Bank, as a Financial Institution

Introduction

Bank, what Wikipedia says is, a financial institution that accepts deposits from the public and creates credit. Banking began with the first prototype banks of merchants of the ancient world, which made grain loans to farmers and traders who carried goods between cities and this system is known as barter system. 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. Banking in its modern sense evolved in the 14th century in the prosperous cities of Renaissance Italy but in many ways was a continuation of ideas and concepts of credit and lending that had their roots in the ancient world.

Modern banking practices, including fractional reserve banking and the issue of banknotes, emerged in the 17th and 18th centuries. Banking had undergone a major transformation during the first half of the 20th century with Wolrd War I followed by major financial crisis in 1930s. Lots of technological innovations like MICR Code (Magnetic Ink Character Recognition) and ATM (Automated Teller Machine) expanded the span of banking. During the second half of the century, fierce competition compelled the innovation of exotic products like Mortage-Backed Securities (MBS)/ Collateralized Debt Obligations (CDO) for sale to investors which is a type of Securitization, as well as form of credit insurance called Credit Default Swaps (CDS). 21st century has subjected immense structural and operational change. A dominant pressure derives from new technology with respect to information, trading and delivery of financial services. Recent era financial innvovations and complexity make the industry quite different than the traditional deposit and loan system. The first decade of the 21st century also saw the culmination of the technical innovation in banking over the previous 30 years and saw a major shift away from traditional banking to internet banking.

The purpose of this project is to bring upon all technological nuances in banking products and risk emanating from those in the modern banking system. Literature Review In 1914 an economist named William A. Scott, Director of the Course in Commerce and Professor of Political Economy in the University of Wisconsin wrote a book about banking called "Banking". It is quite noteworthy to keep concept of Baking on this era as benchmark and compare it with how modern era has changed this orthodox perception of the industry.A s per the book, the terms, "bank" and "banking," are applied to institutions and to businesses which differ considerably in character, functions, and methods, but which nevertheless have certain common features which justify their being grouped together. We can best prepare the way for a discussion of these differences and common features by a descrip tion of the services which these institutions perform in modern society.

Services Performed by Banking From the point of view of their customers these services may be grouped under the following heads :- The safekeeping of money and other valuables: It is a common practice everywhere, and in some countries, notably the United States, almost a universal practice for people to intrust their money to banks for safekeeping. To a degree, hoarding, in the sense of locking up money in private vaults and other recep tacles and keeping it under the eye and in the personal care of the owner, is still practiced, but it is doubtless on the wane in all civilized countries. The practice of intrusting to banks the safekeeping of other valuables, such as important documents, jewelry, plate, etc., is also widespread and growing. The making of payments The service of the safekeeping of money naturally leads to the second, the making of payments. When we intrust our means of pay ment to a bank, it is natural that we should also make it our treasurer and disbursing agent, and so we do. If we have payments to make to people at home, in other cities of our own country, or in other countries, we usually order our bank to perform the service for us. The making of loans Loans of almost all kinds are made by banks, and certain kinds, namely, those to business men for the everyday conduct of commerce and industry, are made almost exclusively by them.

For the most part these are short-term also one of the chief resorts, but in some countries these are not to so great a degree monopolized by them as the short-term variety. The making of investments For the investment of the surplus funds of people, banks are the chief agencies. This function takes the form mainly of the sale of stocks, bonds, and mortgages, and sometimes of the promotion of new enterprises.An article written by Jon Ogden, the Director of Content Marketing at MX comparing Banking industry on www.MX.com pointing precisely what has changed in last one hundred years. The services outlined by Scott are pretty much the same in modern banking. But the methods for performing each of these services has changed — and as a result everything has changed.In short, the 20th century was about paper and locality while the 21st century is about data and networks.

Bankers should ask themselves if they're tied too much to 20th century methods in a 21st century world.The implications of the changes in banking are enormous. As proof, let’s look at each of the four services William Scott outlined in 1914 and how they’ve changed in 2017.The safekeeping of money and other valuables. The method for safekeeping in the 21st century looks almost nothing like traditional methods. Money is mostly just a handful of digits on a network, and the safekeeping of that data doesn’t require big old physical vaults. It just requires secure digital storage space, which can be housed outside of a bank branch entirely.In addition, the need for a bank to store “other valuables” is pretty much non-existent. Forty-five percent of safety deposit boxes are empty, and new branches frequently don’t even offer this service. Documents are stored digitally or in a safe at home without the monthly charges that come with a safety deposit box.

Young people especially have a hard time understanding the value of this service.The making of payments. Something similar is happening with payments. Square Cash, an app that allows users to send payments via email or phone, just added the ability to send cash via text message. In other words, what technology writer Walt Mossberg said is “the quickest, simplest method I’ve seen for sending money from one person to another” just got simpler. And with other companies like PayPal, Dwolla and Venmo at the forefront of the space, payments are sure to be untethered from banks and credit unions more and more frequently.This point was amplified in an article by Jim Marous earlier this month called “Google, Apple, Facebook, and Amazon Should Terrify Banking.” Marous’s main argument is that bankers are stuck in the legacy mindset and don’t realize that tech giants could easily slip into banking through the fringe activities like payments.All it will take is one of these tech giants to gain mass adoption of their payment method (which is more and more likely to happen as people accept the concept of transferring money via phone), and payment revenue at banks and credit unions will dry up.

At that point financial institutions won’t just be saying goodbye to checks — they’ll also be saying goodbye to bill pay. Banks need to anticipate this problem now and seek new solutions to it.The making of loansGenerally speaking, this area of banking is largely the same as it was back in 1914. Lending is certainly still the stronghold of banks.

However, as we covered in our post on tech giants and P2P lending, this too could change. With the advent of the Internet it’s easier than ever for people to originate loans with a diverse set of individuals, all without The intermediation of the banks. Indeed, the rise of lenders like Prosper, Lending Club, and Fundera is evidence that person-to-person lending works — especially because the largest P2P lenders collectively went from $1.2 billion to $3.5 billion in outstanding loans from 2012 to 2013. While this is chump change compared to total loan amounts at banks and credit unions, the growth should concern the banking industry (as well as the fact that Google has invested in Lending Club and the fact that Lending Club has announced its IPO). If this trend continues, P2P lending could be a major force within a decade, eating at the bottom line of financial institutions.The making of investmentsThe popularity of automated investing has started to render active fund managers irrelevant.

An article from the Wall Street Journal this week puts it bluntly: “Active fund management is outmoded, and a lot of stock pickers are going to have to find something else to do for a living.” The article continues: “The debate about whether you should hire an ‘active’ fund manager who tries to beat the market by buying the best stocks and avoiding the worst—or a ‘passive’ index fund that simply matches the market by holding all the stocks—is over.” Sooner or later, investments will trend toward automation. It’s cheaper and in pretty much all cases, the returns are better over the long run.

The Economic Functions of Banks Viewed from the standpoint of the nation rather than from that of individuals, the func tions of banks may be described as those of intermediaries in exchanges and in the invest ment of capital. In the former capacity they supply the world with the major part of its medium of exchange and serve as distributing agents for that portion of the supply which comes from other sources. They create a medium of exchange through a process of bookkeeping which is world-wide in extent, and through which the mutual indebtedness of individuals, cities, and other subdivisions of countries and nations, brought about by pur chases and sales on credit, are offset without the use of money.

The practice of depositing surplus funds with banks for safekeeping and consequently the reliance of everybody upon banks for currency in any form, and has thus thrown upon them the responsibility of directly utilizing all the sources of money supply. Thus while the mints of the United States and most other countries coin gold bullion, and supply sub sidiary silver and copper and nickel coins to private persons on the same terms as to banks, as a matter of fact few private persons take advantage of this privilege, finding it more convenient and profitable to get the coin they want from banks. The same is true of govern ment notes in countries in which such notes constitute a portion of the currency.

The accumulation of a nation's capital and its investment require the cooperation of numerous agencies of which banks are the chief. They collect the savings of the people, combine them into amounts of sufficient size for investment purposes, and invest them temporarily and sometimes permanently. Coop erating agencies in this work are insurance companies, societies of various kinds for the promotion of saving, stock exchanges, pro moters, etc. Some of these take the place of banks in the performance of these services, while others supplement and aid them.

Classification of Banking Institutions Banks differ from one another chiefly in the nature and degree of their specialization, in legal status, and in the place they occupy in the system to which they belong. Some banks devote the major portion of their effort to the conduct of exchanges and are called commercial banks, others to investment bank ing and are called investment banks. The most common subclasses under the latter head are savings banks, land or mortgage banks, and bond houses. Savings banks specialize in the collection and investment of small savings; land banks are primarily inter mediaries between capitalists and people who wish to invest capital in land, building opera tions, and agriculture; and bond houses are intermediaries between capitalists and those who wish to invest capital in industrial, com mercial, and transportation enterprises, or loan it to states, cities, or other public corporations. Commercial banks rarely confine themselves exclusively to the conduct of exchanges.

Most of them also conduct savings departments and invest the funds intrusted to them through such departments in agricultural, industrial, or public corporations. Commercial banking, however, is their main concern, their other departments being side issues of greater or less importance according to circumstances. Investment banks also frequently carry on commercial banking as a side issue. These two lines of business are sometimes mixed in such proportions as to render classification difficult. From a legal point of view the banks of nearly all countries may be classified as private or unincorporated, and incorporated, sometimes also called joint-stock banks. Private banks are started by individuals or firms, like any other private enterprise, with out the formality of application for permission to some public officer, and without compliance with a set of legally prescribed regulations. They are subject to the laws of the country governing all kinds of private business enter prises and sometimes to special laws applying specifically to them. In some of the states of the United States such banks are prohibited by law.

Incorporated banks are usually started by private initiative but owe their actual legal existence and status to a special law, to the requirements of which they must conform before they are permitted to do business. Their right to do business is usually evidenced by a document known as a charter, executed and delivered by a public officer legally endowed with the requisite authority, or passed in the form of a law by the legislative organs of the state. Charters of the latter kind are known as special charters and are rarely used nowa days, except in the case of institutions of a peculiar character, endowed with special func tions. The central banks of Europe owe their existence to such charters, as did also the first and second United States banks. In the early history of the United States special charters were uniformly employed by the states, but for many years general incorporation laws have been the rule, on compliance with the requirements of which persons who desire to incorporate banks can secure charters. In federal states, both the federal govern ment and the governments of the constituent states frequently have and exercise the right to incorporate banks.

In the United States, banks incorporated by the federal government under the terms of a general law, originally passed in 1863 and many times amended since that date, are known as national banks, and those incorporated by the states under the general incorporation laws are known as state banks. These latter are endowed with privileges which enable them to exercise commercial and some investment banking functions.

Other banks also are incorporated by our states under the terms of general laws, which are known as sav ings banks and trust companies. The former, as the name implies, are institutions primarily designed for the encouragement, collection, and investment of savings. The latter are called trust companies because the earliest institutions of this type made the execution of trusts of various kinds their exclusive business. Banking functions were later added and in many cases have now assumed chief importance.The nature of the banking business requires some kind of organization of the individual institutions in which certain ones will assume to a degree at least the role of bankers' banks. In most European countries this position is occupied by single institutions specially char tered and endowed with special privileges and usually described as central banks. Examples are the Bank of England in England, the Bank of France in France, and the Imperial Bank of Germany in Germany.

Around these are grouped the other institutions in a kind of hierarchy, certain large banks in the larger cities forming centers about which smaller in stitutions group themselves. In the United States there is no single central institution, but a small group of banks in New York City are the real centers of the system. Around these are grouped the banks in the other large cities of the country and these in turn perform important services for banks in the surround ing smaller towns and country districts.