You are on page 1of 25

CAT-II (a) DISCUSS THE EVOLUTION OF THE BANKING SECTOR IN KENYA:

The evolution of banking begins with the first prototype banks of merchants of the ancient
world, which made grain loans to farmers and traders who carried goods between cities. This
began around 2000 BC in Assyria and Babylonia. Later, in ancient Greece and during the
Roman Empire, lenders based in temples made loans and added two important innovations:
they accepted deposits and changed money. Archaeology from this period in ancient China
and India also shows evidence of money lending activity.

The History of Banking in Kenya traces its roots at early European trade of East African
Coast and in Zanzibar. In 1887 and 1888, Sir William Mackinnon with the endorsement of
the British foreign office set up what later became to be known as the Imperial British East
Africa Company (IBEAC).The formation of the IBEAC captured the attention of the
National Bank of India (NBI) which entered into the agreement with the East African
Representatives of the Merchant companies, Smith Mackenzie and company, to act as its
agent at the East Africa coast.

In those formative years Indias fortune in East Africa was in explicably linked to the fortunes
of IBEAC which was an independent corporate entity in its own flight, currency, postage
stamps, private army and offices in Mombasa. IBEAC was wound up in March 1895 and
replaced with East Africa protectorate, a system of administration that involved more direct
British Government control through the foreign Office. Perhaps encouraged by the turn of
events, National Bank of India established its first branch in Mombasa the following year
(1896). In the same year the East Africa Protectorate started building a Railway line to
Kisumu. National Bank of India was appointed the Official Bank of adventure marking the
beginning of the Banks Long and profitable relationship with what later became the colonial
Government of Kenya. The Railway finally arrived in Kisumu in 1901, and helped to open up
the hinterland for business. The fastest growing inland center was Nairobi, which had been
established in 1899 as a camp for railway crew. In 1904 National Bank of India set up its first
East Africa Inland branch in Nairobi. The buying business would grow as the Development in
Nairobi grew. With the economic growth in the Protectorate more banks were attracted to the
country, necessitating the Government to pass the first Banking Ordinance in 1910 to regulate
their operations.

In January 1911 Standard Bank of South Africa opened two branches in Kenya one in
Mombasa and the other in Dalamere Avenue in Nairobi. The National bank of South Africa
came in 1916. In 1920 the East Africa Protectorate was declared a colony of the British
Empire and its name changed to Kenya. The new colonial starters helped the three Banks
grow rapidly mainly through European Deposits and Asian customers. The banking services
were not available to Africans, the only banking sources for Africans was the Post Office
savings bank which started in 1910 as a department of the Colonial Postal service, even then
the service was only available in places where Officials of the colonial service were stationed
and therefore did not reach majority of Africans who resided in rural areas. In 1925 the
National Bank of South Africa was merged with the colonial Bank and the Anglo-Egyptian
bank to form the Barclays Bank DCO (Dominion and Colonial Oversees), Barclays to offer
the Operations of the three branches of the National Banks of South Africa then in existence.
Despite political upheaval such as World War II and the subsequent Mau mau uprising,
Banking in Kenya experienced considerable growth.

The steadily growing economy in Kenya would soon lead to an influx of new banks between
1950 and 1959. In 1951 the Dutch bank Nedelandsche opened a branch in Nairobi. It was
followed by the Bank of India which opened its first branch in Treasury square in Mombasa
on January 17th 1953 and the Bank of Baroda on December 4th of the same year with its first
branch also in Mombasa.

The Pakistan based Habib Bank AG Zurich Ltd came in 1956 while the Ottoman Bank and
Commercial Bank of Africa (CBA) rounded off the rush by establishing branches in the
country in 1958.

After Indian attaining independence from Britain in 1947 and the subsequent hiving off of the
Pakistan, India changed its name in 1958 to National Oversees and Grindlays bank later
called National and Grindlays Bank following its merger with Grindlays bank another
landing based bank which traced its roots to Calcutta India. By 1951 the Banks had expanded
its branches considerably but employment opportunities for Africans in the Banking industry
took a long time to materialize.

Indeed it was not until June 1963 a few months before the country attained independence that
the first African manager of a Bank branch Peter Nyakiamo was appointed. By the time
Kenya became independent the currency used by the banks in Kenya, Tanganyika and
Uganda was the East Africa Shilling. This has not always been the case before currency was
introduced to East Africa; Trade was conducted by Barter and later by Cowrie shell and
Beads. The first currency to be used in the East Africa Coastal region was the Maria Teresa
Dollar, a silver coin introduced to East Africa in 1800 and 1850. This was replaced by the
Indian Rupee following the coming of the British Trade to East Africa.

In 1920 came the East Africa Florin introduced by the East Africa currency Board which had
been set up in 1919. The Florin was replaced by the East Africa Shilling in 1922. The first
Kenyan currency notes went into circulation in 1966 up on the establishment of the Central
Bank of Kenya; three years after the country became independent. The bank issued the first
Kenyan Coins on April 10th 1967. They were in denominations of One and Two Shillings, and
five, ten, Twenty Five and Fifty cents. The Central Bank Established all Accounts for
Commercial banks in Kenya, and on November 16th 1966, the Central Bank took over the
operations of the Bankers Clearing House. This was the first step the Central Bank took
towards controlling and regulating the activities of the Banks.

The Commercial Banks the Central Bank regulated were all foreign owned Banks a situation
that was part of the Colonial heritage that the new Government Independent of Kenya was
determined to change. The Countries first fully locally owned Commercial Bank came on
June 1965 when the Cooperative Bank of Kenya was registered as a Cooperative Society;
initially it served the growing farming community. Cooperative bank as it came to be known
commenced its operations as a Bank on January 10th 1968. The first fully Government owned
Bank the National Bank of Kenya was established in June 19 th 1968. The Government also
set up Kenya Commercial Bank after buying 60% stake in the National Grindlays Bank and
splitting up into two Banks namely the Kenya Commercial bank and Grindlays Bank
International Kenya. Kenya Commercial Bank took over all the two branches that previously
operated by the National Bank and Grindlays International Bank. In November 1976 the
Government assumed full ownership by buying out the 40% stake initially retained by the
Grindlays Bank of London.

The formation of the Government owned Banks had the desire to fight the speeding of the
provision of the affordable banking services to the majority of the population. It also
prompted Foreign owned bank to take measures to remain relevant in the Kenyan markets
and beyond. In 1969 Standard Bank of South Africa merged with the Charted Bank of India,
Australia and China to become the Standard Charted Bank (Stand Chart). On its part Barclays
shared the Dominion and Colonial Oversees to become Barclays bank International. A decade
later it was locally incorporated in Kenya as Barclays Bank of Kenya.
CAT II (b) - OBLIGATIONS OF A BANKER TO THEIR CUSTOMERS, WHO IS A
CUSTOMER AND BANKERS RIGHT OF SET OFF:

The classic exposition of the nature of the bank-customer relationship in Joachimson v.


Swiss Bank Corp- by Lord Justice Atkin gives a lucid account of the basic common law
duties of a bank towards its customer, arising out of the general contract between the bank
and the customer. His Lordship stated:
The bank undertakes to receive money and to collect bills for its customer s account. The
proceeds so received are not to be held in trust for the customer, but the bank borrows the
proceeds and undertakes to repay them. The promise to repay is to repay at the branch of the
bank where the account is kept, and during banking hours. It includes a promise to repay any
part of the amount due against the written order of the customer addressed to the bank at the
branch, and as such written orders may be outstanding in the ordinary course of business for
two or three days, it is a term of the contract that the bank will not cease to do business with
the customer, except upon reasonable notice.
The customer on his part undertakes to exercise reasonable care in exercising his written
orders as not to mislead the bank or to facilitate forgery. I think it is necessarily a term of
such a contract that the bank is not liable to pay the customer the full amount of his balance
until he demands payment from the bank at the branch at which the current account is
kept.
In this case, Lord Justice Atkin rejected altogether the contention that the relationship of bank
and customer is that of debtor and creditor with superadded obligations, and that the customer
enjoys the right of a lender to sue for his debt whenever he pleases. Lord Justice Bankes
reached the same decision as Lord Justice Atkin, whilst adhering to the notion of implied
superadded obligations. However, it has been submitted that Lord Justice Aitkins concept
of a single contract is the more convincing one and that it is the said concept which has
prevailed over the time.
Accordingly, the main duty of a bank towards its customer is as follows:-

1. Obligation to obey Instructions, (Customers Mandate)


The customers mandate gives the authority for the bank to act in a particular way.
Once the mandate is given by the customer to his/her bank and becomes binding on the bank,
the bank has a duty to act on the said mandate. See, Huenerbein v. Federal Bank of
Australia (1892) any failure of the bank to act as stipulated in the mandate given by its
customer would result in breach of contract on the part of the bank. When the bank acts
outside the authority conferred by the mandate, effects of such acts will not be binding on the
customer and therefore, bank alone would be liable for any loss incurred thereby acting
beyond the customers authority may also amount to breach of contract on the part of the
bank.

2. Authority to hour Cheques or (Cheque Transactions)


The bank must pay cheques drawn by a customer in legal form on the branch where the
customers account is maintained subject to certain requirements. These requirements
include:-
a. The cheques should be presented for payment during banking hours or within a
reasonable margin of time after the banks advertised hour of closing.
b. There should be sufficient funds in the customers account to meet the cheques drawn
by the customer or else a prior arrangement should have been made by the customer
with the bank for the payment of the cheques drawn by him/her.
c. There should be no legal impediments to the payment of the cheques. The cheque is
also required to be drawn in proper form.

The general rule is that in the absence of specific instructions to the contrary, a bank is under
a duty to pay its customers cheques in the order in which they are presented, whether by post
or otherwise. See the case of Bank of Baroda Ltd. v. Punjab National Bank Ltd. 1944.

3. Banks Duty of Confidentiality


One of the most important and well established rules of banking law is that a bank must
observe strict confidentiality about its customers account. It should be noted that in an
ordinary debtor-creditor relationship, there is no duty of confidentiality imposed by law on
either party. The banks duty of confidentiality arises because of the specialty of the bank
customer relationship as distinguishable from that of debtor-creditor. Apart from the legal
requirement, the banking practice also jealously guards confidentiality of the customer
accounts.
Thus, banks duty of confidentiality is a special doctrine of its own, which cannot be equated
to a similar duty found in any other kind of professional relationship.
The origin and the basis of the banks duty of confidentiality are attributed to common law.
Case of Foster v. Bank of London (1862) is illustrative of this. The general principles
governing the duty of confidentiality was laid down in the well-known case of Tournier v.
National Provincial and Union Bank of England (1924).
The duty also extends to information and knowledge acquired by the bank even before the
bank-customer relationship was in contemplation or even when the account is dormant. The
duty remains even after the closure of the account and the termination of the bank-customer
relationship.

4. Banks Fiduciary Duty


In English law, the general contract giving rise to bank-customer relationship does not
create a fiduciary relationship. The rationale for this is that banks engage in business with a
view of profit quite different from a fiduciary. However, under a special contract where the
bank becomes a trustee, agent or etc. of the customer, such situations may impose fiduciary
duties on the bank.
Apart from this distinction, case law has recognized a fiduciary duty on banks in certain
limited transactions. Accordingly, a fiduciary duty could arise;
a. When the bank provides investment advice or financial advice to the customer,
b. When the customer pledges an asset or signs a guarantee to secure the debt of another
customer, and
c. When the bank acts as an agent or trustee for the customer.

In the cases of National Westminster Bank plc v. Morgan 1983, a fiduciary duty shall arise
only under very special circumstances, such as where relations of special proximity between
the parties exit, where the customer places his trust and confidence in the bank and relies on
its advice.

5. Duty of Care of Paying Banks and Collecting Banks


Paying bank is the bank on which a cheque is drawn. Collecting bank is the bank which
collects cheques and receives the payment for the said cheques from the paying bank on
behalf of its customer.
A bank, whether it is a paying bank or a collecting bank, would not be liable for payment or
collection of, unauthorised, forged, or stolen cheques provided the bank has complied with
the standards of acting in good faith and acting without negligence.
The first standard (i.e. acting in good faith) is a subjective one and would be similar in
application to both paying banks and collecting banks; see the case of Baker v. Barclays
Bank (1955). When it comes to the second standard (i.e. acting without negligence) however,
a distinction is made between the duties and liabilities of a paying bank on one hand, and the
duties and liabilities of a collecting bank on the other.
In establishing acting without negligence, the paying bank is required to show that it has
strictly adhered to the terms of the customers mandate. Whether the paying bank should in
certain suspicious instances, go beyond the customers mandate to establish acting without
negligence is still unsettled law as it was held in the case of Barclays Bank Ltd. v.
Quincecare Ltd. (1992).

Who is a Customer?
Sir John Paget observes:
The law of banking proper is the law of the relationship between a banker and his
customer. Basically the relationship is that of a mandator (the customer) and mandatory (the
bank), but it is nonetheless a relationship which embraces mutual duties and obligations. It is
a relationship peculiar to banking, giving rise to a contract between the two parties. The
relationship is enjoyed by no one but a bank with reference to a customer and thus it is
necessary to know what in law a customer is.
It is hard to find a specific and comprehensive statutory definition for the term customer
however; in common parlance the term customer means a person who has an account with
the Bank. Hence, resort would have to be made to common law to find who would fall under
the definition of customer of a bank.
It has been judicially held that a person may become a customer by entering into a contract
with the bank by way of opening some sort of account reference case of Tax Commissioner
v. English, Scottish and Australian Bank (1920). The word customer signifies a
relationship in which duration is not of essence
A person may also become a customer by entering into relations or negotiations with the
bank, which are to be considered part of the contract ultimately concluded by opening an
account. Thus, in Woods v. Martins Bank Ltd (1959) the bank-customer relationship was
held to have commenced from the time the bank accepted the plaintiffs instructions though at
that time there was no account, but only the likelihood that an account would be opened,
shortly afterwards.
Thus in order to constitute a customer, a person should satisfy two conditions namely;-
I. He should have an account with the Bank, whether fixed, savings, or current.
II. The dealings should be of banking nature.
Conclusion
Law and business are inextricably intertwined. Thus, when businesses and their scope
change, the law should also rationally develop to cope up with the new challenges posed by
the said changes.
The business of banking has undergone a radical transformation from its inception throughout
the years. Banks exert wide influence over not only their customers, but also the overall
economy. In the light of this, the banking law has developed various means to regulate the
affairs of banking business.
The duties of a bank towards its customer, mainly emanates from the bank customer
relationship. Though this relationship is contractual, common law and statute law have
stepped into the relationship in order to safeguard the interests of the customer. Since, banks
are powerful financial institutions, their accountability is vital for the economy as well as the
society.

Chapter three
Kenya monetary institutions
Monetary Financial Institutions (MFIs), as in a definition provided by the
European Central Bank, are defined as central banks, resident credit institutions
as defined in Community Law, and other resident financial institutions whose
business is to receive deposits or close substitutes for deposits from entities
other than MFIs and, for their own account (at least in economic terms), to grant
credits and/or make investments in securities. Money market funds are also
classified as MFIs.
Financial institutions are the firms that provide financial services and advice to
their clients. The financial institutions are generally regulated by the financial
laws of the government authority.

Various types of financial institutions are as follows:

Commercial Banks

Credit Unions

Stock Brokerage Firms

Asset Management Firms

Insurance Companies

Finance Companies

Building Societies

Retailers

Role of Financial Institutions

The various financial institutions generally act as intermediaries between the capital market
and debt market. But the services provided by a particular institution depend on its type.

The financial institutions are also responsible for transferring funds from investors to the
companies. Typically, these are the key entities that control the flow of money in the
economy.

Services Offered by Various Financial Institutions

The services provided by the various types of financial institutions may vary from one
institution to another.
For example, The services offered by the commercial banks are
insurance services, mortgages, loans and credit cards.
Various types of financial institutions are as follows:

Commercial Banks institutions


A commercial bank can be defined as a financial institution which provides a wide range of
services such as mortgage lending, giving business and auto loans and accepting deposits.
The commercial bank also deals in basic investment products such as saving accounts and
certificates of deposit. The traditional commercial banks come with all facilities such as safe
deposit boxes, bank tellers, ATMs and vaults. However, there are some commercial banks
that do not have any physical branches. Here the customer is required to undertake all
transactions either through the Internet or by phone.

Role of commercial banks

There is acute shortage of capital. People lack initiative and enterprise. Means of transport are
undeveloped. Industry is depressed. The commercial banks help in overcoming these
obstacles and promoting economic development. The role of a commercial bank in a
developing country is discussed as under.

The general role of commercial banks is to provide financial services to


general public and business, ensuring economic and social stability and
sustainable growth of the economy. In this respect, "credit creation" is the most
significant function of commercial banks.
1. Mobilising Saving for Capital Formation:
The commercial banks help in mobilising savings through network of branch banking. People
in developing countries have low incomes but the banks induce them to save by introducing
variety of deposit schemes to suit the needs of individual depositors. They also mobilise idle
savings of the few rich. By mobilising savings, the banks channelise them into productive
investments. Thus they help in the capital formation of a developing country.

2. Financing Industry:
The commercial banks finance the industrial sector in a number of ways. They provide short-
term, medium-term and long-term loans to industry. In India they provide short-term loans.
Income of the Latin American countries like Guatemala, they advance medium-term loans for
one to three years. But in Korea, the commercial banks also advance long-term loans to
industry.

In India, the commercial banks undertake short-term and medium-term financing of small
scale industries, and also provide hire- purchase finance. Besides, they underwrite the shares
and debentures of large scale industries. Thus they not only provide finance for industry but
also help in developing the capital market which is undeveloped in such countries.

3. Financing Trade:
The commercial banks help in financing both internal and external trade. The banks provide
loans to retailers and wholesalers to stock goods in which they deal. They also help in the
movement of goods from one place to another by providing all types of facilities such as
discounting and accepting bills of exchange, providing overdraft facilities, issuing drafts, etc.
Moreover, they finance both exports and imports of developing countries by providing
foreign exchange facilities to importers and exporters of goods.

4. Financing Agriculture:
The commercial banks help the large agricultural sector in developing countries in a number
of ways. They provide loans to traders in agricultural commodities. They open a network of
branches in rural areas to provide agricultural credit. They provide finance directly to
agriculturists for the marketing of their produce, for the modernisation and mechanisation of
their farms, for providing irrigation facilities, for developing land, etc.

They also provide financial assistance for animal husbandry, dairy farming, sheep breeding,
poultry farming, pisciculture and horticulture. The small and marginal farmers and landless
agricultural workers, artisans and petty shopkeepers in rural areas are provided financial
assistance through the regional rural banks in India. These regional rural banks operate under
a commercial bank. Thus the commercial banks meet the credit requirements of all types of
rural people.

5. Financing Consumer Activities:


People in underdeveloped countries being poor and having low incomes do not possess
sufficient financial resources to buy durable consumer goods. The commercial banks advance
loans to consumers for the purchase of such items as houses, scooters, fans, refrigerators, etc.
In this way, they also help in raising the standard of living of the people in developing
countries by providing loans for consumptive activities.

6. Financing Employment Generating Activities:


The commercial banks finance employment generating activities in developing countries.
They provide loans for the education of young persons studying in engineering, medical and
other vocational institutes of higher learning. They advance loans to young entrepreneurs,
medical and engineering graduates, and other technically trained persons in establishing their
own business. Such loan facilities are being provided by a number of commercial banks in
India. Thus the banks not only help inhuman capital formation but also in increasing
entrepreneurial activities in developing countries.

7. Help in Monetary Policy:


The commercial banks help the economic development of a country by faithfully following
the monetary policy of the central bank. In fact, the central bank depends upon the
commercial banks for the success of its policy of monetary management in keeping with
requirements of a developing economy.

Thus the commercial banks contribute much to the growth of a developing economy by
granting loans to agriculture, trade and industry, by helping in physical and human capital
formation and by following the monetary policy of the country.

However, besides these functions there are many other functions which these banks perform.
All these functions can be divided under the following heads:

1. Accepting deposits

2. Giving loans

3. Overdraft

4. Discounting of Bills of Exchange

5. Investment of Funds

6. Agency Functions

7. Miscellaneous Functions

1. Accepting Deposits:

The most important function of commercial banks is to accept deposits from the public.
Various sections of society, according to their needs and economic condition, deposit their
savings with the banks.
For example, fixed and low income group people deposit their savings in small amounts from
the points of view of security, income and saving promotion. On the other hand, traders and
businessmen deposit their savings in the banks for the convenience of payment.

Therefore, keeping the needs and interests of various sections of society, banks formulate
various deposit schemes. Generally, there ire three types of deposits which are as follows:

(i) Current Deposits:

The depositors of such deposits can withdraw and deposit money whenever they desire. Since
banks have to keep the deposited amount of such accounts in cash always, they carry either
no interest or very low rate of interest. These deposits are called as Demand Deposits because
these can be demanded or withdrawn by the depositors at any time they want.

Such deposit accounts are highly useful for traders and big business firms because they have
to make payments and accept payments many times in a day.

(ii) Fixed Deposits:

These are the deposits which are deposited for a definite period of time. This period is
generally not less than one year and, therefore, these are called as long term deposits. These
deposits cannot be withdrawn before the expiry of the stipulated time and, therefore, these are
also called as time deposits.

These deposits generally carry a higher rate of interest because banks can use these deposits
for a definite time without having the fear of being withdrawn.

(iii) Saving Deposits:

In such deposits, money upto a certain limit can be deposited and withdrawn once or twice in
a week. On such deposits, the rate of interest is very less. As is evident from the name of such
deposits their main objective is to mobilise small savings in the form of deposits. These
deposits are generally done by salaried people and the people who have fixed and less
income.

2. Giving Loans:

The second important function of commercial banks is to advance loans to its customers.
Banks charge interest from the borrowers and this is the main source of their income.

Banks advance loans not only on the basis of the deposits of the public rather they also
advance loans on the basis of depositing the money in the accounts of borrowers. In other
words, they create loans out of deposits and deposits out of loans. This is called as credit
creation by commercial banks.

Modern banks give mostly secured loans for productive purposes. In other words, at the time
of advancing loans, they demand proper security or collateral. Generally, the value of security
or collateral is equal to the amount of loan. This is done mainly with a view to recover the
loan money by selling the security in the event of non-refund of the loan.
At limes, banks give loan on the basis of personal security also. Therefore, such loans are
called as unsecured loan. Banks generally give following types of loans and advances:

(i) Cash Credit:

In this type of credit scheme, banks advance loans to its customers on the basis of bonds,
inventories and other approved securities. Under this scheme, banks enter into an agreement
with its customers to which money can be withdrawn many times during a year. Under this
set up banks open accounts of their customers and deposit the loan money. With this type of
loan, credit is created.

(iii) Demand loans:

These are such loans that can be recalled on demand by the banks. The entire loan amount is
paid in lump sum by crediting it to the loan account of the borrower, and thus entire loan
becomes chargeable to interest with immediate effect.

(iv) Short-term loan:

These loans may be given as personal loans, loans to finance working capital or as priority
sector advances. These are made against some security and entire loan amount is transferred
to the loan account of the borrower.

3. Over-Draft:

Banks advance loans to its customers upto a certain amount through over-drafts, if there are
no deposits in the current account. For this banks demand a security from the customers and
charge very high rate of interest.

4. Discounting of Bills of Exchange:

This is the most prevalent and important method of advancing loans to the traders for short-
term purposes. Under this system, banks advance loans to the traders and business firms by
discounting their bills. In this way, businessmen get loans on the basis of their bills of
exchange before the time of their maturity.

5. Investment of Funds:

The banks invest their surplus funds in three types of securitiesGovernment securities,
other approved securities and other securities. Government securities include both, central
and state governments, such as treasury bills, national savings certificate etc.

Other securities include securities of state associated bodies like electricity boards, housing
boards, debentures of Land Development Banks units of UTI, shares of Regional Rural banks
etc.

6. Agency Functions:
Banks function in the form of agents and representatives of their customers. Customers give
their consent for performing such functions. The important functions of these types are as
follows:

(i) Banks collect cheques, drafts, bills of exchange and dividends of the shares for their
customers.

(ii) Banks make payment for their clients and at times accept the bills of exchange: of their
customers for which payment is made at the fixed time.

(iii) Banks pay insurance premium of their customers. Besides this, they also deposit loan
installments, income-tax, interest etc. as per directions.

(iv) Banks purchase and sell securities, shares and debentures on behalf of their customers.

(v) Banks arrange to send money from one place to another for the convenience of their
customers.

7. Miscellaneous Functions:

Besides the functions mentioned above, banks perform many other functions of general
utility which are as follows:

(i) Banks make arrangement of lockers for the safe custody of valuable assets of their
customers such as gold, silver, legal documents etc.

(ii) Banks give reference for their customers.

(iii) Banks collect necessary and useful statistics relating to trade and industry.

(iv) For facilitating foreign trade, banks undertake to sell and purchase foreign exchange.

(v) Banks advise their clients relating to investment decisions as specialist

(vi) Bank does the under-writing of shares and debentures also.

(vii) Banks issue letters of credit.

(viii) During natural calamities, banks are highly useful in mobilizing funds and donations.

(ix) Banks provide loans for consumer durables like Car, Air-conditioner, and Fridge etc.

In summary
However, besides these functions there are many other functions which these banks perform.
All these functions can be divided under the following heads:

1. Accepting deposits

2. Giving loans

3. Overdraft

4. Discounting of Bills of Exchange

5. Investment of Funds

6. Agency Functions

7. Miscellaneous Functions

1. Accepting Deposits:

The most important function of commercial banks is to accept deposits from the public.
Various sections of society, according to their needs and economic condition, deposit their
savings with the banks.

For example, fixed and low income group people deposit their savings in small amounts from
the points of view of security, income and saving promotion. On the other hand, traders and
businessmen deposit their savings in the banks for the convenience of payment.

Therefore, keeping the needs and interests of various sections of society, banks formulate
various deposit schemes. Generally, there ire three types of deposits which are as follows:

(i) Current Deposits:

The depositors of such deposits can withdraw and deposit money whenever they desire. Since
banks have to keep the deposited amount of such accounts in cash always, they carry either
no interest or very low rate of interest. These deposits are called as Demand Deposits because
these can be demanded or withdrawn by the depositors at any time they want.

Such deposit accounts are highly useful for traders and big business firms because they have
to make payments and accept payments many times in a day.

(ii) Fixed Deposits:

These are the deposits which are deposited for a definite period of time. This period is
generally not less than one year and, therefore, these are called as long term deposits. These
deposits cannot be withdrawn before the expiry of the stipulated time and, therefore, these are
also called as time deposits.
These deposits generally carry a higher rate of interest because banks can use these deposits
for a definite time without having the fear of being withdrawn.

(iii) Saving Deposits:

In such deposits, money upto a certain limit can be deposited and withdrawn once or twice in
a week. On such deposits, the rate of interest is very less. As is evident from the name of such
deposits their main objective is to mobilise small savings in the form of deposits. These
deposits are generally done by salaried people and the people who have fixed and less
income.

2. Giving Loans:

The second important function of commercial banks is to advance loans to its customers.
Banks charge interest from the borrowers and this is the main source of their income.

Banks advance loans not only on the basis of the deposits of the public rather they also
advance loans on the basis of depositing the money in the accounts of borrowers. In other
words, they create loans out of deposits and deposits out of loans. This is called as credit
creation by commercial banks.

Modern banks give mostly secured loans for productive purposes. In other words, at the time
of advancing loans, they demand proper security or collateral. Generally, the value of security
or collateral is equal to the amount of loan. This is done mainly with a view to recover the
loan money by selling the security in the event of non-refund of the loan.

At limes, banks give loan on the basis of personal security also. Therefore, such loans are
called as unsecured loan. Banks generally give following types of loans and advances:

(i) Cash Credit:

In this type of credit scheme, banks advance loans to its customers on the basis of bonds,
inventories and other approved securities. Under this scheme, banks enter into an agreement
with its customers to which money can be withdrawn many times during a year. Under this
set up banks open accounts of their customers and deposit the loan money. With this type of
loan, credit is created.

(iii) Demand loans:

These are such loans that can be recalled on demand by the banks. The entire loan amount is
paid in lump sum by crediting it to the loan account of the borrower, and thus entire loan
becomes chargeable to interest with immediate effect.

(iv) Short-term loan:

These loans may be given as personal loans, loans to finance working capital or as priority
sector advances. These are made against some security and entire loan amount is transferred
to the loan account of the borrower.

3. Over-Draft:
Banks advance loans to its customers upto a certain amount through over-drafts, if there are
no deposits in the current account. For this banks demand a security from the customers and
charge very high rate of interest.

4. Discounting of Bills of Exchange:

This is the most prevalent and important method of advancing loans to the traders for short-
term purposes. Under this system, banks advance loans to the traders and business firms by
discounting their bills. In this way, businessmen get loans on the basis of their bills of
exchange before the time of their maturity.

5. Investment of Funds:

The banks invest their surplus funds in three types of securitiesGovernment securities,
other approved securities and other securities. Government securities include both, central
and state governments, such as treasury bills, national savings certificate etc.

Other securities include securities of state associated bodies like electricity boards, housing
boards, debentures of Land Development Banks units of UTI, shares of Regional Rural banks
etc.

6. Agency Functions:

Banks function in the form of agents and representatives of their customers. Customers give
their consent for performing such functions. The important functions of these types are as
follows:

(i) Banks collect cheques, drafts, bills of exchange and dividends of the shares for their
customers.

(ii) Banks make payment for their clients and at times accept the bills of exchange: of their
customers for which payment is made at the fixed time.

(iii) Banks pay insurance premium of their customers. Besides this, they also deposit loan
installments, income-tax, interest etc. as per directions.

(iv) Banks purchase and sell securities, shares and debentures on behalf of their customers.

(v) Banks arrange to send money from one place to another for the convenience of their
customers.

7. Miscellaneous Functions:

Besides the functions mentioned above, banks perform many other functions of general
utility which are as follows:

(i) Banks make arrangement of lockers for the safe custody of valuable assets of their
customers such as gold, silver, legal documents etc.

(ii) Banks give reference for their customers.


(iii) Banks collect necessary and useful statistics relating to trade and industry.

(iv) For facilitating foreign trade, banks undertake to sell and purchase foreign exchange.

(v) Banks advise their clients relating to investment decisions as specialist

(vi) Bank does the under-writing of shares and debentures also.

(vii) Banks issue letters of credit.

(viii) During natural calamities, banks are highly useful in mobilizing funds and donations.

(ix) Banks provide loans for consumer durables like Car, Air-conditioner, and Fridge etc.

Credit Unions institutions

A Credit Union is known by various names across the world and is a member-owned, not-for-
profit financial cooperative. Unlike other banks and financial institutions, the Credit Unions
are established and operated by the members. In a Credit Union, the profits are shared
amongst the members. There is no set standard for a Credit Union. It can range from an
organization with just a few members to a large one where there are thousands of people. In a
Credit Union the members pool their money in the bank so that they can provide loan money
to each others. Further, the profits that are achieved are employed to fund projects and
services for the overall benefit of the community. Some of the services offered by the Credit
Unions are online banking, share accounts (savings accounts), share draft accounts (checking
accounts), credit cards and share term certificates (certificates of deposit).

Stock Brokerage Firms institutions

The stock brokerage firm is responsible for facilitating buying and selling of financial
securities between a buyer and a seller. A brokerage firm serves a clientele of investors and
employs a number of stockbrokers through whom they trade public stocks and other
securities. Once a transaction has been successfully completed the brokerage company
receives compensation, which is by means of a commission. Full service brokerages offer
estate planning services, tax advice and consultations. A discount brokerage charges less
money than the traditional brokerage and here clients conduct trades via computerized trading
systems. In online brokerages, the investor is offered a website to conduct his or her
transactions.

Services offered include: Insurance, Securities, Mortgages, Loans, Credit cards, Money
market and Check writing.

Asset Management Firms institutions


An asset management company is beneficial as they provide the investors with more
investment options than they would have by their own as they have a much bigger pool of
resources. The company will invest the pooled funds of its clients into securities that match
declared financial objectives. Asset management companies manage hedge funds, mutual
funds and pension plans. They charge service fees or commissions and may either charge a
set fees or a percentage of the total asset under management.

Insurance Companies institutions

The insurance company is one which signs a contract, which is represented by a policy, and
provides an entity or individual with financial protection or reimbursement against any losses
that may occur. The insurance company is instrumental as a means of protection of financial
losses, both major as well as small, resulted from damage to the insurer or his or her property.
There are a number of insurance polices; however, the most important ones are health
insurance, life insurance, home insurance and vehicle insurance.

Services offered include: Insurance services, Securities, Buying or selling service of the real
estates, Mortgages, Loans, Credit cards and Check writing.

Finance Companies institutions

A finance company is defined as an organization that provides loans for businesses as well as
consumers. A finance company is similar to a bank as it acts as a lending entity by extending
credit. However, unlike a bank, a finance company does not accept deposits from people. In
fact, finance companies get their funding from banks and other resources. The role of a
finance company is to extend credit to companies for commercial use and to individuals to
make various purchases. It may also provide financing for installment plan sales.

A financial institution is an establishment that conducts financial transactions such as


investments, loans and deposits. Almost everyone deals with financial institutions on a
regular basis. Everything from depositing money to taking out loans and exchanging
currencies must be done through financial institutions. Here is an overview of some of the
major categories of financial institutions and their roles in the financial system.

Commercial Banks
Commercial banks accept deposits and provide security and convenience to their customers.
Part of the original purpose of banks was to offer customers safe keeping for their money. By
keeping physical cash at home or in a wallet, there are risks of loss due to theft and accidents,
not to mention the loss of possible income from interest. With banks, consumers no longer
need to keep large amounts of currency on hand; transactions can be handled with checks,
debit cards or credit cards, instead.

Commercial banks also make loans that individuals and businesses use to buy goods or
expand business operations, which in turn leads to more deposited funds that make their way
to banks. If banks can lend money at a higher interest rate than they have to pay for funds and
operating costs, they make money.

Banks also serve often under-appreciated roles as payment agents within a country and
between nations. Not only do banks issue debit cards that allow account holders to pay for
goods with the swipe of a card, they can also arrange wire transfers with other institutions.
Banks essentially underwrite financial transactions by lending their reputation and credibility
to the transaction; a check is basically just a promissory note between two people, but without
a bank's name and information on that note, no merchant would accept it. As payment agents,
banks make commercial transactions much more convenient; it is not necessary to carry
around large amounts of physical currency when merchants will accept the checks, debit
cards or credit cards that banks provide.

Investment Banks
The stock market crash of 1929 and ensuing Great Depression caused the United States
government to increase financial market regulation. The Glass-Steagall Act of 1933 resulted
in the separation of investment banking from commercial banking.

While investment banks may be called "banks," their operations are far different than deposit-
gathering commercial banks. An investment bank is a financial intermediary that performs a
variety of services for businesses and some governments. These services include
underwriting debt and equity offerings, acting as an intermediary between an issuer of
securities and the investing public, making markets, facilitating mergers and other corporate
reorganizations, and acting as a broker for institutional clients. They may also provide
research and financial advisory services to companies. As a general rule, investment banks
focus on initial public offerings (IPOs) and large public and private share offerings.
Traditionally, investment banks do not deal with the general public. However, some of the big
names in investment banking, such as JP Morgan Chase, Bank of America and Citigroup, also
operate commercial banks. Other past and present investment banks you may have heard of
include Morgan Stanley, Goldman Sachs, Lehman Brothers and First Boston.

Generally speaking, investment banks are subject to less regulation than commercial banks.
While investment banks operate under the supervision of regulatory bodies, like the
Securities and Exchange Commission, FINRA, and the U.S. Treasury, there are typically
fewer restrictions when it comes to maintaining capital ratios or introducing new products.

Insurance Companies
Insurance companies pool risk by collecting premiums from a large group of people who
want to protect themselves and/or their loved ones against a particular loss, such as a fire, car
accident, illness, lawsuit, disability or death. Insurance helps individuals and companies
manage risk and preserve wealth. By insuring a large number of people, insurance companies
can operate profitably and at the same time pay for claims that may arise. Insurance
companies use statistical analysis to project what their actual losses will be within a given
class. They know that not all insured individuals will suffer losses at the same time or at all.
Brokerages
A brokerage acts as an intermediary between buyers and sellers to facilitate securities
transactions. Brokerage companies are compensated via commission after the transaction has
been successfully completed. For example, when a trade order for a stock is carried out, an
individual often pays a transaction fee for the brokerage company's efforts to execute the
trade.

A brokerage can be either full service or discount. A full service brokerage provides
investment advice, portfolio management and trade execution. In exchange for this high level
of service, customers pay significant commissions on each trade. Discount brokers allow
investors to perform their own investment research and make their own decisions. The
brokerage still executes the investor's trades, but since it doesn't provide the other services of
a full-service brokerage, its trade commissions are much smaller.

Investment Companies
An investment company is a corporation or a trust through which individuals invest in
diversified, professionally managed portfolios of securities by pooling their funds with those
of other investors. Rather than purchasing combinations of individual stocks and bonds for a
portfolio, an investor can purchase securities indirectly through a package product like a
mutual fund.

There are three fundamental types of investment companies: unit investment trusts (UITs),
face amount certificate companies and managed investment companies. All three types have
the following things in common:

An undivided interest in the fund proportional to the number of shares


held

Diversification in a large number of securities

Professional management

Specific investment objectives

Let's take a closer look at each type of investment company.

Unit Investment Trusts (UITs)


A unit investment trust, or UIT, is a company established under an indenture or similar
agreement. It has the following characteristics:

The management of the trust is supervised by a trustee.

Unit investment trusts sell a fixed number of shares to unit holders, who
receive a proportionate share of net income from the underlying trust.
The UIT security is redeemable and represents an undivided interest in a
specific portfolio of securities.

The portfolio is merely supervised, not managed, as it remains fixed for


the life of the trust. In other words, there is no day-to-day management of
the portfolio.

Face Amount Certificates


A face amount certificate company issues debt certificates at a predetermined rate of interest.
Additional characteristics include:

Certificate holders may redeem their certificates for a fixed amount on a


specified date, or for a specific surrender value, before maturity.

Certificates can be purchased either in periodic installments or all at once


with a lump-sum payment.

Face amount certificate companies are almost nonexistent today.

Management Investment Companies


The most common type of investment company is the management investment company,
which actively manages a portfolio of securities to achieve its investment objective. There are
two types of management investment company: closed-end and open-end. The primary
differences between the two come down to where investors buy and sell their shares - in the
primary or secondary markets - and the type of securities the investment company sells.

Closed-End Investment Companies: A closed-end investment company


issues shares in a one-time public offering. It does not continually offer
new shares, nor does it redeem its shares like an open-end investment
company. Once shares are issued, an investor may purchase them on the
open market and sell them in the same way. The market value of the
closed-end fund's shares will be based on supply and demand, much like
other securities. Instead of selling at net asset value, the shares can sell at
a premium or at a discount to the net asset value.

Open-End Investment Companies: Open-end investment companies,


also known as mutual funds, continuously issue new shares. These shares
may only be purchased from the investment company and sold back to
the investment company. Mutual funds are discussed in more detail in the
Variable Contracts section.

Read more: Series 26 Exam Guide: Investment Companies

Nonbank Financial Institutions


The following institutions are not technically banks but provide some of the same services as
banks.

Savings and Loans


Savings and loan associations, also known as S&Ls or thrifts, resemble banks in many
respects. Most consumers don't know the differences between commercial banks and S&Ls.
By law, savings and loan companies must have 65% or more of their lending in residential
mortgages, though other types of lending is allowed.

S&Ls emerged largely in response to the exclusivity of commercial banks. There was a time
when banks would only accept deposits from people of relatively high wealth, with
references, and would not lend to ordinary workers. Savings and loans typically offered lower
borrowing rates than commercial banks and higher interest rates on deposits; the narrower
profit margin was a byproduct of the fact that such S&Ls were privately or mutually owned.

Credit Unions
Credit unions are another alternative to regular commercial banks. Credit unions are almost
always organized as not-for-profit cooperatives. Like banks and S&Ls, credit unions can be
chartered at the federal or state level. Like S&Ls, credit unions typically offer higher rates on
deposits and charge lower rates on loans in comparison to commercial banks.

In exchange for a little added freedom, there is one particular restriction on credit unions;
membership is not open to the public, but rather restricted to a particular membership group.
In the past, this has meant that employees of certain companies, members of certain churches,
and so on, were the only ones allowed to join a credit union. In recent years, though, these
restrictions have been eased considerably, very much over the objections of banks.

Shadow Banks
The housing bubble and subsequent credit crisis brought attention to what is commonly
called "the shadow banking system." This is a collection of investment banks, hedge funds,
insurers and other non-bank financial institutions that replicate some of the activities of
regulated banks, but do not operate in the same regulatory environment.

The shadow banking system funneled a great deal of money into the U.S. residential
mortgage market during the bubble. Insurance companies would buy mortgage bonds from
investment banks, which would then use the proceeds to buy more mortgages, so that they
could issue more mortgage bonds. The banks would use the money obtained from selling
mortgages to write still more mortgages.

Many estimates of the size of the shadow banking system suggest that it had grown to match
the size of the traditional U.S. banking system by 2008.

Apart from the absence of regulation and reporting requirements, the nature of the operations
within the shadow banking system created several problems. Specifically, many of these
institutions "borrowed short" to "lend long." In other words, they financed long-term
commitments with short-term debt. This left these institutions very vulnerable to increases in
short-term rates and when those rates rose, it forced many institutions to rush to liquidate
investments and make margin calls. Moreover, as these institutions were not part of the
formal banking system, they did not have access to the same emergency funding facilities.
Building Societies institutions

A Building Society is defined as a financial institution that gives banking and other financial
services to its members. The Building Societies are owned by the members as a mutual
organization. Services offered by Building societies include mortgages and demand-deposit
accounts. They are often supported by insurance firms. The term Building Society dates back
to the 19th century England. It was introduced from groups of co-op savers in the building
trade. Though mainly found in the UK, building societies also exist in other countries such as
Australia, Ireland and Jamaica.

Retailers institutions

A retailer sells goods directly to consumers with an aim of earning profit. This is done
through various distribution channels. Retailers can vary in size ranging from small family
operated stores to big super markets. Large retailers buy directly from a manufacture or
wholesaler and then sell the product to the end user at a marked up price. The retailers rarely
manufacture their own product. They mainly act as a link in getting the product from the
wholesaler and selling it to the consumer.

Insurance companies

You might also like