Traditional and Non-traditional Activities of Commercial Banks - Research Paper Example

Traditional and Non-traditional Activities of Commercial Banks Overview and Definition Commercial banks are integral part of the modern day economy. In order to discuss about the commercial banks, at the outset it is prudent to understand the definition of banks. According to the United States Supreme Court, “A bank is an institution, usually incorporated with power to issue its promissory notes intended to circulate as money (known as bank notes); or to receive the money of others on general deposit, to form a joint fund that shall be used by the institution, for its own benefit, for one or more of the purposes of making temporary loans and discounts; of dealing in notes, foreign and domestic bills of exchange, coin, bullion, credits, and the remission of money; or with both these powers, and with the privileges, in addition to these basic powers, of receiving special deposits and making collections for the holders of negotiable paper, if the institution sees fit to engage in such business" (Duhaime, “Bank Definition”). Commercial bank is a type of financial intermediary that provides a broad range of deposit accounts which include facilities like checking, time deposits, and savings and provide loans to business firms and individuals. Functioning of commercial banks is regulated by the bank regulatory authority of the particular country (Ugur, Z., “The need for commercial banks”). Types of Banks There can be various types of banks namely: a) Central Bank b) Commercial Banks c) Development Banks d) Co- operative Banks e) Specialized Banks (NIOS, “Types of Banks”). Difference between Commercial Banks and Other Banks Commercial Banks Central Banks Development Banks Commercial bank is a type of bank that offers services like opening of account, mobilization of savings and dispersion of cash directly to public and business houses. Its functions include lending money, opening and facilitating bank accounts, dispensing cash to its customers and providing capital to the people who need it. Central bank is a bank that is responsible for the promotion and maintenance of sound financial and monetary system in the country. It does not directly deal with public. Central bank usually deals with issuing of bank notes, acts as commercial bank to the government, regulates other commercial banks of the country and is in charge of formulation and implementation of monetary policies. Development bank is such a bank which is concerned with improving the monetary and social developments of a nation. It is established with an aim of development of a nation. Development banks deals with providing assistance to regional co-operation, implementation of development projects and infrastructural development of a country. History of Commercial Banks In order to know the history of commercial banks, various countries would be taken into consideration. In United States, the origin of commercial banks date backs to 1781. Early commercial banks in US were non profit making organizations. At the time of colonial America though there were many banks but only a few of them were commercial banks. The first commercial bank in US was established by Morris, Willing, and other prominent Philadelphia based merchants in 1871 and was called Bank of North America. In Australia, distressed by the monetary policies of the colonial rule, Governor Macquarie gave a charter to some of its citizens to form Australia’s first bank which was the Bank of South Wales in the year of 1817. In India, although the banking system dates back to ancient times where banking was practiced by the Vaishya, the first commercial bank was established in the year 1786, which was the General Bank of India. After that more banks were set up like Bank of Hindustan and Bengal Bank. Since then, there has been a revolution in banking system in India. In China, previously the banking functions were conducted by various financial institutions which dealt with acceptance of deposits, money exchange, making of loans, etc. The early Chinese banks were called Piaohao and Qianzhuang which first came into existence from the Xiyuecheng Dye Company. Soon in middle of nineteenth century, foreign banks entered into Chinese market. The first foreign bank in China was British Oriental bank. Traditional and Non-traditional Activities of Commercial Banks Traditional activities are the standard activities of banks. These activities are the primary activities or functions of banks that provide the bank the main source of income. Traditional activities of banks include: a) Accepting deposits: It is the most important activity of commercial bank as it helps in mobilization of funds in an economy. Bank collects surplus funds from people as their saving and provide it to those who need it. This function also provides people security of their funds. Commercial banks primarily accept three types of deposits, current account deposit, fixed account deposit and savings account deposit. b) Granting of loans and advances: It is the other traditional activity of bank which deals with granting of loans and advances to the public. It is the main source of income for the bank and bank charges a certain percent of interest from the public. The rate of charges varies according to the amount and the period of loan. A loan is a long term credit whereas advances are short term credit facilities provided by the bank. Advances can be in form of cash credit, discounting of bills, overdraft, etc. Non-traditional activities of banks include the following activities: a) Investment of surplus fund in government securities: Government securities are safe for investment. Commercial bank can invest its surplus fund in government securities which would in turn provide income for the bank. b) Safe custody of customer’s valuable documents: Bank has to keep the documents of its customers in safe custody so that it does not get lost or hampered. c) Issuing demand draft and pay orders: A bank has to issue drafts and pay orders as and when necessary for the public. d) Provide information on credit worthiness of the customers: Bank has to provide information to any party with whom its customer has entered into contract for business primarily to validate the credit worthiness of its customer. e) Transfer of funds from one place o another: Commercial banks need to provide its customers facility of transfer of funds from one place to another and from one branch to another for the convenience of its customer. Current Issues in Commercial Banking In recent years, the banking sector showed a growth of 8.3%, which is the fastest growth rate as compared to past few years. But despite of its growth in recent years, financial soundness of the commercial banks still remains inconstant due to the high amount of non-performing assets in the banks’ assets. The main issues of commercial banking are: a) Persistence of NPAs and NPLs: NPAs and NPLs have tremendously affected the growth of commercial banks as these limits the ability of bank to increase interest income. The reduction in the level of non-performing assets is slow. (SENATE, “Issues and Challenges Facing the Banking Sector”). b) High operating expenses: High operating expense results in less profit generation by the commercial banks. The high operating expenses depict improper banking system adopted by the banks which affects its operating fundamentals. (SENATE. “Issues and Challenges Facing the Banking Sector”). c) Undercapitalization: Undercapitalization of the resources of the banks leads to inefficient usage of its assets. If resources are idle then the non-performing assets increases which would make banking functions inefficient. d) Increased competition: Today there are many commercial banks with their branches spread all over the national and international boundaries. If on one hand, competition has led to better service offers to the public, on the other hand it has also accounted for misguiding and misleading customers. e) Defaults in mortgage debts: In 2008, regular and large number of defaults in mortgage loans led to failure of many banking entities. This resulted in bankruptcy of many banks and these were liquidated in value which was much lesser than their actual value. f) Increase in the product range: Currently banks have been increasing their product range from merely accepting deposits to other broad range of services like mutual funds, insurance, etc. With the increase in their product range, banks are now able to fulfill various needs of its customers (SENATE, “Issues and Challenges Facing the Banking Sector”). Regulations Commercial banks are supervised and regulated by both the federal as well as provincial governments. Banks require special charter from the state government or Federal Reserve for its operations. The following regulations were passed by the Federal Reserve for the regulation of banks (Investments & Income, “Bank Regulators”). a) Truth in Lending Act: This act requires clear and proper disclosure of important terms of lending arrangement or credit transactions. It was primarily enacted by the Congress in 1968 for the protection of consumers. b) Fair Credit Reporting Act: The Act that was passed in 1996 regulates the collection and use of consumer information which includes consumer credit information and credit rights. This act supervises that the credit bureaus give complete information of applicants while evaluating them for credit or employment. c) Fair Housing Act: This act is meant to protect consumers by restricting discrimination to people in financing, renting or selling of houses. Everyone should be treated equally regardless of their sex, caste, region, etc. d) Community Reinvestment Act: This Act was enacted by Congress in 1977 and was targeted towards encouraging banks and other financial institutions to provide credit to the people in low and moderate interest rates. e) Home Mortgage Disclosure Act: It was enacted by Congress in 1975. The aim of this act was to help in finding out whether financial institutions were meeting the housing needs of the people or not. With this Act it could also be checked if there was any lending discrimination by the credit agencies. f) Equal Credit Opportunity Act: Equal Credit Opportunity Act was enacted in 1998 in order to stop creditors from distinguishing people on the basis of religion, race, sex, age, etc (BYU Marriott School, “Bank Regulation”). References BYU Marriott School. “Bank Regulation”. October 25, 2010. Commercial Banking Regulation, 2007. < http://marriottschool.byu.edu/emp/HBH/mba624/5%20Commercial%20Banking%20Regulation.pdf> Duhaime. “Bank Definition”. October 25, 2010. Law + Legal Information = Justice, No Date. < http://www.duhaime.org/LegalDictionary/B/Bank.aspx> Investments & Income. “Bank Regulators”. October 25, 2010. Commercial Bank Regulation, 2010. < http://www.investmentsandincome.com/banks-banking/com_banks_regulation.html> NIOS. “Types of Banks”. October 25, 2010. Banking, No Date. < http://www.nios.ac.in/Secbuscour/15.pdf> SENATE. “Issues and Challenges Facing the Banking Sector”. October 25, 2010. Banking on Banking, 2005. Ugur, Z. “The need for commercial banks”. October 25, 2010. Commercial Banks and Microfinance, 2006. < http://repository.upenn.edu/cgi/viewcontent.cgi?article=1042&context=curej> Bibliography Trevor Sykes. “Private Banks (1817-1911)”. October 25, 2010. Australia’s Banking History, 2010. < http://www.abc.net.au/money/currency/features/feat3.htm> CiteFin. “Phase I”. October 25, 2010. History of Banking in India, No Date. < http://www.citefin.com/1405-history-banking-india.html> NIOS. “Introduction”. October 25, 2010. Functions of Commercial Banks, No Date. < http://www.nios.ac.in/srsec319/319-33.pdf> Ennis, H.M. “Economic Quarterly”. October 25, 2010. Some Recent Trends in Commercial Banking, 2004. Read More