CLASS 12 CHAPTER 10 ''BANKING'' (ECONOMICS)

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CHAPTER 10: BANKING

Concept:

The term Bank is derived from latin word Banko which means ‘to exchange money sitting on the bench’. Banking may be defined as financial institutions which deal with money and credit.

According to R. S. Syers ‘The financial institution which deal with money and credit and performs role in lending and borrowing to fulfill financial requirement of country can be defined as Bank’.

There are two definitions of Bank and they are given below:

1. Based on Deposit Collection: According to World Bank ‘Banks are financial institutions that accept funds in the form of deposits repayable on demand or in short notice’

2. Based on both Deposit and Loan: According to Crowther ‘A banker is a dealer in debts. The banker’s business is to take the debts of other people to offer his own in exchange and thereby to create money’. In other words the business of the bank is to accept deposits from the depositors and to provide loan or credit creation.

If Banking sector of a country is properly developed it promotes development of almost all sectors of a country. Thus, development of Banking sector is essentially needed for socio-economic and business economic development of a country. The Central Bank is the mother of entire banking and financial sector of a country. The commercial banks are followers of rules and regulations of central bank.

The oldest bank of the world is ‘Riks Bank of Sweden’ established in 1563 A.D. but the oldest central bank of the world is ‘Bank of England’ established in 1694 A.D. There are different categories of Banks are they are as follows:

1. Central Bank

2. Commercial Bank

3. Agricultural Bank

4. Industrial Bank

5. Foreign Exchange Bank

6. Export-Import Bank

7. Share Transaction Bank and Others

ROLE OR FUNCTIONS OF BANK:

1. Mobilization of Savings

2. Creation of Credit

3. Channelizing Fund

4. Proper Utilization of Resources

5. Encouragement to Industrial Development

6. Development of Trade and Commerce

7. Finance to Government

8. Sustainable Economic Development

CENTRAL BANK:

Concept:

Central Bank is the mother and leader of entire banking and financial institutions of a country. Central Bank controls entire financial system of a country. The oldest central bank of the world is ‘Bank of England’ established in 1694 A.D. The central bank of Nepal is Nepal Rastra Bank.

Functions of Central Bank:

A. Regular/Administrative Functions:

1. Monopoly of Note Issue: Central Bank has complete monopoly and command over the issue of currency. There are two main deposits in Central Bank:

a.Issue Department

b.Banking Department

The Issue Department of Central Bank prints notes and coins and circulatory currency in the country. Central Bank issues notes on the basis of 4 main system:

a. Proportionate Fiduciary System

b. Fixed Fiduciary System

c. Percentage Fiduciary System

d. Government Bond Deposit System

2. Control of Credit: The Central Bank attempts to control credit for monetary stability in the country. There are two main methods to control credit:

a. Quantitative Method

i. Bank Rate

ii. Open Market Operation

iii. Variable Reserve Ratio

b. Qualitative Method

i. Fixation of Credit Margin

ii. Regulation of Consumer’s Credit

iii. Moral Persuasion

iv. Direct Action

v. Publicity

3.Banker’s Bank:Central Bank is the bank of all commercial banks. In fact, Central Bank is known as Mother of entire banking system. According to Central Banking principles all commercial banks need to deposit a certain percentage of their deposits compulsorily in central bank. Likewise, commercial banks also obtain loan from central bank on easy terms and conditions. Thus, Central Bank is Bank of all Commercial Banks.

4.Central Bank as Treasurer, Financial Advisor and Agent of Government:

a. As Treasurer:Central Bank performs role of treasurer of government. The entire income of government is deposited at Central Bank. If needed Central Bank also provides overdraft loan facility to government. The metallic and monetary income of government both are deposited at Central Bank.

b.As Financial Advisor:Central Bank is financial advisor to government in formulation of fiscal policy and overall economic policy alongwith budget formulation and it also provides proper financial advices to government.

c.As Agent of Government:Central Bank on behalf of government transacts money with other government and other international financial institutions. Thus, central bank performs role of agent for the government.

5.Custodian of Nation’s Reserve of International Currencies:There are two major funds created and maintained at central bank which can be listed as follows:

a. National Reserve Fund

b.International Reserve Fund

In National Reserve Fund all the metallic income in the form of gold, silver and other precious metals of government are deposited. However, in International Reserve Fund the foreign currencies s income of government are always deposited.

B. Development Functions:

1. Clearing House Functions: According to Prof. Taussig the central bank performs role of clearing house function in which the obligation of a bank is cleared by central bank in settlement of financial liability.

According to Taussig ‘Clearing House is general organization of bank of a given place having for its main purpose, clear off settling of cross obligations in the form of cheques’

The clearing house function has simplified the financial transactions of commercial bank and it helps to facilitate the smooth development of financial system in a country.

2. Lender of Last Resort:In delicate situation if a commercial bank demands loan from central bank then central bank evaluates the financial status of that particular commercial bank and lends money to the commercial bank. Central Bank cannot deny in providing loan at difficult situation of commercial bank. The central bank provides loan to commercial bank as lender of last resort through two main techniques:

a. Central Bank provides loan on the basis of security management.

b. Discounting and Re-Discounting Bills of Exchange and other financial instruments of Commercial Banks.

COMMERCIAL BANK:

Concept:

It is a financial institution established in order to earn profit doing its banking business. It accepts deposits of money from general public and advances loans for commercial purposes to businessmen, individuals etc. In Nepal the oldest commercial bank is Nepal Bank Limited established in 1994 A.D. before the establishment of Nepal Rastra Bank.

Functions of Commercial Bank:

A. Primary Functions:

1. Acceptance of Deposits: The primary function of commercial bank is to accept deposit of customers. The scattered savings of customers and people are accepted by commercial bank in form of three deposits:

a. Current A/C Deposit

b. Saving A/C Deposit

c. Fixed A/C Deposit

The commercial bank provides interest on the deposits of saving and fixed account.

2. Advancing of Loans:Commercial Banks provide loan to customers on the basis of their approved securities. Commercial bank provides loan to customers on the basis of four main components:

a. Cash Credit

b. Loan and Advances

c. Overdraft Loan

d. Discounting Bills of Exchange

On the basis of all these components Commercial Bank provides loan to customers claiming certain rate of interest.

B. General Utility Functions:

1. To issue Letter of Credit: Commercial Bank issues Letter of Credit on the name of customers to facilitate trade and commerce situation of the country. While issuing Letter of Credit, commercial bank claims certain commission from customers.

2.Safe Custody Functions:Commercial Banks keep valuable ornaments, securities and valuable documents of customers through Locker System Facility which is known as Safe Custody Function of commercial bank. While providing locker facility commercial bank claim certain charge or commission from customers.

3.Remittance of Money:Commercial Bank transfer money of customers from one place to another through draft system or computer transfer system. Such a function is technically known as Remittance of Money. Commercial Bank claims certain commission while sending money of customers from one place to another.

4.To Deal with Foreign Exchanges:Commercial bank sells and purchases foreign currencies of customers according to the rules and regulations of central bank. While selling or purchasing foreign currencies commercial bank claims certain commission from customers.

5.Collection of Trade Information and Statistics:Commercial bank collects trade information and statistics to facilitate the commercial activities of customers. In fact, proper trade statistics are made available by commercial bank to their customers to promote their trade and commercial activities practically.

C.Agency Functions:

1. To Collect Money of Customers from other Banks: Commercial Banks collect money of customers from other banks claiming certain commission.

2.To Pay Insurance Premium, House Rent and Income Tax:Commercial Bank as agent of customers pay insurance premiums, house rent and income tax on behalf of customers claiming certain commission.

3.To Issue and Sell Share and Securities:Commercial Bank on behalf of customers issue and sell their share and securities claiming certain commission.

4.Attorney, Trustees and Executors:Commercial Bank on behalf of customers work as attorney, trustees and executors of customers claiming certain commission.

5.Commercial Bank as Financial Advisor:Commercial Banks provide varieties of financial advices regarding money marketing management to customers so that customers can take productive decisions in their business management.

FINANCIAL MARKET:

It is a market mechanism which deals with short term and long term lending and borrowing of financial instruments. Financial Market carries the transaction of money, cheque, treasury bills, government securities etc. Financial Market is broadly classified into two categories: a. Money Market and b. Capital Market.

MONEY MARKET:

Money Market may be defined as those financial institutions which provide short term loan to customers.

According to G. R. Crowther ‘Loan for less than a year credit instruments are called Near Money Assets transacted in Money Market’

Commercial Banks are major stakeholders of Money Market because it generally provides loan to customers for a period of one year.

Main Institutions:

1. Central Bank

2. Commercial Bank

3. Financial Institutions as Insurance Companies, Provident Fund and others

4. Corporate Financial Institutions as Cooperative Societies

5. Discount Houses

Major Instruments:

1. Certificates of Deposits

2. Treasury Bills

3. Commercial Paper

4. Call Term Money

5. Others

CAPITAL MARKET:

Capital Market may be defined as those financial institutions which provide long term loan to customers. Capital Market is regulated by Central Bank. Capital Market consists of both Primary and Secondary Capital Market. In Capital Market mortgage, bonds, equities and such other investment funds are traded. Capital Market includes Stock Market, Bond Market.

COMPONENTS:

1. Primary Capital Market: Here newly issued bonds and stocks are exchanged. It is the market of first issue of securities.

2.Secondary Capital Market:Here buying and selling of already existent bonds and stocks take place. Thus, it is market for trading securities already been issued.

Capital Market may be divided into two main sectoral markets:

1. Bond Market

2. Stock Market

Main Institutions:

1. Central Bank

2. NIDC (Nepal Industrial Development Corporation)

3. Stock Exchange (NEPSE)

4. Acceptance Houses

5. Securities Sales and Purchase Centre

Main Institutions:

1. Long term Securities

2. Long term Bonds

3. Shares

4. Newly issued Stocks and Securities