Read the following text, paying particular attention to the highlighted words.
Banking is transactions carried on by any individual or firm engaged in providing financial services to consumers, businesses, or government enterprises. In the broadest sense, banking consists of safeguarding and transfer of funds, lending or facilitating loans, guaranteeing creditworthiness, and exchange of money. These services are provided by such institutions as commercial banks, central banks, savings banks, trust companies, finance companies, life insurance agencies, and merchant banks or other institutions engaged in investment banking. A narrower and more common definition of banking is the acceptance, transfer, and, most important, creation of deposits. This includes such depository institutions as central banks, commercial banks, savings and loan associations, building societies, and mutual savings banks. All countries subject banking to government regulation and supervision, normally implemented by central banking authorities.
Aspects of Banking
The most basic role of banking, safeguarding funds, is done through vaults, safes, and secure facilities which physically store money. These physical deposits are in most cases insured against theft, and in most cases against the bank being unable to repay the funds. In some banks, the service is extended to safety deposit boxes for valuables. Interest given on savings accounts, a percentage return on the bank's investments with the money, gives an additional incentive to save. Transfer of funds can be handled through negotiable instruments, cheques, or direct transfers performed electronically. Credit cards and account debit cards, electronic cash tills, computer on-line banking, and other services provided by banks extend their usefulness by offering customers additional ways of gaining access to and using their funds. Automated clearing houses perform similar services for business customers by handling regular payments, such as wages, for a company banking with the bank. Longer-term schemes for providing regular income on savings are often offered through trust funds or other investment schemes.
Loans to bank customers are drawn on the funds deposited with the bank and yield interest which provides the profits for the banking industry and the interest on savings accounts. These loans may take the form of mortgages or other sophisticated policies. Banks may guarantee credit for customers who wish to obtain loans from other institutions. They also provide foreign exchange facilities for individual customers, as well as handling large international money transfers.
Many banking functions such as safeguarding funds, lending, guaranteeing loans, and exchanging money can be traced to the early days of recorded history. In medieval times, the Knights Templar, an international military and religious order, not only stored valuables and granted loans but also arranged for the transfer of funds from one country to another. The great banking families of the Renaissance, such as the Medici in Florence (Italy), were involved in lending money and financing international trade. The first modern banks were established in the 17th century, notably the Riksbank in Sweden (1656) and the Bank of England (1694).
17th-century English goldsmiths provided the model for contemporary banking. Gold stored with these artisans for safekeeping and was expected to be returned to the owners on demand. The goldsmiths soon discovered that the amount of gold actually removed by owners was only a fraction of the total stored. Thus, they could temporarily lend out some of this gold to others, obtaining a promissory note for principal and interest. In time, paper certificates redeemable in gold coin were circulated instead of gold. Consequently, the total value of these banknotes in circulation exceeded the value of the gold that was exchangeable for the notes.
Two characteristics of this fractional-reserve banking remain the basis for present-day operations. First, the banking system's monetary liabilities exceed its reserves. This feature was responsible in part for Western industrialisation, and it still remains important for economic expansion. The excessive creation of money, however, may lead to inflation. Second, liabilities of the banks (deposits and borrowed money) are more liquid - that is, more readily convertible to cash - than are the assets (loans and investments) included on the banks' balance sheets. This characteristic enables consumers, businesses, and governments to finance activities that otherwise would be deferred or cancelled; however, it underlies banking's recurrent liquidity crises. When depositors en masse request payment, the inability of the banking system to respond because it lacks sufficient liquidity means that banks must either renege on their promises to pay or pay until they fail. A key role of the central bank in most countries is to regulate the commercial banking sector to minimise the likelihood of a run on a bank which could undermine the entire banking system. The central bank will often stand prepared to act as "lender of last resort" to the banking system, to provide the necessary liquidity in the event of a widespread withdrawal of funds. This does not equal a permanent safety net to save any bank from collapse, as was demonstrated by the Bank of England's refusal to rescue the failed investment bank Barings in 1995.
Banking in Britain
Since the 17th century Britain has been known for its prominence in banking. London still remains a major financial centre, and virtually all the world's leading commercial banks are represented.
Aside from the Bank of England, which was incorporated, early English banks were privately owned rather than stock-issuing firms. Bank failures were not uncommon; so in the early 19th century, joint-stock banks, with a larger capital base, were encouraged as a means of stabilising the industry. By 1833 these corporate banks were permitted to accept and transfer deposits in London, although they were prohibited from issuing banknotes, a monopoly prerogative of the Bank of England. Corporate banking flourished after legislation in 1858 approved limited liability for joint-stock companies. The banking system, however, failed to preserve a large number of institutions; at the turn of this century, a wave of bank mergers reduced both the number of private and joint-stock banks.
The present structure of British commercial banking was substantially in place by the 1930s, with the Bank of England, then privately owned, at the apex, and 11 London clearing banks ranked below. Two changes have occurred since then: The Bank of England was nationalised in 1946 by the postwar Labour government; and in 1968 a merger among the largest five clearing banks left the industry in the hands of four (Barclays, Lloyds, Midland, and National Westminster). Financial liberalisation in the 1980s has resulted in the growth of building societies, which in many ways now carry out similar functions to the traditional "clearing banks".
The larger clearing banks, with their national branch networks, still play a critical role in the British banking system. They are the key links in the transfer of business payments through the checking system, as well as the primary source of short-term business finance. Moreover, through their ownership and control over subsidiaries, the big British banks influence other financial markets dealing with consumer and housing finance, merchant banking, factoring, and leasing. The major banks responded to competition from building societies by offering new services and competitive terms.
A restructuring in the banking industry took place in the late 1970s. The Banking Act of 1979 formalised Bank of England's control over the British banking system, previously supervised on an informal basis. Only institutions approved by the Bank of England as "recognised banks" or "licensed deposit-taking institutions" are permitted to accept deposits from the public. The act also extended Bank of England control over the new financial intermediaries that have flourished since 1960.
London has become the centre of the Eurodollar market; participants include financial institutions from all over the world. This market, which began in the late 1950s and has since grown dramatically, borrows and lends dollars and other currencies outside the currency's home country (for example, franc accounts held in any country other than France).
Banking in the United States
The United States banking system differs radically from such countries as Canada, Britain, and Germany, where a handful of organisations dominate banking. In the past, geographical constraints on expansion prevented banks from moving beyond their state or even beyond their county. Thus, many small bankers were protected from competition. The result is a national network of almost 12,000 commercial banks. More recently most states as well as the federal government have loosened the regulation of banks, especially in the area of mergers and acquisitions. Many banks have grown by taking over other banks inside and outside their home states. The largest banks account for the bulk of banking activity. Fewer than 5 per cent of the banks in the United States are responsible for more than 40 per cent of all deposits; 85 per cent of the banks hold less than one fifth of total deposits. The Federal Reserve System, composed of 12 Federal Reserve Banks and 25 Federal Reserve Districts throughout the United States, is the central bank, banker to the US government, and supervisor of the nation's banking industry.
The US banking system is distinguished by a tradition of thrift institutions established to remedy the commercial sector's historic neglect of the non-business consumer market. Savings and loan associations (SLAs) which first appeared in the 1830s, were patterned after cooperative movements in Scotland and England. Dealing mostly in residential real estate mortgages, and particularly in home mortgage loans, SLAs exist primarily to support home ownership. In the late 1980s the failures of many SLAs caused the government to overhaul the industry and place it under federal supervision. American savings banks, established with similar intentions, invest the deposits of customers in stocks and bonds, especially government bonds, and also provide mortgage services. Credit unions likewise invest money on behalf of members.
While government regulation of commercial banking since the mid-1930s has led to a low failure rate and preserved a substantial amount of competition in some markets, local monopolies have also been implicitly encouraged. Moreover, stringent regulations have caused some bankers to devote considerable resources to circumventing government controls. Rethinking of the role of government regulation in the economy in general may lead towards even further liberalisation of controls over the banking system.
Banking in Continental Europe
Major central banks in the European Union are France's Banque de France, Germany's Bundesbank, and the Bank of Italy. Major commercial banks include Germany's Deutsche Bank A.G., Dresdner Bank A.G., and Commerzbank A.G., and France's nationalised Banque Nationale de Paris, Cr�dit Lyonnais, and Soci�t� G�n�rale. Significant structural differences distinguish the banking system of continental Europe from that of many other developed nations. The main differences are in ownership, scope, and concentration of activities.
One distinguishing aspect of European banking, especially in the Latin countries, is the role of the state. Virtually all banking institutions in the United States, Canada, and Britain, are privately owned. In France and Italy, however, the government either owns the major commercial banks or the majority of their stock. The role of the government in banking is therefore significant, and often controversial. France's Cr�dit Lyonnais was the subject of considerable criticism in the early 1990s because of the government assistance extended to it to cover its heavy trading losses. European banks engage in some activities prohibited elsewhere, such as the placement and acquisition of common stock. Commercial banks in Europe tend to be highly business orientated and limit their lending to shorter-term loans. Long-term loans are handled by bank affiliates. The share of the deposits and loans handled by the major European banks tends to be particularly large. This stems from the absence of restrictions on branching, leading the large European banks to maintain extensive networks of branches in their home countries. The absence of an antitrust tradition also accounts for the greater degree of concentration.
Germany's Bundesbank has become the dominant central bank in the European Union, thanks mainly to its success in controlling inflation and Germany's economic strength. Its constitution leaves it notably independent from government interference. There is a broad consensus that it will serve as the basis for any European central bank in the event of full European Monetary Union. However, the Bundesbank itself has in the past been conspicuously lukewarm about the prospect, apparently fearing the effect of association with other national economies on its own sound record on inflation.
Banking in Switzerland
Switzerland is renowned as a centre for world banking because of its political neutrality, its financial stability, and the national tradition of confidentiality in banking, dating from a law of 1934 which made it an offence for banks to disclose details about their customers without express authorisation. Subsequent legislative changes and international agreements have not overly compromised this secrecy, especially with regard to noncriminal tax evasion. Private banking is one of the country's principal sources of income.
The semiprivate Swiss National Bank, Switzerland's central bank, is owned jointly through shares held by the cantons, other banks, and the public. Swiss commercial banking is dominated by the "Big Four": the Union Bank of Switzerland, the Swiss Bank Corporation, Cr�dit Suisse, and Swiss Volksbank. Numerous smaller banks and branches of foreign banks also operate in Switzerland. There are also 28 canton banks, funded and controlled by their respective cantons.
Banking in Japan
As one of the world's richest countries, Japan has a banking sector with considerable influence on the world economy as a whole. The Bank of Japan is the national central bank, and controls the banking system; it has less constitutional autonomy than in many other developed countries. Several government banks and institutions supplement the commercial banking sector: the Japan Export-Import Bank handles large credits for international trade; the Housing Loan Corporation assists the provision of company housing; and the Agriculture, Forestry, and Fisheries Finance Corporation advances loans for equipment purchase. The Japan Development Bank supports industrial finance, assisted by the private Industrial Bank of Japan, Long-Term Credit Bank of Japan, and Nippon Credit Bank Ltd. Some private banks such as Dai-Ichi Kangyo Bank (the world's largest bank) are tied closely to the government through government investment; the Bank of Tokyo specialises in foreign exchange. Commercial banks such the Mitsubishi Bank, the Mitsu Bank, and the Sumitomo Bank are often relics of the great prewar commercial and industrial conglomerations, the so-called zaibatsu, and maintain close ties with their associated businesses and financial institutions. Small-scale cooperatives and credit associations, grouped on a prefectural basis, are important in providing banking services for farmers and small businesses. Japan's mutual loans and savings banks all converted into full commercial banks after reform in 1989. The state Postal Savings System is also an important channel for domestic savings. Reform of Japanese banking laws in the mid 1990s freed banks to operate in the international securities trade frequented by Japan's highly successful financial houses. Reciprocal opportunities were also opened for securities houses to offer banking services. The banking sector is expected to expand its business in the long term as a result of these changes.
Banking in Canada
The Bank of Canada is the national central bank. Canada has numerous chartered commercial banks. In 1980 Canadian banks were reorganised into two bands: "Schedule I", with shareholdings by any individual limited to 10 per cent; and "Schedule II", either foreign-owned or in private hands. Further legislation in 1992 freed banks, trust companies, and insurance companies to diversify into each other's areas of interest, and opened ownership of Schedule II banks to nonbanking institutions. Trust and mortgage loan companies, provincial savings banks, and credit unions are also important components of the banking system.
Banking in Australia
The Reserve Bank of Australia, established in 1911, is the national central bank. The components of the Commonwealth Banking Corporation, including the Commonwealth Trading Bank and the Commonwealth Savings Bank (Australia's largest savings bank), are also government owned. Large commercial banks in Australia are normally referred to as trading banks: major examples include the Australia and New Zealand Banking Group, the Commonwealth Bank of Australia, the National Australia Bank, and the Westpac Banking Corporation. Building societies are also common. Banking reform in the 1980s similar to that enacted in Britain freed many building societies to become banks or offer banking services, and also opened the domestic market to more foreign competition.
Banking in New Zealand
The Reserve Bank of New Zealand is the national central bank. The Post Office Savings Bank (the largest saving bank), the Reserve Bank, and the Bank of New Zealand (largest of the commercial banks) are owned and operated by the government. Commercial banks are called trading banks as in Australia: the Australia and New Zealand Banking Group and the Westpac Banking Corporation are both also represented in Australia. Trustee savings banks are also prevalent. The government lends money at low interest to farmers, home builders, and small businessmen through the State Advances Corporation.
Banking in Singapore
As one of the world's major financial centres and a regional economic giant, Singapore has an internationally significant banking regime. Central banking functions are exercised by the Monetary Authority of Singapore, though issuing of currency is conducted by a separate government body. The domestic commercial banking industry in Singapore consists of some 13 local banks and is dominated by the leading houses. The Post Office Savings Bank serves as the national savings bank. There are also numerous merchant banks. Singapore is also host to numerous foreign banks, divided according to the type of licence they are granted: full, restricted, or "offshore". The Singaporean government operates a compulsory savings scheme for employees, the Central Provident Fund. Singapore's banking industry continues to grow and mature with the development of the nation's economy.
Banking in Hong Kong
Nominally under British jurisdiction and banking law until 1997, Hong Kong is important as a banking centre in proportion to its position as one of Asia's major economic axes. The Office of the Commissioner of Banking supervises banking in Hong Kong, in conjunction with the Hong Kong Monetary Authority (established 1993). There are three banks of issue in the dependency: the Hong Kong and Shanghai Banking Corporation, the Standard Chartered Bank, and the Bank of China. Numerous locally incorporated commercial banks operate alongside branches of foreign banks; there are also many banks operating under restricted licences and numerous deposit-taking companies.
Banking in India
The central bank of India is the Reserve Bank: most large commercial banks were nationalised in 1969, with more being nationalised in 1980. The Department of Banking at the Ministry of Finance controls all banking. The State Bank of India, the largest commercial bank, handles some of the Reserve Bank's roles. The other nationalised banks share the commercial market with nonnationalised and foreign banks. Some of them offer merchant banking services, though there are no independent merchant banks in India. Cooperatives and credit societies are an important supplement to the private banking industry, especially in rural areas. It remains to be seen whether India's process of economic liberalisation will spread to the banking sector.
Banking in Developing Countries
The type of national economic system that characterises developing countries plays a crucial role in determining the nature of the banking system. In capitalist countries a system of private enterprise in banking prevails; in a number of socialist countries (for example, Egypt and Sudan) all banks have been nationalised. Other countries have patterned themselves after the liberal socialism of Europe; in Peru and Kenya, for instance, government-owned and privately owned banks coexist. In many countries, the banking system developed under colonialism, with banks owned by institutions in the parent country. In some, such as Zambia and Cameroon, this heritage continued, although modified, after decolonisation. In other nations, such as Nigeria and Saudi Arabia, the rise of nationalism led to mandates for majority ownership by the indigenous population.
Banks in developing countries are similar to their counterparts in developed nations. Commercial banks accept and transfer deposits and are active lenders, especially for short-term purposes. Other financial intermediaries, particularly government-owned development banks, arrange long-term loans. Banks are often used to finance government expenditures. The banking system may also play a major role in financing exports.
In the poorer countries, an extensive but primitive nonmonetary sector usually continues to exist. It is the special task of the banking community to encourage the use of money and instil banking habits among the population.
Role of Central Banking
The foremost monetary institution in a free market economy is the central bank. These are usually government-owned institutions, but even in countries where they are owned by the nation's banks (such as the United States and Italy), the responsibility of the central bank is to the national interest.
Most central banks perform the following functions: they serve as the government's banker, act as the banker of the banking system, regulate the monetary system for both domestic and international policy goals, and issue the nation's currency. As banker to the government, the central bank collects and disburses government income and receipts, manages the issue and redemption of government debt, advises the government on all matters pertaining to financial activities, and makes loans to the government. As banker to the nation's banks, the central bank holds and transfers banks' deposits, supervises their operations, acts as a lender of last resort, and provides technical and advisory services. Monetary policy for both domestic and foreign purposes is implemented and, in many countries, decided by the national banking authorities, using a variety of direct and indirect controls over the financial institutions. Coins and notes that circulate as the national currency are usually the liability of the central bank.
The ability of the central bank to control the money supply and thus the pace of economic growth is responsible for a major economic policy debate. Some economists believe that monetary control is extremely effective in the short run and can be used to influence economic activity. Nevertheless, some hold that discretionary monetary policy should not be used because, in the long run, central banks have been unable to control the economy effectively. Another group of economists believes that the short-term impact of monetary control is less powerful, but that the central banking authorities can play a useful role in mitigating the excesses of inflation and depression. A newer school of economists claims that monetary policy cannot affect systematically the pace of national economic activity. All agree that problems related to the supply side of the economy, such as fuel shortages, cannot be resolved by central-bank action.
The expansion of trade in recent decades has been paralleled by the growth of multinational banking. Banks have historically financed international trade, but the notable recent development has been the expansion of branches and subsidiaries that are physically located in other countries, as well as the increased volume of loans to borrowers internationally. For example, in 1960 only eight US banks had foreign offices; by 1987, 153 US banks had a total of 902 foreign branches. Similarly, in 1973, fewer than 90 foreign banks had offices in the United States; by 1987, 266 foreign banks operated 664 offices in the United States. Most are business-orientated banks, but some have also engaged in retail banking.
The growth of the Eurodollar market has forced major banks to operate branches worldwide. The world's banking system played a key role in the recycling of petrodollars, arising from the surpluses of the oil-exporting countries and the deficits of the oil-importing nations. This activity, while it smoothed international financial arrangements, is currently proving awkward as foreign debtors find it more difficult to repay outstanding loans.
Now try the exercises. Exercise a, Exercise b, Exercise c
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