UNIT 15: BANKS

• Banking – helps people to borrow and lend

money to the people and involves financial
activity
• Commercial banks[joint sock, retail or high
street bank]:private sector banks which aim to
make a profit by providing a range of banking
services
Main types of Banks
Commercial Banks
Central Banks.
Commercial Banks
Commercial banks are private sector banks which aim to make a profit by providing a
range of banking services.
They are also known as joint stock banks, retail or high street banks
Commercial banks are banks that seek to make a profit.
Shareholders have limited liability ( the state of being legally responsible for
something )
They are in the private sector
They are either public limited companies or private limited companies.
They sell banking services.
They are the banks we are most familiar with
 Main Functions of commercial banks
1. Accept deposits
Deposits can be made into two types of banks accounts.
Current accounts (a.k.a demand accounts) and deposit
accounts(a.k.a time accounts)
In current accounts:
There is easy and immediate access to money.
However interest is not paid on such accounts
Customers use these accounts to receive and make payments
In deposit accounts:
A period of notice has to be given before money can be
withdrawn.
Interest is paid on money held in such accounts
Customers use such accounts as a way of saving.
2. Lend money
Banks make most of their profit by charging higher interest from borrowers than that is paid on
the money held within the banks. There are two main way
of doing this- Overdrafts and loans
In overdrafts
A customer is allowed to spend more than what is in his or her account up to an agreed limit.
Interest is charged on the amount borrowed
This is a relatively expensive way of borrowing money.
Customers use it to cover short term gaps between expenses and income
In loans
Taking a loan is for a particular purpose.
Interest is charge on the full amount of the loan.
The rate of interest for loans is likely to be lower than that of an overdraft.
The customer may be asked to give some form of security- collateral
This is to ensure that if the loan is not paid the collateral can be sold and the money can be recovered.
Banks try to avoid this, by checking very carefully, whether the person seeking the loan would be able to repay it.

Lending and borrowing from banks means that they act as financial intermediaries.
They accept deposits from those with more money than they want to spend and lend it to those
with an immediate desire to spend more money than they have at hand.
3. Enabling customers to receive and make payments
Banks act as agents for payments and provide money transmission services. There is now range
of ways in which people can receive money and make payments out of their accounts such as
cheques, standing orders[an instruction to a bank by an account holder to make regular
fixed payments to a particular person or organization.], direct debits, debit/credit cards
and online banking.

4. Other Functions
Provide travellers with cheques
Change foreign currency
Customers can leave important documents such as house deeds and small valuables with their
banks.
Banks can also help with the administration of customers' wills
Provide advice and help with financial matters-Such as completion of tax forms and the
purchase and sale of shares.
Sell insurance
Offer a wide variety of savings accounts with a range of conditions and interest rates.
Offer mortgage loans as well
Aims of commercial banks
Making a profit for their shareholders
The main way it does this is by giving out loans
Liquidity
Banks have to ensure that they can meet their customers' requests to
withdraw money from their accounts.
To do this banks have to keep a certain amount of liquid assets –items
that can be quickly turned into cash without incurring loss.
Banks earn most of their interests by giving out long term loans
However if they lend out all their money in these loans then they will
not be able to pay money to the consumers who are requesting it.
Thus, banks have to balance profitability and liquidity
Having some assets that are earning profit while being illiquid and
having others that are earning low or no interest but being liquid.
 Banking and islam
In Muslim countries, commercial banks are not allowed to
charge interest on bank loans. This is because Muslims
regard charging of interest (usury) a sin.
So to tackle this problem- Muslim banks have provided
finance to banks by lending to them in return for a share
of Profits.
Islamic sharia scholars are employed to issue religious
edicts that approve financial products including loans.
US based Bank citigroup for instance has created and independent
Sharia advisory board of Islamic scholars to offer it advice and
the German based Bank -Duetshebank is a majority shareholder
in the dar Al Istithmar Sharia consultancy which launched the
world’s first dedicated training program to create financially
qualified Islamic scholars
 Other Types of banks
There are two other types of banks- investment banks and savings banks
Investment banks or merchant banks-
• These are banks that tend only to large firms. They accept deposits from
• them and lend money to them as well.
• They manage the issue of new shares and buy and sell shares and other
• financial securities on behalf of their own customers.
• They also give advice on, and help with mergers and takeovers.
Savings banks
• They try to encourage people with relatively low incomes to save,
• They make it easy to withdraw cash with few penalties
• A large proportion of the money lent by these banks goes to the govt.
Central Banks
Central Banks are government-owned banks
which provide banking services to the
government and commercial banks.
For example: Federal Reserve Bank Of the USA,
European Central Bank and Bank Of England.
Functions of a Central Bank
1. Acts as a banker to the government
o Tax revenue is paid into the government's account at the
central bank
o Payments by the government are made out of the
government's account at the central bank.
2.Operates as a banker to the commercial banks
Central bank keeps part of the cash balances of all commercial
banks as deposit with a view to meeting liabilities of these
banks in times of crises. These cash balances are kept by the
commercial banks in 2 ways: a] part of the cash balances with
themselves b] another part with the central bank as deposit
o Holding accounts at the central banks allows the commercial banks to
withdraw money to settle the debts between each other and draw out
the cash if their own customers are taking out more money than
usual.
3. Acts as a lender of last resort
If a commercial bank fails to get financial accommodation
from anywhere , it approaches the central bank as a last
resort
o It will lend money to those banks that are temporarily out of cash.
4. Manages the national debt
o National debt is the total amount of money that the government owes.
o Over time government debt tends to build up.
o The central bank carries out borrowing on the government's behalf
It does this by issuing government securities such as issuing government bonds, paying
interest on these and repaying them when they fall due

5. Holds the country's reserves of foreign currency and gold

o The central bank keeps foreign currency and gold to influence the exchange
rate
The main responsibility of central banks is to keep the external value of the
country’s currency stable. Central bank maintains Foreign Exchange Reserves
in order to settle debts or avoid financial crises
6. Issues bank notes
o It is responsible for printing notes and destroying notes which are no longer
available for circulation. It also authorises the minting of coins.
7.Implements the government's monetary policy
The policy is to keep the inflation low and steady.
This involves controlling the money supply and influencing interest rates
through the economy by changing interest rates it charges on loans.
The gov may instruct the central bank to increase or decrease the money
supply. In some cases central banks implements interest rate changes
decided by their respective gov.
In others, the central banks have been given the responsibility to set the
interest rates
8. Controls the banking system
Central banks regulates and supervises commercial banks making sure that
they operate with appropriate levels of cash and acc.to rules that ensure
the safety of financial system . This is a very important function bec the
funds that commercial banks use to make loans are the savings and other
deposits that consumer and firm deposit with commercial banks
9. Represents the government
Central bank represent their countries in international organisations
such as the World Bank and international monetary fund about economic
growth, capital development , foreign exchange position of the country
 Independence of central banks
• Gov have given the CB the authority to decide
the RATE OF INTEREST
• Use the ROI to achieve an inflation target of
2%
• CB- will not lower ROI to win public support
• Extensive knowledge of the banking system
and appropriate ROI to set.