Prepared By: Mohammad Kamrul Arefin Principles of Banking Lecture 1 Prepared By: Mohammad Kamrul Arefin

An Overview of Banks and Their Services Banks are among the most important financial institutions in the economy. They are the principal source of credit (loanable funds) for millions of individuals, families, businesses and many units of governments. What is Bank: A financial intermediary accepting deposits and granting loans; offers the widest menu of services of any financial institution. Banks are those financial institutions that offer the widest range of financial services- especially credit, savings, and payment services-and perform the widest range of financial functions of any business firm in the economy. This multiplicity of bank services and functions has led to banks being lebeled “financial department stores” Nonbank Banks: Depository institutions offering checking accounts or commercial loans but not both. Mohammad Kamrul Arefin 2

The Investment/financial planning function The Modern Bank The Investment/financial planning function The Security Brokerage(trading) Function The thrift (savings) function The real estate & community dev. function The insurance (risk mgt. function The investment banking (security underwriting) function The credit (loan) function The payments (transactions) function The merchant banking (temporary stock inv. The cash mgt function Figure: Service Areas in the Modern Bank Mohammad Kamrul Arefin 3

Figure: The Key Nonbank Competitors Bankers Face Today The Modern Bank Real Estate Developers and Mortgage Companies supplying building and construction expense/ financing Credit Unions and other Thrift Institutions offering customers credit, payments and savings deposit services often fully comparable to what banks offer Check-Cashing Firms, Small Loan Vendors, and Finance Companies supplying customers with ready cash (liquidity) and short to medium term loans for everything from daily household and operating expenses to the purchase of appliances and equipment Security Brokers and Dealers, providing investment and savings planning, executing security purchases and sales, and providing credit cards to their customers Insurance Companies and Pension Plans, providing customers with long term savings plans, risk protection, and credit Mutual Funds, supplying professional cash management and investing services for longer term savers Figure: The Key Nonbank Competitors Bankers Face Today Mohammad Kamrul Arefin 4

Table: The Many Different Roles Banks Play in the Economy The intermediation role Transforming savings received primarily from households into credit (loans) for business firms and others in order to make investments in new buildings, equipment, and other goods. The payments role Carrying out payments for goods and services on behalf of their customers (such as by issuing and clearing checks, wiring funds, providing a conduit for electronic payments, and dispensing currency and coins) The guarantor role Standing behind their customers to pay off customer debts when those customers are unable to pay (such as by issuing letters of credit) The risk management role Assisting customers in preparing financially for the risk of loss to property and people. Mohammad Kamrul Arefin 5

The savings/investment advisor role Aiding customers in fulfilling their long range goals for a better life by building, managing, and protecting savings. The safekeeping/ certification of value role Safeguarding a customer’s valuables and appraising and certifying their true market value. The agency role Acting on behalf of customers to manage and protect their property or issue and redeem their securities (usually provided through the bank’s trust department) The policy role Serving as a conduit for govt policy in attempting to regulate the growth of the economy and pursue social goals. Mohammad Kamrul Arefin 6

The Services Banks Offer the Public: Services Bank Have Offered Throughout History: Carrying out currency exchanges: The service offered by banks in which they trade one nation’s currency for that of another. History shows that one of the first services offered by banks was currency exchange. Discounting Commercial Notes and Making Business Loans: Banks convert IOUs (I owe you) received by merchants from their customers into cash. Early in their history, bankers began discounting commercial notes, in effect making loans to local merchants who sold the debts (accounts receivables) they held against their customers to a bank to raise cash quickly. Mohammad Kamrul Arefin 7

Offering Savings Deposits: Banks offer thrift accounts that pay interest and encourage people to save. Making loans proved so profitable that banks began searching for ways to raise additional loanable funds and one of the earliest sources of funds consisted of offering savings deposit, interest bearing funds left with banks for a period of weeks, months or years. Safekeeping of Valuables and Certification of Value: During the middle ages, banks began the practice of holding gold, securities, and other valuables owned by their customers in secure vaults. They would also, when asked, assay the market value of their customers’ valuables, especially gold and jewellery and certify whether or not these so called valuables were worth what others had claimed. Mohammad Kamrul Arefin 8

Supporting Govt Activities with Credit: Banks purchase Govt bonds with a portion of any deposits they received to finance govt expenditure to maintain growth in the economy. Offering Checking Accounts (Demand Deposit): Demand deposit is a checking account that permitted the depositor to write checks in payment for purchases of goods and services that the bank had to honour immediately. Trust Services: For many years banks have managed the financial affairs and property of individuals and business firms in return for a fee that is often based on the value of properties or the amount of funds under management. This property management function is known as trust services. Many banks offer both personal trust services to individuals and families and commercial trust services to corporations and businesses. Mohammad Kamrul Arefin 9

Services Bank Have Developed More Recently: Granting Consumer Loans: Historically, most banks did not actively pursue loan accounts from individuals and families, believing that the relatively small size of most consumer loans and their relatively high default rate would make such lending unprofitable. However in the early 1920s, heavy competition for business deposits and loans caused bankers increasingly to turn to the consumer as a potentially more loyal customer. Financial Advising: Bankers have long been asked for financial advice by their customers, particularly when it comes to the use of credit and the saving or investing of funds. Many banks today offer a wide range of financial advisory services, from helping to prepare tax returns and financial plans for individuals to consulting about marketing opportunities at home and abroad for their business customers. Mohammad Kamrul Arefin 10

Equipment Leasing Services: An alternative to lending in which a bank buys equipment and rents it to its customers. Making Venture Capital Loans: Increasingly, banks have become active in financing the start up costs of new companies, particularly in high-tech industries. Because of the added risk involved in such loans, this is generally done through a venture capital firm, a subsidiary of a bank holding company such as Citigroup Venture, Inc. Selling Insurance Services: For many years, bankers have sold credit life insurance to their customers receiving loans, thus guaranteeing loan repayment if borrowers die or become disabled. Generally, insurance policies are contracts that protect customers by covering the costs of property damage and health care and make monetary payments in case of death. Mohammad Kamrul Arefin 11

Selling Retirement Plans: Retirement plans are pension programs that individuals to save money for retirement. Bank trust departments are active in managing the retirement plans that most businesses make available to their employees, investing incoming funds and dispensing payments to qualified recipients who have reached retirement or become disabled. Bank also sell deposit retirement plans (known as IRAs and keoghs) to individuals holding these deposits until the funds are needed for income after retirement. Security Brokerage Service: Recently many banks started offering security brokerage service to their customers by executing customer orders to buy or sell securities. Security Underwriting Service: Banks provide assistance in launching securities to raise funds for corporations Mohammad Kamrul Arefin 12

Offering Mutual Funds and Annuities: Annuities consist of long term savings plans that promise the payment of a stream of income to the annuity holder beginning on a designated future date (such as at retirement). In contrast, mutual funds are professionally managed investment programs that acquire stocks, bonds, and other securities that appear to fit the funds’ announced goals. Merchant Banking Service: These services are defined as the temporary purchase of corporate stocks to aid the launching of a new business venture or to support the expansion of an existing company. Mohammad Kamrul Arefin 13