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 merchants2. The goldsmiths3. The money lenders

Evolution of Banking

1. The merchants:

The earliest stage in the growth of banking can be traced to 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 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 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 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 Functions2. Secondary Functions

1. Basic Functions

What are basic functions of a Commercial Bank?

The basic functions of a Commercial bank area. Accepting of Depositsb. 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 Account2. Saving Account3. 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.

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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.

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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).

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Withdrawal of amountThe 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.

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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.

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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.

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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.

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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.

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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 2-2.5% 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 deposit Account

Current Deposit Account

1- Objective To Earn Interest.

To Cultivate habit of Saving.

To provide the facility to Industrialist and businessman to deposit or withdraw the money as and when need.

2- Period of Deposit

Deposits are made on fixed period.

No fixed period for deposits.

It is an open & running account for which there is no fixed period for deposits.

3- Frequency of deposits

Deposit is made only at one time in this account.

Deposits can be made any number of times here.

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 be paid at maturity. When withdrawal is made before maturity, interest is either not allowed or minimum interest is paid.

There are restrictions on withdrawal.

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 forms.

1. Overdraft 2. Bank Loan3. Cash credit4. Discounting of bills5. Letters of credit

Overdraft

It is a convenient form of short term financing by a bank. 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 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 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 Servicesb. 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 creditMoney transfer

SWIFT (Society for world wide inter bank financial telecommunication)

Bank Draft Western union Money gram

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Most of the banks offers ATM cards(Automated Teller Machines) Master card ,Visa card ,Debit card Credit card

Hajj applicationZakat deductionPassport servicesCollection of taxes and utility billsFinancing foreign trade by processing the

documents of trade between two parties

b. Agency Functions

Banks act as agents of their customers in various 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 businessUnderwriting (the process of purchasing the shares by

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 facilityRelief fundInvestment of funds in shares and bondsBill of exchangeBank accepts Shares application for subscription of

shares on behalf of company.

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