, Promissory Notes, etc
b) Carrying out of Standing Orders
They pay:
oInsurance premiums
oSubscriptions on clubs & societies, and
oSimilar payments of a regularly recurring
nature
c) Purchasing & Sale of Securities
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 d) Collection of DIVIDENDS on shares on
behalf of his customer.
e) Income Tax Consultancy
f) Acting as Trustee and Executor.
g) Acting as representative and
correspondent
h) Remittance of funds
 The important methods of transferring
funds from one place to another
through banks are:
i. Bank draft
ii. Telegraphic Transfers and Mail transfer
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 i.Bank Draft
 It is an order to pay money
 drawn by one branch/office of the bank
 upon another branch of the same bank
 to pay a specific sum of money
 to a person named therein or to his order.

Essential Features of a Bank Draft

A bank draft possesses the following important
features.
a)It is drawn by one branch of a bank upon some other
branch of the same bank
b)It is payable on demand, not payable to the banker
c)It is equivalent to a bill of exchange

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 i.Bank Draft
 A bank draft has three parties
1) The DRAWER Branch
 the branch that receives money to
be remitted.
2) The DRAWEE Branch
 the branch that is ordered to pay the
remitted money to a person named in
the draft; and
3) The PAYEE
 the party in whose favor money is
transferred
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 ii. Mail/Telex Transfers
A mail transfer is an internal message sent
through ordinary postal channel advising the payee
branch or bank to pay a specifically stated amount
of money to a specified payee or to his order.
The following are the necessary
requirements.
 The name of the beneficiary
 His/her account number, if any
 The amount to be transferred, and
 The name of the branch where the account is
maintained or the beneficiary can receive .

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 6) General Utility
Function
A.Traveler's Cheques
Banks to avoid the risk of loss or inconvenience in to
carrying large amount of cash while traveling issue
Traveler’s cheques.
B.Safe Custody of Valuable and
Securities
Banks accept valuables for safe custody
purpose.
Valuables such as:
negotiable securities,
jewelers and
documents of the title to property, etc.
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 C. Foreign Exchange
 In assisting foreign trade by discounting foreign
bills of exchange and facilitating foreign currency,
a bank has sometimes arrange for the payment of
costs to the transport, insurance and warehousing
of goods.
D. Collection of Statistics
 Banks collect statistics relating to industry, trade
and commerce, money and banking and publish
journals and bulletins containing research articles
on economic and financial matters.
E. Underwriting Securities
 They underwrite securities issued by the
government, public or private bodies.
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 The end !

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 Group Discussion
1) Define & discuss what is meant by a bank.
2) Identify & discuss the classification of a bank.
3) Identify the functions of a bank. Discuss.

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