Transcript Numerical of Chapter no 3

ORIGIN AND GROWTH OF
COMMERCIAL BANKING
Evolution of Banking
 What is bank?
 There are various views about the origin of the word ‘bank’. One view is
that it is derived from an Italian word ‘banque’ which means a
‘bench’.
 In the explanation of this view they are saying that in past in Italy the
money exchanger were sitting on benches and doing there businesses.
 Today banks are dealing in money so the work of today banks and work
of those money exchangers is the same, as both are dealing in money
that’s why they are saying that the word bank has derived from an
Italian word ‘banque’ which means a ‘bench’.
Evolution of Banking
 The other point of view is that it has originated
from the German word ‘banc’ which means a
‘joint stock firm’.
 In the explanation of this view they are saying that
today banks are working as a joint stock firm that’s
why the word bank has been originated from the
German word ‘banc’ which means a ‘joint stock
firm’.
Evolution of Banking
 As regards the growth of modern commercial bank,
it can be traced to as early as 600 BC. Crowther
in his famous book “An outline of money” has
traced the history of modern commercial banking.
According to him the present day banker has three
ancestors.
 1. The merchants
 2. The goldsmiths
 3. The money lenders
Evolution of Banking
1. The merchants:
 The earliest stage in the growth of banking can be traced to
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the working of merchants. These merchants were traders in
commodities.
The trading activities were carried on by them from one place
to another.
It was risky for traders to carry metallic money with
themselves for payment.
The traders with high reputation begin to issue receipts which
were accepted as title of money.
These receipts or letters of transfer also called hundi in indo
sub continents were the first mode of payments.
The merchant banking thus form the earliest stage in the
evolution of modern banking
Evolution of Banking
2. The Goldsmiths:
 The second stage in the growth of banking is normally
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traced to the earlier goldsmith.
These goldsmiths also called “seths” in India used to receive
gold and silver for safe custody.
The goldsmiths begin to issue receipts for the metallic
money (gold and silver) kept with them.
These receipts became payable to the bearer on demand.
In this way the goldsmith note became a medium of
exchange and a mean of payment.
The goldsmith thus can rightly be termed as the
forerunners of the modern bank notes.
Evolution of Banking
3. The money lenders:
 The third stage in the development of banking arose when
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goldsmiths became money lenders.
By experience the goldsmith (who were called money lenders)
came to know that they could keep a small proportion of the total
deposits for meeting the demands of customers for cash and the
rest the could easily lend.
They allow the depositors to draw over and above the money
actually standing to their credit (they allow overdraft facility).
When every money lender/goldsmith issued receipts and many
of them allowed overdraft facilities there were then too much
confusion in the banking system.
The money lenders/goldsmiths in order to earn more profits
could not keep adequate reserves for meeting the demands of the
customers for cash.
Evolution of Banking
 The failure on the part of the money lenders/goldsmiths to return
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money caused wide spread distress among the people.
In order to create confidence among the people, steps were taken to
regulate the banking organization.
A conference was held in Nuremberg in 1548. It was decided that a
bank should be set up by the state which should regulate the banking
organization and techniques.
The 1st central bank was formed in Geneva in 1578. Bank of England
was established in 1694.
The modern commercial banking system actually developed in
nineteenth century.
With the passage of time the scope of the commercial banks have
greatly increased. They now deal with large number of matters such as
obtaining funds, advancing loans to the businesses, farmers,
households, making investments in stocks, discounting bill of exchange
etc.
The commercial banks are now multi service organizations and play a
very important role in the financial markets and economic development
of a country.
What is a Commercial Bank?
 According to Crowther;
“A bank is a firm which collects money from those
who have it spare. It lends money to those who
require it.”
 In the words of Parking;
“A bank is a firm that takes deposits from house
hold and firm and makes loans to other households
and firms”.
What is a Commercial Bank?
 Commercial bank accepts deposits from individuals,
firms and companies at a lower rate of interest and
gives it at higher rate of interest to those who need
them.
 The difference between the terms at which it borrows
and those at which it lends forms the source of its
profit.
Functions of a Commercial Bank
 A commercial bank performs a variety of functions.
These functions are classified under two main heads
 1. Basic Functions
 2. Secondary Functions
1. Basic Functions
 What are basic functions of a Commercial Bank?
 The basic functions of a Commercial bank are
 a. Accepting of Deposits
 b. Advancing of money
a. Accepting of Deposits
 The 1st important function of a bank is to accept
deposits from those who can save but can not make
profitable use of their savings themselves.
 In order to attract the savings from different
persons and institutions, The bank maintain the
following three types of accounts
 1. Current Account
 2. Saving Account
 3. Fixed or Term deposit account
Current account
 The businesses and traders usually maintain their
funds in current account.
 What is a current account?
 “Current account is one where money is constantly
being drawn out and put in”.
 Since the money is withdraw able at any time by
the customer, therefore the bank do not pay
interest on current deposits.
 Current account holders receive a check book and
regular statements containing details of money
paid in and paid out.
Features of current account
Approved parties:
 The bank can open current account for approved parties.
The businessmen and individuals are entitled for
opening current account. But some banks don’t need
approved parties, they open account on the basis of NIC
(Tazkeera) only.
Service charges:
 The bank has right to claim service charges if you did not
make any transection within 6 months in your account.
Moreover they inactivate your account if you did not
make any charges within one year.
Continue…
Statement of account:
 The bank sends statement of account to their customers at
their addresses. The customer can ask for statement of
account for any particular period.
Standing Instructions;
 The bank accepts standing instructions. These instructions
are issued to pay expenses or collect income regularly on
behalf of customers.
Continue…
Introduction;
 Bank can open current account after proper introduction.
The old customers & bank employees can introduce new
customers. Some banks don’t need introduction even.
Pay-in-slip;
 The customers can use pay-in-slip to deposit money and
cheques into bank accounts. The color of pay-in-slip for
current account is different from other accounts.
Minimum Amount;
 The account can opened with any amount in Afghanistan.
But you should keep minimum balance of $100 or Afs
5000 in individual account and $ 300 or Afs 15,000 for
corporate account. (It varies from bank to bank).
Continue…
Withdrawal of amount
 The account holder can withdraw amount standing
to this credit. There is no limit on number of
withdrawal.
Cheque Book/Card;
 A cheque book or card is issued to the account holder
at the time of account opening through which the
customer can withdraw amount from bank.
Continue…
Interest is not allowed;
 The bank do not allow interest on current account
balance because money is withdraw able any time
from this account.
Overdraft facility;
 Overdraft are granted in current account against
securities. Interest on overdraft is calculated on daily
basis.
No notice of Withdrawal;
 The customer can withdraw money from this account
during banking hours any number of times without
notice.
Saving Account
 The aim of this account is to encourage the savings of
the people.
 “Saving account is generally opened by persons of
small income. The banks pay interest on this type of
deposits”.
 However, the banks normally place restrictions on
their frequent withdrawal.
Features of Saving Account
 Account Holders;
Any person or persons who are competent to contract
can open single or joint saving account. The legal bodies
like associations, club, schools, local bodies etc can open
such accounts.
 Introduction;
The saving bank is opened with proper introduction if it
is checking account. When cheque book is not used to
operate account there no need of such introduction. The
old customers of bank or employees of bank can
introduce new customers. Some banks don’t need
introduction even.
Continue…
 Initial Deposit;
Saving account can be opened with any amount. The
account holder can deposit more amount.
 Cheques/Card;
The customers can withdraw money from bank
through cheque or bank card, provided by bank.
 Pass Book;
The customer can bring pass book for withdrawal, if
pass book is issued by bank. It is a type of book in
which customer maintain entries of their own
deposit and withdrawal.
Continue…
 Interest;
The banks pay interest on the end of June or
December at fixed rate on minimum monthly
balance.
 Withdrawal;
Account holder is allowed to with draw money up to
Afs. 15,000 at a time. S/he can withdraw amount
twice in a week.
 Notice;
A notice of 7 days is required for withdrawal of more
than Afs 15,000/-. Such notice should be in writing.
Fixed or Term deposit account
 Fixed or Long term deposits are kept with the banks
for a specified period of time. The rate of interest on
fixed deposits (also called term deposits) are high.
 The longer the period of deposit, the higher is the
rate of interest and vise versa.
 As well as the larger is the amount of the deposit, the
higher is the rate of interest and vise versa.
Features of Fixed Deposit Account
 No Introduction;
The bank accepts fixed deposit accounts without
introduction. A copy of identity card (Tazkeera) is
sufficient to open such an account.
 Time of Deposit;
The customer can decide the time of deposit. It may
vary from three months to five years.
 Rate of Profit;
The bank offers different rate of interest on different
time period. The fixed deposit account offers higher
rate than other accounts.
Continue…
 Fixed deposit receipt;
The bank provides receipt for deposit of money. The
receipt is called fixed deposit receipt.
 Non-Transferable;
The fixed deposit receipt is not transferable from one
person to another. The owner is bound to keep
receipt till maturity.
 Loan Facility;
The bank can provide loan facility to customer. The
amount of loan is 60-80% of fixed deposit.
Continue…
 Withdrawal of amount;
The customer can withdraw amount before due date.
The bank does not pay interest on the withdrawal of
amount on the request of depositor.
 Interest rate on loan;
The bank can charge rate of interest on loan from 22.5% per annum over and above rate of interest on
deposit. It may vary from 11-14%.
Various Bank Accounts--- A
Comparison
Basis of
Difference
Fixed or Term
Deposit
Account
Saving Bank
Current Deposit
deposit Account Account
1- Objective
To Earn Interest.
To Cultivate habit
of Saving.
2- Period of
Deposit
Deposits are made
on fixed period.
No fixed period for It is an open &
deposits.
running account
for which there is
no fixed period for
deposits.
3- Frequency of
deposits
Deposit is made
Deposits can be
only at one time in made any number
this account.
of times here.
To provide the
facility to
Industrialist and
businessman to
deposit or
withdraw the
money as and
when need.
No restriction on
making deposits in
this account.
Various Bank Accounts--- A
Comparison (Continue…)
Basis of
Difference
Fixed or Term
Deposit Account
Saving Bank
deposit
Account
Current Deposit
Account
4- Restrictions
on Withdrawal
The amount can generally There are
be paid at maturity.
restrictions on
When withdrawal is made withdrawal.
before maturity, interest
is either not allowed or
minimum interest is paid.
There is no
restriction on
withdrawal in this
account.
5- Interest
As the cost of operation is
very low in this account
so high rate of interest is
allowed.
Interest is
allowed at a
rate lower than
fixed account.
No interest or only a
nominal interest is
allowed as the cost of
account is very high.
6- Cheque
Facility
Not Permitted.
Cheques are
used for
withdrawal.
Cheques are used for
withdrawal.
b. Advancing of money or Making loans
 The second major function of a commercial bank
is to make loans to the businessmen, traders,
exporters, households etc
 These loans are made against documents of title
to goods, marketable securities, personal security
of borrowers etc
 A very large portion of bank’s total assets consist
of the advances (loans) of the bank.
b. Advancing of money or Making loans
 “ Specific amount given by the bank for a specific time period for
earning profit is called loan”
 Secured/ Collateral/ Parallel Loan;
Loan given on the basis of securities i.e.
 Movable property (Gold, merchandise),
 Immovable property (Land, building),
 marketable securities (Bond, shares)
 Maturity of Loan;
 The total period of time in which the total loan along with interest will
be paid back to the lender is called maturity of loan.
 Short term loan (less than 1 year)
 Medium term loan (1-5 years)
 Long term loan (6-10 years)
b. Advancing of money or Making loans
 The lending of money may be in any of the following
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forms.
1. Overdraft
2. Bank Loan
3. Cash credit
4. Discounting of bills
5. Letters of credit
Overdraft
 It is a convenient form of short term financing by a bank.
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Under this facility a customer may arrange with his bank to
permit him to overdraw on his current account known is
overdraft (O/D).
The bank allows customer to overdraw his account up to a
certain limit on providing securities of shares, insurance
policies, deposits receipts etc.
Interest is charged on daily basis on the overdrawn amount
only.
An overdraft also called running finance & its allowed to
current account holder only.
The difference between cash credit and overdraft is that
cash credit is given on regular basis and for relatively
greater time period. The overdraft facility is for short
period.
Cash Credit (C.C)
 It is a very common form of borrowing by business
concerns. The banks advance long term loan to the
commercial and industrial units against the
security of goods.
 The borrower has to open a new loan account for
cash credit.
 Cash credit is given on the basis of securities of any
type.
 The borrower is permitted to draw with in the cash
credit limit sanctioned by the bank.
 The interest is charged only on the amount of
money withdrawn by the borrower.
Bank Loan
 The commercial banks grant short and long term
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loans to individuals, firms and companies mostly
against securities.
The borrower has to open a new loan account.
Interest is charged on monthly, semi annually or
annual basis.
The borrower has to keep any type of securities with
the bank acceptable to the bank.
These loans are repayable either in periodic
installments or in lump sum at a fixed period of time.
Types of bank loan
1. Demand loan;
As repayable to the bank as and when demanded by the bank as per
agreed agreement.
2. Fixed or Term loan;
It is advanced for a fixed period of time. It is repayable according
to repayment schedule or in lump sum after a fixed period of time.
3. Consortium Loan;
If a single loan is jointly granted by more than one bank, it is known
as consortium or participation loan.
4. Bridge loan;
The loan is granted to customer for meeting his temporary needs
until permanent funds are raised by him.
Discounting of bills
 Discounting of bills of exchange is another short
term method of profitable investment of bank funds.
 Discounting of bills of exchange refers to making the
payment of bill before its maturity. The discount
charge is the earning of the bank.
 The premature payment made is a loan to the holder
of the bill.
 Usually bank pay the 75 % of the bill in advance and
the letter 25 % is paid when the bill is matured after
deduction bank charges.
Letters of Credit
 Trade between countries is mainly financed by letters of
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credit.
The buyer who is an importer, applies to his bank for
opening a letter of credit.
The bank issuing the letter of credit assures the exporter
that the payment will be made to him as soon as the
documents completed in all respect are received by it.
The buyer bank thus makes payment in advance to the
exporter bank on fulfilling the terms and conditions of
credit.
The full amount is later on recovered by the importer along
with service charges.
2. Secondary Functions
 The secondary function of a bank are classified into
two categories,
 a. Special Financial Services
 b. Agency Functions
 c. Utility Functions
a. Special Financial Services
 The business of today is highly competitive. It is not
enough for the banks now to accept deposits and
make loans only.
 Currency exchange
 Letters of credit
 Money transfer
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SWIFT (Society for world wide inter bank financial
telecommunication)
Bank Draft
Western union
Money gram
Cont…
 Most of the banks offers ATM cards(Automated
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Teller Machines) Master card ,Visa card ,Debit card
Credit card
Hajj application
Zakat deduction
Passport services
Collection of taxes and utility bills
Financing foreign trade by processing the documents
of trade between two parties
b. Agency Functions
 Banks act as agents of their customers in various
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ways as:
(i) Collection of Checks
(ii) Collection of Dividends
(iii) Purchase or sale of Securities
(iv) Execution of standing instructions
(v) Acting as trustee or executors
Agency Functions
 (i) Collection of Checks:
 Banks act as an agent in collection and payment of
checks for their customers.
 (ii) Collection of Dividends:
 The bank provide a very useful service in the collection
of dividends or interest earned on shares held by its
customers.
Agency Functions
 (iii) Purchase or sale of Securities:
 The bank, if authorized by the customer, purchase or
sells securities on his behalf.
 (iv) Execution of standing instructions:
 The customer may order in writing to his bank to make
payments of regularly recurring nature to an individual
or firm.
 The bank will make payments and charge a small
commission. The payments will be stopped on written
instructions of the customer only.
Agency Functions
 (v) Acting as trustee or executors:
 If a client directs his bank to act as trustee or executor
in the administration of a will or in any business
settlement requiring a technical knowledge, the bank
will take this responsibility for the benefits of customer
and charge a small fee for providing this essential
service.
Utility Functions
 Provide information for starting international business
 Underwriting (the process of purchasing the shares by
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the bank from the company for the 1st time and reselling
it back to the people).
Status report (for foreign trips we need bank statement)
Lockers facility
Relief fund
Investment of funds in shares and bonds
Bill of exchange
Bank accepts Shares application for subscription of
shares on behalf of company.
END OF CHAPTER