Types_of_Banks

TYPES OF BANKS Central Bank A bank that controls a country’s money supply and monetary policy. It acts as a banker to other banks, and a lender of last resort. In some countries, including the UK, the central bank is also the main regulator of other banks. A central bank is ultimately controlled by a country’s political system; whether central bankers should be controlled by the current government, or should be independent is controversial. Commercial Bank A bank dealing with the general public, accepting deposits from and making loans to a large number of households and small firms. They also provide various services for depositors, including provision of cash and credit cards, storage facilities for valuables and documents, foreign exchange, stockbroking, mortgage finance, and executor services. Merchant Bank A bank dealing mainly with other firms rather than the general public. Merchant banks engage in a variety of specialist activities, including: financing foreign trade by accepting bills of exchange (they provide a form of trade credit. When a company supplies goods on credit terms which allow the purchaser 3 or 3 months in which to make payment, it is in effect providing the buyer with a short-term loan); providing hire purchase and industrial finance; underwriting new issues (acts as issuing house, that is, carry all the work involved in floating a new issue); advising on and arranging finance for mergers and takeover bids; and investment management for institutions and wealthy individuals. Trustee Savings Bank A trustee savings bank provides deposit facilities for small savers. They also provide a current account service (i.e. payment may be made by cheque. The greater part of the assets of a Trustee Savings bank consists of government securities (i.e. loans to the government). Development Bank A development bank provides a savings collection system for small savers in the rural areas, while at the same time administering external lines of credit on behalf of the government (such as those in existence from the African Development Bank and IFAD), and undertaking only a limited amount of well-defined term lending activity. Ensure continued access to rural and agricultural based financing programmes for development purposes. Development finances embraces investments in revenue generating enterprises and projects, whether public or private and whether operating on the basis of: (a) commercial profitability; (b) full-cost recovery autonomous to the enterprise; or partial cost recovery with an explicit subsidy provided by the fiscus at whatever level of government to cover the balance. Building Society A financial institution, whose main activity is accepting, deposits from the general public to finance lending on private housing. Building societies are the largest single source of mortgage finance. They also engage in some lending on commercial properties, and in other financial activities. Some provide current account facilities, including cheques and electronic transfers, for their depositors. COMMERCIAL BANK A commercial bank can be defined as an institution carrying out business of which a substantial part consists of the acceptance of deposits of money withdrawable by cheque. As profit-seeking institutions commercial banks derive their profits from two major sources. Firstly, revenue is derived from loan activities, namely the difference between income on funds lent and the cost of deposits. The second source is commission, and the fees recovered for financial services rendered. Although interest income still constitutes the most important component of commercial banks’ income, commission and service-fees income are increasingly assuming greater significance. Commercial banks perform various very important functions in the financial system. Firstly, banks accept deposits to fund their loan activities. Commercial banks accept demand deposits on current account that can be drawn by way of cheque and other electronic funds transfer means from the public (individuals and business) They also accept notice, term and savings deposits. From the central bank’s point of view, the extent and growth of these deposits are of great importance seeing that it represents a major portion of the money supply. Secondly, commercial banks make credit available, mainly in the form of overdrawn accounts. Through this process the banks create funds that flow back to the banking system as money. As a result of the ability of banks to create money central banks place commercial banks under strict control by way of monetary policy measures in the form of discount rate policy and often reserve requirements. Commercial banks also offer acceptance and bills of financing, as well as advances on credit card accounts. Homeloans and term loans for both individual and corporate clients are also extended on a large scale. Thirdly, commercial banks also offer money transmission services which involve payments by way of standing orders (regular payments of a fixed amount); direct debits (regular or irregular amounts payable to specific persons such as telephone bills); local and foreign travellers cheques (when the user pays the face value of the cheque plus commission when he receives it, but will be refunded if lost); credit card facilities (used for making payments or obtaining credit) and debit card facilities (for motor vehicle services and fuel purchases). Commercial banks also render financial services in the fourth place. Service fees are charged for administering cheque accounts as well as payment instructions debited automatically against these accounts. Significant expansion has also taken place in the field of electronic banking. Valuables are kept in safe custody for clients in return for certain fees, while the administration of estates has become a notable source of income. Shares and fixed-interest stock are negotiated on clients’ behalf, and insurance services and investment advice are increasingly offered. Cash management services for corporate clients have been developed to assist them with optimum application of their short-term surplus funds. Fifthly, commercial banks also act as authorised currency dealers. Banks act on the foreign exchange market, buying and selling various currencies on behalf of importers and exporters. Commercial banks also arrange for the transfer of funds internationally on behalf of their clients. They also handle foreign financing and provide advice on exchange rates and foreign market conditions. Lastly, commercial banks play a vital role in the execution of monetary policy by the central bank in a country. The rates charged by the central bank for accommodation or assistance to the banking system impact on the banks’ rates for call funds, other money market instruments and, subject to expectations, term rates. Changes in the accommodation rate will give indications to the market of the stance of the current monetary policy of the monetary authorities. CENTRAL BANK A completely autonomous body responsible for formulating and implementing monetary policy Monetary Policy Monetary policy refers to attempts by monetary authorities to manipulate money supply, thru interest rates and exchange rate so as to bring about desired changes in the economy. The aims of monetary policy are the maintenance of full employment, price stability, a satisfactory rate of economic growth, and balance of payments equilibrium. There are number routers through which monetary policy affects output and prices. Changes in monetary policies and therefore interest rates not only cause the money supply to change; in addition, they lead to changes in exchange rates, which in turn affect the broad economy. What is more, changes in interest rates affect real demand in an economy, which in turn affects output and prices and also exchange rates, which in turn again affect output and prices. In total changes in monetary policies and therefore interest rates can exert a powerful effect on an economy assuming inflation expectations remain unchanged. In what follows the impact of higher interest rates is described. There is to begin with a substitution effect. An increase in interest rates reduces the attractiveness for individuals and companies of borrowing now and spending now rather than later. Domestic credit, the quantity of money, and real demand all decline. There is also an income effect. Higher interest rates redistribute income from borrowers to savers. This increases the spending power of savers but reduces that of borrowers. Since savers have a lower propensity to spend than borrowers total expenditures decline. In addition, there is the wealth effect. Higher interest rates usually reduce the price of assets such as houses and shares. The decline in wealth discourages individuals from spending their current income. Moreover, unless the economy is operating at above capacity, lower demand will exert downward pressure on prices and costs in the economy. Companies will reduce their profit margins, while workers will accept lower pay increases. Changes in monetary policies also affect output and prices in an economy via the channel of the exchange rate mechanism. For countries with no exchange controls unexpected increases in domestic interest rates (with interest rates in other countries unchanged) will encourage an inflow of foreign capital. If the exchange rate is floating the domestic currency appreciates. (For countries with fixed exchange rate unexpected increases in domestic interest rates result in capital inflows, and an increase in money supply. This offset to some extent the trend towards slower increases in domestic credit, and weakens the overall effect of rising interest rates). The more liberalized are the capital markets, and the closer that domestic financial assets are perceived as substitutes for foreign assets, the larger the appreciation in the exchange rates. Such a rise in the exchange rate leads to at least a lower increase in import prices measured in terms of domestic currency. Such a trend in turn directly curbs the rate of inflation, since cheaper imported inputs and intermediate goods moderate inflation through positive impact on the costs of domestically produced goods and services Fiscal Policy Fiscal policy refers to the tools used by government to manipulate aggregate demand, which in turn, tend to influence inflation, employment, output and the balance of payments. Defined differently fiscal policy is the deliberate manipulation of government income and expenditure so as to achieve desired economic and social objectives.