Ask Me Anything: About Origin And Nature Of Banking
The word “Bank” is said to have been derived from the Italian word ‘banco’, the original meaning of which is ‘shelf’, ‘bench’. It was extended to that of ‘counter’, money-lenders and money changers used to display their coins, whence ‘bank’. The above version seems to be correct, for changing, in ancient banking was looked upon as the most important function of a banker. The banco or bench of a medieval banker was broken by the people if he failed in his business and probably is the origin of the word ‘bankrupt’.
None of the statutory definitions of a bank is completely general. The New York state banking law defines a bank as ‘any domestic moneyed corporation, other than a trust company, authorized to discount and negotiate promissory notes, drafts, bills of exchange and other evidences of debt: to receive deposit of money and commercial paper; to lend money on real or personal security, and to buy and sell gold and silver bullion, foreign coins or bills of exchange.’ The term ‘banker’ defined in the Bills of Exchange Act.1882, and the Stamp Act 1891, as any person carrying on the business of banking, is not of any value and does not carry us very far.
Modern bank perform a variety of functions, some of which are given below:
- Various kinds of money dealings, such as money changing, shipment of money or bullion, purchases and sale of bullion.
- Receiving deposits.
- Discounting (i.e. purchasing at present worth) commercial paper (e.g. bill of exchange and promissory notes).
- Granting loans in other way either by advances against securities or by way of overdraft, mortgages loans, or by the purchases of shares in industrial companies.
- Issues of bank notes-this functions is now a days virtually restricted to the central bank of issue in the eighteenth century it was regarded as an essential function of all banks.
- Dealing in foreign exchange.
- Performing agency functions on behalf of clients. Such as:
- Safe custody, sale or purchase of securities.
- Safe custody of others valuables.
- Collections of dividends and bills.
- Acting as correspondents and clearing agents for others banks.
- Issuing letters of credit.
- Acting as trustees, executors, attorneys.
- Serving as bankers to the joint stock companies.
It must be remembered that all the above functions are not performed by every bank. There is division of labor and specialization. Commercial banks are formed to accept deposits for short periods and credit also for short periods (for the current finance of trade and industry) in England and in the U.S.A. In contradistinction to these are the industrial or investment Banks, like those of Japan, which make advances for long period to industrial concerns and raise their capital by debentures. But the Credit banks in Germany, are of the mixed type and combine ordinary commercial banking with investment banking. There are, in addition, certain banks specialized in mortgage banking, some in financing of foreign trade or foreign exchanges. All these banks may be called profit making concerns. While Central banks are of a special class acting as agents to their governments and generally empowered to issue paper currency.
The process of amalgamation between private and joint stock banks as well as between joint stock banks themselves has been a striking feature of modern banking. It is all under the stimulus of a desire to avoid competition and promote large scale production and in consequence five most powerful banking institutions or the ‘Big Five’ ( Barclays, Lloyds, The Midland, National Provincial and Westminster banks) have come to the fore in England.
While this amalgamation is advantageous in bringing about efficient organization, expert management, centralization of sources, wider and cheaper banking facilities, it is attended by the evils of monopoly and becomes unwieldy, cumbersome and excessively centralized ( if this process of amalgamation is carried too far), and leads to the neglect of local interests.
Another striking feature of modern banking is the development of branch and unit banking systems. They are in fact, the two rival systems. Under the branch banking system, there is a small number of very large banks, each having numerous branches. The system has been popular in England, Canada, South Africa and France. The USA retains the same original system of unit banking i.e. a great many small independent banks. In the unit banking systems bankers operation are confined in general to a single office, though some few are allowed to have branches with in a strictly limited area. The sort of restriction is the outcome of the traditional fear of a ‘Money Trust’. Even the Central Bank of the United States is a federation of twelve banks, each with its own region.
The branch banking is useful in this respect that it offers cheap and widespread facilities and enables funds to be transferred from one branch to another according to the needs of different places while its defect lies in this that it results in monopolistic control, excessive centralization of authority at head-quarters and neglect of local interests. Unit banking possesses opposite merits and weaknesses. On the whole, branch banking is preferable as it minimizes the risk of failure.
The most common classification of banks in according to the purpose they serve. In this respect banks are many kinds. Throughout the world we find commercial banks, saving banks, mortgage banks, investment banks, agricultural banks, cooperative banks and many others that perform special or general services. So far as their policy in making advances is concerned, most of them fall into two categories:
- Commercial banks whose deposits are known as demand deposits, and therefore they prefer to have credit transactions of comparatively short terms,
- Investment banks whose deposits are known as time deposits and therefore they embark upon the policy of advancing long term loans. But it has to be admitted that commercial banks have combined, in them, the features of investment banks in that their short terms loans are at times, extended to become long-term loans. And, therefore, it is remarked that the theory of banking deals largely with the operations of commercial banks.
The above two categories do not include Central banks which are a class in themselves as they act as fiscal agents to their governments and are custodians of treasury funds, issue paper currency, carry the gold reserves, serve as a depository for other banks and as the bank of last resort bear the responsibility for controlling the supply of credit.
Almost each country in the world has got a central bank to perform the functions, more or less, similar to those of the Bank of England which is a central bank itself. But the United States of America and the Union of Soviet Socialist Republics stand apart with distinct banking systems of their own. So we rest contented with giving in some detail, the main features of the Bank of England, whose pattern is followed, with some changes, by most of the countries. Added to this are the short sketches of the banking systems in the United States and USSR.
Branch banking is prevalent in England. This is in sharp contrast to the United States where due to fear of what is called a ‘Money Trust’ Unit banking is continued. The Bank of England was established in 1694 and it is the only bank of issue in the country. The Bank charter Act of 1844, divided it into two departments, namely. 1) the issue department and (2) the banking department which is concerned with normal commercial banking business of this Bank.
The bank of England is the banker of the government, as well as the nation, and as such, has accounts of almost all the principal joint stock banks with it, where all surplus cash and other money of each of these banks is deposited. It occupies the position of the bankers’ bank so far as the London Money Market concerned through this bank discounts bills for a few customers, it does not do so for the general public. It has ten branches: The Western and Law court Branches in London, and branches of Manchester, Birmingham, Liverpool, Bristol, Newcastle, Hull and Plymouth. The bank does not accept any new customers for ordinary banking business which is limited to a few old connections.
It is in 1946, that the bank of England became nationalized and its capital stock was brought into public ownership. The management of the Bank is in the hands of ‘Court of Directors’ composed of the Governor, the Deputy Governor and 16 Directors of the Bank to be appointed by His Majesty. The Governor and the Deputy Governor are to hold office for 5 years. The terms of office of the Directors is four years. A person who has held office as Governor or Deputy Governor or Director, is however, eligible for reappointment.
The Treasury has been given the right of giving directions from time to time to the bank which they think, after consulting the Governor of the Bank, are necessary in the public interest. The bank has also the right of requiring information from and can make recommendations to bankers and, with the authority of Treasury, can issue direction to any banker to secure that effect.
In the United Kingdom, commercial banks do not usually borrow from the bank of England to meet the abnormal public demands for cash but they call in their advances to the money market. The discount houses and bill-brokers, who generally handle most of the demand and supply of bills of exchange can get cash from this bank by rediscounting ‘first class’ eligible bills. Thus, on such occasions, the bank of England can influences the discount market and through that the money market where short term loans are handled.
A new development, in the banking history of England, occurred in the middle of 1958. The system of special deposits was introduced to control the credit under which the Bank of England, if so required, may restrict the liquidity of the Banking system.
Unit banking system is the outstanding feature of banking in the United States. Another unique aspect of the banking system in USA is compulsory insurance by the Federal Department Insurance Corporation of deposits up to $10000 which was instituted to preserve the unit banking system after the banking crisis of 1933. As a result of which 98% of all deposits are now insured. The rigidity of legislation and the strict control under which the commercial banks operate are other features not to be found in other countries. There are, again, twelve separate Federal Reserve Banks, s against a single central bank in Great Britain.
The central banking organization in USA came into existence in 1913, with the passing of Federal Reserve Act. Consequently there are twelve Federal Reserve Banks and a coordinating body called the Federal Reserve Board with head-quarters in Washington. The vast area of the country has been divided into twelve districts, each having its own Federal Reserve bank which acts, within its area, as a banker’s bank. The Reserve Banks have the privilege of note issue against gold reserves, rediscount eligible paper brought to them by member banks and make advances against the security of such paper and thus they act as the lenders of last resort.
In short, they perform the function for which the Central Bank exists, namely, to carry out the country’s monetary policy with the instrument of the Bank Rate. Open market operations and the Cash Ratio. Although the main function of the Federal Reserve Bank is to regulate the flow of credit and money, it performs other functions such as performances of essentials services for the member banks of the Federal Reserve System, facilitating the clearance and collection of cheques, effecting telegraphic transfers funds, acting as fiscal agents, custodians and depositories for the Treasury and other Government agencies.
There are two types of commercial banks in United States. National Banks and State banks, the former obtain charter from the Federal Government while the latter from a State Government. Not all banks are members of the Federal Reserve System, so they can be classified as member and non-member banks. The credit policy of these banks is controlled by the Reserve Banks but where as in England there are only a few large banks with a nation-wide network of branches, there were in the United States in January 1959, a total of 13,514 independent commercial banks, most of which unit banks with no branches at all. Both countries possess money market, but whereas the London money market forms the integral part of the British banking system, the New York money market occupies a much less important position. American member banks borrow from their central bank, whereas British commercial banks never do this directly, but instead call in some of their loans to the money market thereby compelling bill brokers and discount houses to borrow from the Bank of England. Unlike the Bank of England which does not compete against the commercial banks for ordinary banking business. The Federal Reserve banks may. If they so desire, make loan directly to businessmen. These are, in brief, the differences between central banking in Great Britain and that of the United States.
The whole banking system of the country is State owned and is under the Ministry of Finance. The structures of this system consists of three groups. Namely
- The State Bank (i.e. Gos bank) which performs the function of a Central Bank such as note issue and acting as a fiscal agent of the government.
- Network of savings banks and
- Four special banks for agriculture and industry.
But in 1959 the structure was streamlined into (1) The State Bank, (2) The Industrial Bank (3) a new investment Bank.
The Gosbank is for all practical purposes the only commercial bank with a network of correspondents abroad. Further, it has the exclusive right to deal in foreign exchange. Its function is closely geared to the budget and the national plan. Since virtually all deposits come from enterprises controlled by the State plan, there is no need for Soviet banking officials to give some attention to liquidity as a Western banker does.
Personal banking is carried on through the State Savings Bank. It has a network of some 50,000 savings banks usually attached to local finance department offices, post offices, or village clubs. Interest is allowed at 3% on ordinary accounts – which by no means all banks in western countries can match. The banking services offered is a narrow one and normally makes no provision for loans or overdrafts. However, those who are fortunate enough to be able to buy houses and durable consumer goods are able to apply for mortgage credits, repayable over a fifteen year period, and since 1959, instalment purchase has also been available.