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The
essential function of a bank is to provide services related to
the storing of deposits and the extending of credit. The
evolution of banking dates back to the earliest writing, and continues
in the present where a bank is a financial institution that provides
banking and other financial services. Currently the term bank
is generally understood as an institution that holds a banking
license. Banking licenses are granted by bank regulatory authorities
and provide rights to conduct the most fundamental banking services
such as accepting deposits and making loans. There are also financial
institutions that provide certain banking services without meeting the
legal definition of a bank, a so called non-banking financial company.
Banks are a subset of the financial services industry.
The word bank is derived from the Italian banca, which
is derived from German language and means bench. The terms bankrupt
and "broke" are similarly derived from banca rotta, which
refers to an out of business bank, having its bench physically broken.
Money lenders in Northern Italy originally did business in open areas,
or big open rooms, with each lender working from his own bench or
table.
Typically, a bank generates profits from transaction fees on financial
services and on the interest it charges for lending.
Although
the type of services offered by a bank depends upon the type of bank
and the country, services provided usually include:
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Directly taking deposits from the general public and
issuing cheque and savings accounts
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Lending out money to companies and individuals
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Cashing cheques
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Facilitating money transactions such as wire
transfers and cashiers cheques
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Issuing credit cards, ATM, and debit cards
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online banking
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Storing valuables, particularly in a
safe deposit box
There are
several different types of banks including:
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Central banks usually control monetary policy and may
be the lender of last resort in the event of a crisis. They are
often charged with controlling the money supply, including printing
paper money. Examples of central banks are the Bank of England, the
European Central Bank and the U.S. Federal Reserve Bank.
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Commercial bank, is the term used for a normal bank
to distinguish it from an investment bank. Since the two no longer
have to be under separate ownership, some use the term "commercial
bank" to refer to a bank or a division of a bank that mostly deals
with corporations or large businesses.
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Community development bank are regulated banks that
provide financial services and credit to underserved markets or
populations.
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Investment banks "underwrite" (guarantee the sale of)
stock and bond issues and advise on mergers. Examples of investment
banks are Goldman Sachs of the USA or Nomura Group of Japan.
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Merchant banks were traditionally banks which engaged
in trade financing. The modern definition, however, refers to banks
which provides capital to firms in the form of shares rather than
loans. Unlike Venture capital firms, they tend not to invest in new
companies.
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Offshore banks are banks located in jurisdictions
with low taxation and regulation, such as Switzerland or the Channel
Islands. Many offshore banks are essentially private banks.
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Postal savings banks are savings banks associated
with national postal systems. Japan and Germany are examples of
countries with prominent postal savings banks.
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Private banks manage the assets of high net worth
individuals.
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Retail banks' primary customers are individuals.
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Savings banks traditionally accepted savings deposits
and issued mortgages. Today, some countries have broadened the
permitted activities of savings banks.
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Universal banks, more commonly known as a financial
services company, engage in several of these activities. For
example, Citigroup, a very large American bank, is involved in
commercial and retail lending; it owns a merchant bank (Citicorp
Merchant Bank Limited) and an investment bank (Salomon Smith
Barney); it operates a private bank (Citigroup Private Bank);
finally, its subsidiaries in tax-havens offer offshore banking
services to customers in other countries. Almost all large financial
institutions are diversified and engage in multiple activities. In
Europe, big banks are very diversified groups that, among other
services, distribute also insurance, whence the bancassurance term.
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Islamic banking revolves around several
well-established concepts - based on Islamic canons. Concept of
Interest, in Islam is forbidden. Hence, all banking activities must
avoid interest. Instead of interest, the Bank earns profit (mark-up)
and fees on financing facilities it extends to customers. Also,
depositors earn a share of the Bank’s profit as opposed to interest.
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Susceptibility to
crisis
Banks are
susceptible to many forms of risk which have triggered occasional
systemic crises. Risks include liquidity risk (the risk that many
depositors will request withdrawals beyond available funds), credit
risk (the risk that those that owe money to the bank will not repay),
and interest rate risk (the risk that the bank will become
unprofitable if rising interest rates force it to pay relatively more
on its deposits than it receives on its loans), among others.
Banking
crises have developed many times throughout history when one or more
risks materialize for a banking sector as a whole. Prominent examples
include the U.S.
Savings and Loan crisis in 1980s and early 1990s, the Japanese
banking crisis during the 1990s, and the banking crisis that developed
during the Great Depression.
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A bank
raises funds by attracting deposits, borrowing money in the inter-bank
market, or issuing financial instruments in the money market or a
capital market. The bank then lends out most of these funds to
borrowers.
However, it would not be prudent for a bank to lend out all of its
balance sheet. It must keep a certain proportion of its funds in
reserve so that it can repay depositors who withdraw their deposits.
Bank reserves are typically kept in the form of a deposit with a
central bank. This behaviour is called fractional-reserve banking and
it is a central issue of
monetary policy. Some governments (or their central banks)
restrict the proportion of a bank's balance sheet that can be lent
out, and use this as a tool for controlling the money supply. Even
where the reserve ratio is not controlled by the government, a minimum
figure will still be set by regulatory authorities as part of bank
regulation.
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The
combination of the instability of banks as well as their important
facilitating role in the economy led to banking being thoroughly
regulated. The amount of capital a bank is required to hold is a
function of the amount and quality of its assets. Major banks are
subject to the Basel Capital Accord promulgated by the Bank for
International Settlements. In addition, banks are usually required to
purchase deposit insurance to make sure smaller investors are not
wiped out in the event of a bank failure.
Another reason banks are thoroughly regulated is that ultimately, no
government can allow the banking system to fail. There is almost
always a lender of last resort—in the event of a liquidity crisis
(where short term obligations exceed short term assets) some element
of government will step in to lend banks enough money to avoid
bankruptcy.
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Banks
have a long history of being characterized as heartless, rapacious
creditors, hounding honest folk down on their luck for the last penny.
In US history, the National Bank was a major political issue during
the presidency of Andrew Jackson. Jackson fought against the bank as a
symbol of greed and profit-mongering, antithetical to the democratic
ideals of the United States.
“The bank is something else than men. It happens that every man in
a bank hates what the bank does, and yet the bank does it. The bank is
something more than men, I tell you. It’s the monster. Men made it,
but they can’t control it.” – John
Steinbeck, The Grapes of Wrath
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Large
banks in the United States are some of the most profitable
corporations, especially relative to the small market shares they
have. This amount is even higher if one counts the credit divisions of
companies like Ford, which are responsible for a large proportion of
those company's profits. For example, the largest bank, Citigroup,
which for the past 3 years has made more profit than any other company
in the world, has only a 5 percent market share.
In the past 10 years in the United States, banks have taken many
measures to ensure that they remain profitable while responding to
ever-changing market conditions:-
Firstly, this includes the 'Gramm-Leach-Bliley Act', which allows
banks again to merge with investment and insurance houses. Merging
banking, investment, and insurance functions allows traditional banks
to respond to increasing consumer demands for "one stop shopping" by
enabling the crossing selling of products (which, the banks hope, will
also increase profitability).
Secondly, they have moved toward risk based pricing on loans, which
means charging higher interest rates for those people who they deem
more risky to default on loans. This dramatically helps to offset the
losses from bad loans, lowers the price of loans to those who have
better credit histories, and extends credit products to high risk
customers who would have been denied credit under the previous system.
Thirdly, they have sought to increase the methods of payment
processing available to the general public and business clients. These
products include debit cards, pre-paid cards, smart-cards, and credit
cards. These products make it easier for consumers to conveniently
make transactions and smooth their consumption over time (in some
countries with under-developed financial systems, it is still common
to deal strictly in cash, including carrying suitcases filled with
cash to purchase a home).
However, with convenience there is also increased risk that consumers
will mis-manage their financial resources and accumulate excessive
debt. Banks make money from card products through interest payments
and fees charged to consumers and companies that accept the cards.
The banks' main obstacles to increasing profits are existing
regulatory burdens, new government regulation, and increasing
competition from non-traditional financial institutions.
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Citigroup — 20 billion
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Bank of America — 15 billion
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HSBC — 10 billion
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Royal Bank of Scotland — 8 billion
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Wells Fargo — 7 billion
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JP Morgan Chase — 7 billion
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UBS AG — 6 billion
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Wachovia — 5 billion
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Morgan Stanley — 5 billion
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Merrill Lynch — 4 billion
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History of
Banking
he very
first banks were probably the religious temples of the ancient world.
In them were stored
gold in the form of easy to carry compressed plates. Their owners
justly felt that temples were the safest places to store their gold as
they were constantly attended, well built and were sacred, thus
deterring would-be thieves. There are extant records of loans from the
18th Century BC in Babylon that were made by temple priests to
merchants.
Ancient Greece holds further evidence of banking. Greek temples as
well as private and civic entities conducted financial transactions
such as loans, deposits, currency exchange, and validation of coinage.
Interestingly, there is evidence too of credit, whereby in return for
a payment from a client, a Money Lender in one Greek port would write
a credit note for the client who could "cash" the note in another
city, saving the client the danger of carting coinage with him on his
journey.
Ancient Rome perfected the administrative aspect of banking and saw
greater regulation of financial institutions and financial practices.
Charging interest on loans and paying interest on deposits became more
highly developed and competitive. The ascent of Christianity in
Rome and its influence restricted banking, as the charging of interest
and usury were seen as immoral. Jewish entrepreneurs, free of
Christian taboos about money, established themselves in the provision
of financial services increasingly demanded by the expansion of
European trade and commerce.
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see also Money
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