What is the Iimportance of Bank in the Economy?
The role of banks in an economy
We all think we know what a bank is and what it does. And not without reason:
most people have had experience of at least one bank, even if it is only through
having a salary account or withdrawing cash from an ATM.
My aim in talking to you today about the role of banks in an economy is not to
lecture you from high on banking theory. Although my goal is simple, it appears
almost unattainable: to promote a slightly better understanding of what a bank
can do and what a bank should do. Before this question can be answered, we need
to look at what banks actually do and how they do it. Here we are not in the
exclusive domain of bank employees and specialists. As we have seen over recent
months, these matters can affect ordinary citizens and voters very quickly.
At several stages before, during and after the campaign on the part of the federal
government, cantonal authorities and business community to save Switzerland's
national airline, the feeling was very much one of "it's up to the banks to do
something". In letters to the press and in some articles, a great number of
contradictory, confused and in many cases unrealistic hopes, accusations and
expectations were laid at the banks' door. For example, the banks were criticised for
not stopping to recommend Swissair bonds to investors long before the crisis
broke, but at the same time they were pilloried for failing to grant far more credit
to Swissair during the crisis. Contradictory reactions such as these are
understandable up to a point. They are a measure of the shock, uncertainty and
helplessness experienced by many people in Switzerland, and not just the average
man in the street. As understandable as these reactions were from the
psychological perspective, however, they proved to be extremely unhelpful in
practice. Any "Bank of Joe Public" that would have attempted, even for a moment,
to satisfy the expectations held of it would not only have failed to save the airline;
it would most probably have faced bankruptcy itself, destroying its clients' deposits,
employees' jobs and owners' capital in the process.
Banks are widely held to be powerful and rich. This view is generally based on the
very accurate observation that banks deal with vast amounts of money. A quick
look at a bank's balance sheet quickly puts this perception into perspective: in
contrast to industrial companies, more than 90% of a bank's balance sheet consists
of loans and deposits; the proportion of tangible assets such as buildings,
machinery, etc. is minimal. What is generally most striking in a bank's balance
sheet, however, is that the (unweighted) portion of equity rarely exceeds 5%. The
proportion of borrowings is far higher. This is, of course, in the nature of the
business: banking means working with and managing outside capital entrusted to
a bank by, for example, people like yourselves, the companies you work for or your
pension fund. Unlike the people who actually own this capital, banks have very
limited powers when it comes to deciding what should be done with the money.
Regardless of how individual aspects are structured, a bank's business policy will
always have to be geared in equal part to the clients of that bank and its owners.
Clients choose a bank because they trust it not to lose their money and because
they expect a specific level of value added and are willing to pay fees and
commissions in return. The same applies to the owner who makes his or her capital
available to the bank, thereby taking on certain risks and expecting to benefit from
part of the profit.
A bank's activities in all its divisions can basically be simplified as follows: it
transfers money and information, and in doing so transforms money, maturities
and risks. In the rest of my speech, I intend to use the example of four lines of a
bank's business to examine how it does this, the value added it creates, the risks it
encounters and the restrictions to which it is subject: (1) lending and deposit
business, (2) securities issuing, (3) asset management and (4) foreign exchange
trading.
Lending and deposit business
A bank's role as an "intermediary" is clearest in the credit and deposit business.
Clients "bring" to the bank their savings, i.e. the money they have chosen not to
spend. The bank transfers this money to its credit clients in the form of loans. What
is on the face of it extremely simple is nevertheless fraught with a great many risks.
A bank's loans lack liquidity, either partially or totally. This means that the bank
cannot sell them in return for demand deposits or central bank funds whenever it
likes. On top of this, a borrower's credit rating may change during the life of a loan,
thereby changing the value of the loan at that point in time, which reflects the
interest and amortisation payments expected in the future. Due to the lack of a
secondary market, credits are mostly carried in balance sheets at their nominal
value, with provisions and write-offs only being formed or effected if there are any
indications that the borrower may have trouble meeting payments or is actually in
arrears. In some cases, credits may even become entirely worthless if borrowers
become insolvent and bankrupt.
On the other side of the balance sheet, a bank guarantees its creditors the nominal
value of their deposits plus interest due, irrespective of the profit or otherwise
made in lending transactions. Furthermore, the amounts a bank owes are generally
more liquid than the amounts it is owed; in other words, creditors can call in the
amounts the bank owes them more quickly than the bank can call in what is due to
it from its borrowers. One of the banks' fundamental roles in the economy is to
"transform" maturities in this way at its own risk. This is part of the service it offers
as intermediary and a form of risk management.
Another function which the banks perform within an economy is rating and
selecting the loans they finance. The supply of client deposits is limited; the
demand for credit generally less so. This being the case, credits have to be subject
to a selection process. The reason why this selection process cannot be performed
solely via the price (or rate of interest) is that lending transactions are not the same
as cash transactions, where payment is provided immediately upon a product or
service being rendered. Instead, the borrower undertakes to make future payments
of interest and principal. As a consequence, the bank cannot base itself solely on
the ability to pay as presented at that particular point in time; it also has to
attempt to make some sort of assessment with regard to the borrower's ability to
pay in the future.
Through their activities as "agent", another essential function performed by the
banks is to reduce risks overall. A bank that uses deposits from a large number of
private households to finance loans to a large number of companies is leveraging
the advantages of diversification. Insofar as depositors take the decision to
withdraw their funds independently of one another, the bank benefits from the
Law of Large Numbers , given that it is not anticipating a situation where all
depositors withdraw their savings at the same time. Diversification places a role in
the lending business, too, this time over a large number of companies and sectors:
a proportion of individual risks is evened out on aggregate and the bank functions
in much the same way as an insurance company.
As financial intermediaries, banks have a responsibility towards both their
borrowers and creditors. Their prime responsibility is that towards their creditors
(Implementing Ordinance on Banks and Savings Banks, 1998; Swiss Federal Law on
Banks and Savings Banks, Article 4.). Together with protecting the function and
reputation of the banks, the main aim of the law on banks and savings banks is to
protect creditors. The Federal Banking Commission's regulatory and supervisory
activities are all geared primarily to this aim.
There is no similar protection under public law for those who have been lent money
by a bank. The rights of such borrowers are covered in particular by the private
contract which they have entered into with the bank. Within such contracts, banks
generally undertake to provide specific products or services. They also contract to
fulfil their due diligence and fiduciary responsibilities towards their borrowers.
There is no legal obligation upon a bank to grant a loan to its clients under certain
circumstances. Indeed, the banks could not possibly be subject to such an
"obligation to contract", and for an obvious reason: it would be diametrically
opposed to the aim of protecting creditors. This said, there have been and there are
still banks which function mainly upon the principle of providing cheap loans or
allowing co-operative structures to become self-sufficient in loan provision. Some
examples of this are the Swiss cantonal banks founded in the 19th century, the
Raiffeisen banks and community development banking in the United States.
Securities issuing
Loans account for only part of the long-term financing provided by the banks.
While bank loans are often the only source of outside financing for many small and
medium-sized enterprises, a substantial proportion of the capital raised by larger
companies comes from the issuing of securities. This is also reflected in overall asset
structures: banks hold around CHF 1,100 billion in bonds in their clients' portfolios,
compared to the client deposits of CHF 900 billion carried in the banks' balance
sheets.
In a securities issue, a bank or group of banks generally agrees to underwrite the
entire amount of the issue. The securities acquired in this way are then offered for
public subscription for the account and at the risk of the bank or banks involved.
The risk that not all the securities will be placed with clients is carried by the bank.
The issuer, for its part, has immediately available to it the entire proceeds from the
transaction, regardless of how successful the offering has been. For a bank to be
successful with an offering, it has to be able to gauge market conditions correctly
at the time of the issue and has to have access to as broad a base of custody
account clients as possible, in order to place the securities with these clients.
Securities issues are a volatile source of earnings, as we have seen over recent
months with IPOs in particular. They can be lucrative, especially if they do not only
involve the simple issuing of fixed-income paper but are structured around more
complex transactions in several currencies with the aim of, for example, financing
an acquisition. In transactions such as these, the in-depth analysis and specialist
knowledge a bank provides are critical.
The universal banks active in the issuing sector face a whole range of potential
conflicts of interest, given that issues often involve various parties from within and
outside the bank and that these parties are not motivated by the same interests:
the issuance unit is interested in the offering, securities trading is looking for high
revenues, asset management clients expect the bank to safeguard their interests
irrespective of its role in the issuing transaction, the lending unit may have
information on the issuer that is otherwise not in the public domain, etc. Defusing
and controlling potential conflicts such as these places enormous demands on a
bank's organisational structure, processes and compliance activities. Only when a
bank succeeds in controlling the potential conflicts and managing them on a
transparent basis can the different stakeholders involved be sure that their
legitimate interests are equitably upheld.
Asset management
Asset management covers a range of banking activities: portfolio management,
investment advisory, securities trading and lending business (collateral loans,
securities lending and borrowing). With a discretionary portfolio management
agreement, clients authorise a bank to undertake, for their account and at their
risk, all the actions it deems appropriate within the framework of the normal asset
management activities of a bank. Clients expect their assets to be managed
professionally and in their best interests. The bank contracts to exercise its
undertaking to the best of its knowledge and abilities, taking into account clients'
circumstances but acting as it sees fit within the scope outlined as part of the
investment goals defined with the client.
What is clear from this is that the singularly most important factor in asset
management, independently of any law or regulation, is the trust a client has in his
or her bank. Our Association's Portfolio Management Guidelines form part of the
regulations which a bank must observe. These guidelines specify that a bank which
accepts portfolio management agreements must have appropriate professional
organisational structures which are commensurate with the activities involved, that
concentrations of risk must be avoided, that, where there are no instructions to the
contrary, the bank must invest in securities for which there is a ready market, etc.
The asset management business places exacting requirements on banks and
bankers in terms of the expertise and ethical issues involved. Under no
circumstances can a bank simply "do as it pleases" in the portfolios it manages for
clients, nor should it be allowed to do so.
Foreign exchange trading
The last business I mentioned was foreign exchange trading, an activity which has
been unjustly attacked as "casino capitalism". Various factors have given rise to this
perception. First, without a doubt the massive amounts traded in the foreign
exchange markets every day. According to figures from the Swiss National Bank, for
example, in April 2001 foreign exchange trades in Switzerland alone amounted to
CHF 121 billion each working day. (For the purposes of comparison, the global
figure was USD 1,210 billion.) The vast majority of this trading takes place between
financial intermediaries, the aim being to exploit even the slightest differences
between exchange rates (arbitrage). Only a very small proportion of these trades is
used to finance foreign trade and hedge foreign currency positions. Furthermore,
the fact that serious economic crises such as the one Argentina is experiencing at
present are almost always currency crises may fuel suspicions that it is currency
traders with their speculative attacks that trigger such developments.
In fact, the very opposite is true. Many people may fail to see the point of the vast
amounts of arbitrage transactions, since they are not primarily used for financing
purposes. In reality, however, they underpin liquidity in the markets, thus helping
them to function smoothly. In less liquid markets, new information would
inevitably lead to much greater volatility in rates. A distinction has to be made in
the case of protracted currency over- or undervaluations (in terms of interest rates
and purchasing power parity), which are a genuine problem, as they could result in
the misallocation of resources.
The scope available to banks
But what is the actual function of a bank within an economy? By granting loans,
processing payments, accepting deposits, carrying out investments, etc. it is
creating added value for its clients, employees, service providers and shareholders.
In this, it is no different from any other company. The real difference lies in the
extent of the potential damage were a bank to collapse: Then it would not only be
employees losing their jobs, shareholders losing their capital and clients their
provider; clients could potentially lose their entire savings and financial assets. This
explains why banks are so heavily regulated and so strictly monitored.
Nevertheless, the economic benefits generated by a bank are basically no different
from the economic benefits generated by a doctor, teacher or train driver: by
exercising, to the best of their knowledge and abilities, their specialist function in
competition with others, companies and their employees make their contribution
to economic benefit. And their motivation need not be a selfless one. Pilots do not
fly planes to generate economic benefit, just as bankers do not grant credits for
any such selfless reasons. Economic utility is created as a "by-product" anywhere
women and men function successfully, and this does not apply solely to their jobs.
Even though a banker grants loans to many companies and sectors of the
economy, this does not mean he can do their work or bear their responsibilities.
The argument of economic goals and responsibility is generally seized on by
politicians when it is a matter of re-distributing capital, risks, profits or costs.
Although not strictly wrong, the economic responsibility argument has the major
political advantage that it can be flexibly deployed for absolutely anything. You will
look long and hard - and probably in vain - for any "handy" definition of a bank's
economic responsibility that is at the same time general enough. Which is why my
suggestion is the following: bankers act responsibly when they ensure that their
house is in order and resist the temptation to pass off poor financial performance
as a contribution to the economy.
A commercial bank refers to a normal bank that provides the basic banking services to the residents of a country. Some of the different services available from commercial banks to its customers are: Checking/Current account Savings accounts internet/Mobile Banking ATM Cards Check Books Deposit Accounts Loans Credit Cards etc
Role of Banks
Banks serve as depository of idle funds. Individuals having excess funds deposit them in banks for the interest and services that they may obtain. The prospective depositors consider the total assets and the liquidity of the bank that they will choose. Banks serve as a major source of loandable funds. Deposits received by the bank are immediately lent out by the bank. This way the banks make money out of the other people's money. Banks also give counsel in financial matters. Banks employ people who are experts on various fields, who can advise companies and businessmen on their financial problems. Advice may be in the form of financial or managerial know-how.
It help improve the transparency, comparability and accountability of financial reporting.
your a but
Standardized measures of economic development are used to identify the status of one's country, state, or local community.
Russia.
Budget is very essential tool for the economic development of any country.
It help improve the transparency, comparability and accountability of financial reporting.
your a but
How much the economy is growing in that country
Standardized measures of economic development are used to identify the status of one's country, state, or local community.
Economic development of a country ensures that the global economy becomes more stable. It also makes international business much easier and lucrative.
Economic development of a country ensures that the global economy becomes more stable. It also makes international business much easier and lucrative.
hardly is something least helpful in measuring economic status of a country
Russia.
Economic growth is defined by increases in GDP. Whereas, economic development is more of a vague measure usually encorporating social measures such as literacy rates or life expectancy as a means of measuring a country's level of development.
Budget is very essential tool for the economic development of any country.
An organization or country that is engaged in commercial or economic competition with others
Yes, the Economic Development Board has been a major hit in Bahrain with many of the initiatives launched, inward investment coming into the country and government institutions playing a huge role in the development of the country.