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Banks

Alternate uses: Bank (disambiguation)

The essential function of a bank is to provide services related to the storing of value and the extending 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 an institution that holds a banking license. Banking licenses are granted by financial supervision 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-bank. Banks are a subset of the financial services industry.

The word bank is derived from the Italian banca, which is derived from German 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 or the interest spread on resources it holds in trust for clients while paying them interest on the asset.

Services typically offered by banks

Although the type of services offered by a bank depends upon the type of bank and the country, services provided usually include:

• Directly take deposits from the general public and issue checking and savings accounts
• Lend out money to companies and individuals (see moneylender)
• Cash checks
• Facilitate money transactions such as wire transfers and cashiers checks
• Issue credit cards, ATM, and debit cards
• online banking
• Storage of valuables, particularly in a safe deposit box

Types of banks

There are several different types of banks including:

• 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 European Central Bank and the US Federal Reserve Bank.
• Investment banks underwrite stock and bond issues and advise on mergers. Examples of investment banks are Goldman Sachs of the USA or Nomura Securities of Japan.
• 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.
• Private banks manage the assets of the very rich. An example of a private bank is the Union Bank of Switzerland.
• Savings banks write mortgages exclusively.
• 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.
• Commercial banks primarily lend to businesses (corporate banking)
• Retail banks primarily lend to individuals. An example of a retail bank is Washington Mutual of the USA.
• Universal banks engage in several of these activities. For example, Citigroup, a 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.

Banks are prone to crisis

The traditional bank has an inherent tendency to crisis. This is because the bank borrows short term and lends leveraged long term. The sum of deposits and the bank's capital will never equal more than a modest percentage of the loans the bank has outstanding.

Even if liquidity is not a concern, if there is no run on the bank, banks can simply choose a bad portfolio of loans, and lose more money than they have. The US Savings and Loan Crisis in the late 1980s and early 1990s is such an incident.

Role in the money supply

A bank raises funds by attracting deposits, borrowing money in the inter-bank market, or issuing financial instruments in the money market or a securities 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 banking supervision.

Regulation

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.

How banks are viewed

Banks have a long history of being characterized as heartless, rapacious creditors, hounding honest folk down on their luck for the last dime. See Populism.

In United States 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.

Profitability

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 then any other company in the world, has only a 5 percent market share. Now if Citigroup were to be as dominant in its industry as a Home Depot, Starbucks, or Wal Mart in their respective industries, with a 30 percent market share, it would make more money than the top ten non-banking US industries combined.

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. First, 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). Second, 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. Third, 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 exisiting regularory burdens, new government regulation, and increasing competition from non-traditional financial institutions.

Top ten banks in the world ranked by profit in 2003

1. Citigroup — 20 billion
2. Bank of America — 15 billion
3. HSBC — 10 billion
4. Royal Bank of Scotland — 8 billion
5. Wells Fargo — 7 billion
6. JP Morgan Chase — 7 billion
7. UBS AG — 6 billion
8. Wachovia — 5 billion
9. Morgan Stanley — 5 billion
10. Merrill Lynch — 4 billion

History of banking

• Florentine banking — The Medicis and Pittis among others
• Banknotes — Introduction of paper money
• Bank of Amsterdam
• Bank of Sweden — The rise of the national banks
• Bank of England — The evolution of modern central banking policies
• Bank of America — The invention of centralized check and payment processing technology
• United States Banking

See also

• Currency
• Economics
• Finance
• Islamic Banking
• Money
• Piggy Bank
• Venture capital
• SWIFT

Related topics

• list of banks
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• list of business law topics
• list of business ethics, political economy, and philosophy of business topics
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