The essential function of a bank is to provide services related to the storing of value 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 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 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.
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 taking deposits from the general public and issuing checking and savings accounts
- Lending out money to companies and individuals (see moneylender)
- Cashing checks
- Facilitating money transactions such as wire transfers and cashiers checks
- Issuing credit cards, ATM, and debit cards
- online banking
- Storing 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 U.S. Federal Reserve Bank.
- 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 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 traditionally just did savings and mortgages, and have special charters, but at present there is nothing inherently distinct about a savings bank.
- 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 bank, is the term used for a normal bank to dinstinguish 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.
- Retail banks primary customers are individuals. An example of a retail bank is Washington Mutual of the USA.
- Universal banks, more commonly known as a financial services company, 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. 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 bankinsurance term.
Susceptibility to crisis
The traditional bank has an inherent susceptibility to crisis, in that it 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, or more precisely incorrectly price the interest rates of those loans, and lose more money than they have.
The United States Savings and Loan Crisis in the late 1980s and early 1990s has been interpreted by some as a symptom of this inherent susceptibility of banking to crisis. By others, though, it is taken to be a sign of the dangers of moral hazard generated by government guarantees and quasi-public insurance schemes.
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.
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.
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. Its the monster. Men made it, but they cant control it. John Steinbeck, The Grapes of Wrath
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. 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 U.S. 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 bank holding companies in the world ranked by profit in 2003 (In U.S. Dollars)
- Citigroup — 20 billion
- Bank of America — 15 billion
- HSBC — 10 billion
- Royal Bank of Scotland— 8 billion
- Wells Fargo — 7 billion
- JP Morgan Chase — 7 billion
- UBS AG — 6 billion
- Wachovia — 5 billion
- Morgan Stanley — 5 billion
- Merrill Lynch — 4 billion
Top ten bank holding companies in the U.S. ranked by deposits
As of June 30, 2004
- Bank of America Corp.— 526 billion
- Wells Fargo & Co. — 256 billion
- Wachovia Corp.— 238 billion
- J.P. Morgan Chase & Co.— 227 billion (1)
- Citigroup Inc.— 193 billion
- Bank One Corp.— 150 billion (1)
- U.S. Bancorp— 112 billion
- SunTrust Banks, Inc.— 78 billion
- BB&T Corporation — 67 billion
- National City Corp.— 64 billion
(1) Since this report, J.P. Morgan Chase & Co. has acquired Bank One Corp., making the combined 6/30/04 deposit total for the merged company $377 billion, vaulting it to second place on the list.
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
- Imperial Bank of Persia — History of banking in the Middle-East
- List of bank mergers
- Bank regulation
- Capitalism in the nineteenth century
- Islamic Banking
- Piggy Bank
- Venture capital
- World Bank
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