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ORIGIN AND GROWTH OFCOMMERCIAL BANKING

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Evolution of Banking

What is bank?

There are various views about the origin of the word bank. One view isthat it is derived from an Italian word banquewhich means abench.

In the explanation of this view they are saying that in past in Italy the

money exchanger were sitting on benches and doing there businesses. Today banks are dealing in money so the work of today banks and work

of those money exchangers is the same, as both are dealing in moneythats why they are saying that the word bank has derived from anItalian word banquewhich means a bench.

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The other point of view is that it has originatedfrom the German word bancwhich means ajoint stock firm.

In the explanation of this view they are saying thattoday banks are working as a joint stock firm thatswhy the word bank has been originated from theGerman word bancwhich means a joint stock

firm.

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As regards the growth of modern commercial bank,it can be traced to as early as 600 BC. Crowtherin his famous book An outline of moneyhastraced the history of modern commercial banking.

According to him the present day banker has threeancestors.

1. The merchants

2. The goldsmiths

3. The money lenders

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1. The merchants:

The earliest stage in the growth of banking can be traced tothe working of merchants. These merchants were traders incommodities.

The trading activities were carried on by them from one placeto another.

It was risky for traders to carry metallic money withthemselves for payment.

The traders with high reputation begin to issue receipts which

were accepted as title of money. These receipts or letters of transfer also called hundi in indo

sub continents were the first mode of payments. The merchant banking thus form the earliest stage in the

evolution of modern banking

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2. The Goldsmiths:

The second stage in the growth of banking is normallytraced to the earlier goldsmith.

These goldsmiths also called seths in India used to receivegold and silver for safe custody. The goldsmiths begin to issue receipts for the metallic

money (gold and silver) kept with them. These receipts became payable to the bearer on demand.

In this way the goldsmith note became a medium ofexchange and a mean of payment. The goldsmith thus can rightly be termed as the

forerunners of the modern bank notes.

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3. The money lenders:

The third stage in the development of banking arose whengoldsmiths became money lenders.

By experience the goldsmith (who were called money lenders)came to know that they could keep a small proportion of the totaldeposits for meeting the demands of customers for cash and therest the could easily lend.

They allow the depositors to draw over and above the moneyactually standing to their credit (they allow overdraft facility).

When every money lender/goldsmith issued receipts and manyof them allowed overdraft facilities there were then too muchconfusion in the banking system.

The money lenders/goldsmiths in order to earn more profitscould not keep adequate reserves for meeting the demands of thecustomers for cash.

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The failure on the part of the money lenders/goldsmiths to returnmoney caused wide spread distress among the people. In order to create confidence among the people, steps were taken to

regulate the banking organization. A conference was held in Nuremberg in 1548. It was decided that a

bank should be set up by the state which should regulate the banking

organization and techniques. The 1stcentral bank was formed in Geneva in 1578. Bank of England

was established in 1694. The modern commercial banking system actually developed in

nineteenth century. With the passage of time the scope of the commercial banks have

greatly increased. They now deal with large number of matters such asobtaining funds, advancing loans to the businesses, farmers,households, making investments in stocks, discounting bill of exchangeetc.

The commercial banks are now multi service organizations and play avery important role in the financial markets and economic developmentof a country.

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What is a Commercial Bank?

According to Crowther;

A bank is a firm which collects money from thosewho have it spare. It lends money to those who

require it. In the words of Parking;

A bank is a firm that takes deposits from household and firm and makes loans to other households

and firms.

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What is a Commercial Bank?

Commercial bank accepts deposits from individuals,firms and companies at a lower rate of interest andgives it at higher rate of interest to those who needthem.

The difference between the terms at which it borrowsand those at which it lends forms the source of itsprofit.

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Functions of a Commercial Bank

A commercial bank performs a variety of functions.These functions are classified under two main heads

1. Basic Functions

2. Secondary Functions

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1. Basic Functions

What are basic functions of a Commercial Bank?

The basic functions of a Commercial bank are

a. Accepting of Deposits

b. Advancing of money

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a. Accepting of Deposits

The 1stimportant function of a bank is to acceptdeposits from those who can save but can not makeprofitable use of their savings themselves.

In order to attract the savings from different

persons and institutions, The bank maintain thefollowing three types of accounts 1. Current Account 2. Saving Account

3. Fixed or Term deposit account

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Current account

The businesses and traders usually maintain theirfunds in current account.

What is a current account? Current account is one where money is constantly

being drawn out and put in. Since the money is withdraw able at any time by

the customer, therefore the bank do not payinterest on current deposits.

Current account holders receive a check book andregular statements containing details of moneypaid in and paid out.

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Features of current account

Approved parties: The bank can open current account for approved parties.

The businessmen and individuals are entitled foropening current account. But some banks dont need

approved parties, they open account on the basis of NIC(Tazkeera) only.

Service charges:

The bank has right to claim service charges if you did not

make any transection within 6 months in your account.Moreover they inactivate your account if you did notmake any charges within one year.

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Statement of account:

The bank sends statement of account to their customers attheir addresses. The customer can ask for statement of

account for any particular period.

Standing Instructions;

The bank accepts standing instructions. These instructions

are issued to pay expenses or collect income regularly onbehalf of customers.

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Introduction; Bank can open current account after proper introduction.

The old customers & bank employees can introduce newcustomers.Some banks dont need introduction even.

Pay-in-slip; The customers can use pay-in-slip to deposit money and

cheques into bank accounts. The color of pay-in-slip forcurrent account is different from other accounts.

Minimum Amount; The account can opened with any amount in Afghanistan.

But you should keep minimum balance of $100 or Afs5000 in individual account and $ 300 or Afs 15,000 forcorporate account. (It varies from bank to bank).

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Withdrawal of amount

The account holder can withdraw amount standing

to this credit. There is no limit on number ofwithdrawal.

Cheque Book/Card;

A cheque book or card is issued to the account holderat the time of account opening through which thecustomer can withdraw amount from bank.

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Interest is not allowed; The bank do not allow interest on current account

balance because money is withdraw able any timefrom this account.

Overdraft facility;

Overdraft are granted in current account againstsecurities. Interest on overdraft is calculated on daily

basis.

No notice of Withdrawal;

The customer can withdraw money from this accountduring banking hours any number of times withoutnotice.

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Saving Account

The aim of this account is to encourage the savings ofthe people.

Saving account is generally opened by persons ofsmall income. The banks pay interest on this type ofdeposits.

However, the banks normally place restrictions ontheir frequent withdrawal.

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Features of Saving Account

Account Holders;Any person or persons who are competent to contractcan open single or joint saving account. The legal bodieslike associations, club, schools, local bodies etc can open

such accounts. Introduction;

The saving bank is opened with proper introduction if itis checking account. When cheque book is not used tooperate account there no need of such introduction. Theold customers of bank or employees of bank canintroduce new customers. Some banks dont needintroduction even.

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Initial Deposit;Saving account can be opened with any amount. Theaccount holder can deposit more amount.

Cheques/Card;

The customers can withdraw money from bankthrough cheque or bank card, provided by bank.

Pass Book;

The customer can bring pass book for withdrawal, ifpass book is issued by bank. It is a type of book in

which customer maintain entries of their owndeposit and withdrawal.

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Interest;The banks pay interest on the end of June orDecember at fixed rate on minimum monthly

balance.

Withdrawal;

Account holder is allowed to with draw money up toAfs. 15,000 at a time. S/he can withdraw amount

twice in a week. Notice;

A notice of 7 days is required for withdrawal of morethan Afs 15,000/-. Such notice should be in writing.

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Fixed or Term deposit account

Fixed or Long term deposits are kept with the banksfor a specified period of time. The rate of interest onfixed deposits (also called term deposits) are high.

The longer the period of deposit, the higher is therate of interest and vise versa.

As well as the larger is the amount of the deposit, the

higher is the rate of interest and vise versa.

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Features of Fixed Deposit Account

No Introduction;The bank accepts fixed deposit accounts withoutintroduction. A copy of identity card (Tazkeera) issufficient to open such an account.

Time of Deposit;

The customer can decide the time of deposit. It mayvary from three months to five years.

Rate of Profit;The bank offers different rate of interest on differenttime period. The fixed deposit account offers higherrate than other accounts.

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Fixed deposit receipt;

The bank provides receipt for deposit of money. Thereceipt is called fixed deposit receipt.

Non-Transferable;The fixed deposit receipt is not transferable from oneperson to another. The owner is bound to keepreceipt till maturity.

Loan Facility;

The bank can provide loan facility to customer. Theamount of loan is 60-80% of fixed deposit.

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Withdrawal of amount;

The customer can withdraw amount before due date.The bank does not pay interest on the withdrawal of

amount on the request of depositor. Interest rate on loan;

The bank can charge rate of interest on loan from 2-2.5% per annum over and above rate of interest on

deposit. It may vary from 11-14%.

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Various Bank Accounts--- AComparison

Basis of

Difference

Fixed or Term

DepositAccount

Saving Bank

deposit Account

Current Deposit

Account

1- Objective To Earn Interest. To Cultivate habitof Saving.

To provide thefacility toIndustrialist and

businessman todeposit orwithdraw themoney as andwhen need.

2- Period of

Deposit

Deposits are made

on fixed period.

No fixed period for

deposits.

It is an open &

running accountfor which there isno fixed period fordeposits.

3- Frequency of

deposits

Deposit is made

only at one time inthis account.

Deposits can be

made any numberof times here.

No restriction on

making deposits inthis account.

V i B k A A

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Various Bank Accounts--- AComparison (Continue)

Basis ofDifference

Fixed or TermDeposit Account

Saving Bankdeposit

Account

Current DepositAccount

4- Restrictionson Withdrawal

The amount can generallybe paid at maturity.

When withdrawal is madebefore maturity, interestis either not allowed orminimum interest is paid.

There arerestrictions on

withdrawal.

There is norestriction on

withdrawal in thisaccount.

5- Interest As the cost of operation is

very low in this accountso high rate of interest isallowed.

Interest is

allowed at arate lower thanfixed account.

No interest or only a

nominal interest isallowed as the cost ofaccount is very high.

6- ChequeFacility

Not Permitted. Cheques areused forwithdrawal.

Cheques are used forwithdrawal.

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b. Advancing of money or Making loans

The second major function of a commercial bankis to make loans to the businessmen, traders,exporters, households etc

These loans are made against documents of titleto goods, marketable securities, personal securityof borrowers etc

A very large portion of banks total assets consistof the advances (loans) of the bank.

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Specific amount given by the bank for a specific time period forearning profit is called loan

Secured/ Collateral/ Parallel Loan;

Loan given on the basis of securities i.e.

Movable property (Gold, merchandise),

Immovable property (Land, building),

marketable securities (Bond, shares)

Maturity of Loan;

The total period of time in which the total loan along with interest willbe paid back to the lender is called maturity of loan.

Short term loan (less than 1 year)

Medium term loan (1-5 years)

Long term loan (6-10 years)

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The lending of money may be in any of the followingforms.

1. Overdraft

2. Bank Loan 3. Cash credit

4. Discounting of bills

5. Letters of credit

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Overdraft

It is a convenient form of short term financing by a bank.Under this facility a customer may arrange with his bank topermit him to overdraw on his current account known isoverdraft (O/D).

The bank allows customer to overdraw his account up to a

certain limit on providing securities of shares, insurancepolicies, deposits receipts etc. Interest is charged on daily basis on the overdrawn amount

only. An overdraft also called running finance & its allowed to

current account holder only. The difference between cash credit and overdraft is that

cash credit is given on regular basis and for relativelygreater time period. The overdraft facility is for shortperiod.

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Cash Credit (C.C)

It is a very common form of borrowing by businessconcerns. The banks advance long term loan to thecommercial and industrial units against thesecurity of goods.

The borrower has to open a new loan account forcash credit. Cash credit is given on the basis of securities of any

type.

The borrower is permitted to draw with in the cashcredit limit sanctioned by the bank. The interest is charged only on the amount of

money withdrawn by the borrower.

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Bank Loan

The commercial banks grant short and long termloans to individuals, firms and companies mostlyagainst securities.

The borrower has to open a new loan account. Interest is charged on monthly, semi annually or

annual basis.

The borrower has to keep any type of securities with

the bank acceptable to the bank. These loans are repayable either in periodic

installments or in lump sum at a fixed period of time.

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Types of bank loan

1. Demand loan;As repayable to the bank as and when demanded by the bank as peragreed agreement.

2. Fixed or Term loan;

It is advanced for a fixed period of time. It is repayable according

to repayment schedule or in lump sum after a fixed period of time.

3. Consortium Loan;

If a single loan is jointly granted by more than one bank, it is knownas consortium or participation loan.

4. Bridge loan;The loan is granted to customer for meeting his temporary needsuntil permanent funds are raised by him.

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Discounting of bills

Discounting of bills of exchange is another shortterm method of profitable investment of bank funds.

Discounting of bills of exchange refers to making the

payment of bill before its maturity. The discountcharge is the earning of the bank.

The premature payment made is a loan to the holderof the bill.

Usually bank pay the 75 % of the bill in advance andthe letter 25 % is paid when the bill is matured afterdeduction bank charges.

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Letters of Credit

Trade between countries is mainly financed by letters ofcredit.

The buyer who is an importer, applies to his bank foropening a letter of credit.

The bank issuing the letter of credit assures the exporterthat the payment will be made to him as soon as thedocuments completed in all respect are received by it.

The buyer bank thus makes payment in advance to the

exporter bank on fulfilling the terms and conditions ofcredit.

The full amount is later on recovered by the importer alongwith service charges.

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2. Secondary Functions

The secondary function of a bank are classified intotwo categories,

a. Special Financial Services

b. Agency Functions c. Utility Functions

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a. Special Financial Services

The business of today is highly competitive. It is notenough for the banks now to accept deposits andmake loans only.

Currency exchange

Letters of credit Money transfer SWIFT (Society for world wide inter bank financial

telecommunication)

Bank Draft Western union

Money gram

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Cont

Most of the banks offers ATM cards(AutomatedTeller Machines) Master card ,Visa card ,Debit cardCredit card

Hajj application Zakat deduction

Passport services

Collection of taxes and utility bills

Financing foreign trade by processing the documentsof trade between two parties

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b. Agency Functions

Banks act as agents of their customers in variousways as:

(i) Collection of Checks

(ii) Collection of Dividends

(iii) Purchase or sale of Securities

(iv) Execution of standing instructions

(v) Acting as trustee or executors

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Agency Functions

(i) Collection of Checks:

Banks act as an agent in collection and payment ofchecks for their customers.

(ii) Collection of Dividends: The bank provide a very useful service in the collection

of dividends or interest earned on shares held by itscustomers.

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Agency Functions

(iii) Purchase or sale of Securities: The bank, if authorized by the customer, purchase or

sells securities on his behalf.

(iv) Execution of standing instructions: The customer may order in writing to his bank to make

payments of regularly recurring nature to an individualor firm.

The bank will make payments and charge a small

commission. The payments will be stopped on writteninstructions of the customer only.

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Agency Functions

(v) Acting as trustee or executors:

If a client directs his bank to act as trustee or executorin the administration of a will or in any businesssettlement requiring a technical knowledge, the bankwill take this responsibility for the benefits of customerand charge a small fee for providing this essentialservice.

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Utility Functions

Provide information for starting international business

Underwriting (the process of purchasing the shares bythe bank from the company for the 1sttime and resellingit back to the people).

Status report (for foreign trips we need bank statement)

Lockers facility

Relief fund

Investment of funds in shares and bonds Bill of exchange

Bank accepts Shares application for subscription ofshares on behalf of company.

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END OF CHAPTER

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