Introduction to Business Chapter 3 : BANKING

Introduction Functions and characteristics of money Services provided by various types of banking institutions Roles and responsibilities of banks Impacts of strong banking infrastructure

What is Money? Characteristics of Money What are the functions of money? Credit cards

Characteristics of Money It must be easily visible in units that are easy to be calculated It must be portable It must be physically stable and durable It must not be easily counterfeited It’s perceived value must be stable

Functions of Money 3 main functions As a mean in which we can measure the value of all goods and services As a medium for exchange of goods and services to take place A money system that is stable will be a medium for the storage of value

Credit Cards Issued by commercial banks which provide a reliable and convenient way for users to pay for purchases. Credit cards also allow users to carry less cash when making purchases and thereby reducing the risks for the users. The institutions received revenue from 2 sources: From the merchant that accept the credit card payment From interest charged to card holders for outstanding balances

Banking Institutions Commercial Bank 2 main forms of services Services offered by the diversified commercial banks Saving and Loan Associations and Mutual Saving Banks Finance companies, Merchant banks and other Financial Institutions Central Bank Roles of Central Bank

Commercial Banks Important role: facilitating the flow of money from those surplus to those with a need of money. 2 main forms of services: In receiving and holding the surplus money from depositors who are individuals, businesses and other organizations in the form of deposit (saving accounts) or current accounts In making available the fund received and held for the depositors to individuals and businesses in the form of loans.

Depositors Bank Borrowers Put money into bank Receive interests or cheque issuing facilities (or both) from bank) Bank Receive money from depositors Loan money to borrowers. Provide saving and current accounts services to both depositors and borrowers. Borrowers Receive money from bank in the form of loans Repayment to bank for capital and interest.

Other services Following are the services available: Credit cards and charge cards Safe deposit boxes Time deposit account Foreign exchange Wired transfer of funds (domestics & international) Mortgage and termed loan for residential and commercial properties. Overdraft facilities for individual and businesses Stock brokerage services Personal financial planning services Insurance and mutual funds transactions Automatic teller machine Cash & cheque deposit machines On-line banking services

Saving and Loan Associations and Mutual Saving Banks SLA : commonly provide home mortgage loans to its borrowers from the money deposited by its depositors. They provide the depositors with saving and current account. Operations are restricted to the long term mortgage loan at fixed-rate while taking in short term deposits.

Finance Companies, Merchants and Other Financial Institution Finance companies provide loans to individuals and businesses for the purchase of equipment, cars and even properties. E.g. insurance companies utilize large amount of money that they collect from their policyholder’s premium and provide mortgage loan to public Merchant Bank Provide clients : advise, consultancy, arrangement for finance, placement of shares, ensuring their clients adhere to regulations relating to listing and requirements, ensuring there are sufficient takers for the new issues of shares. Derived profits by purchasing and selling clients shares. Investment Bank Trade stocks, share and bonds on stock exchanges Trade on their own stocks and bonds to achieve profit.

The Central Banks To regulate the activities of the various banking institutions and implement the fiscal policies of the country. The central bank’s main roles are: Influencing money supply Regulate the availability of credit Supplying currency and processing of cheque

Influencing Money Supply The most crucial role played by the central bank in the regulation of the supply of credit and money to ensure that economic growth is promoted and the stability of the country’s currency is maintained. The central bank influence money by: Regulating the reserve requirement for commercial bank Conducting open-market operation where the central bank either buys or sells government bonds Regulating the discount rate, which is the interest rate the central bank charges on loans to commercial banks

Regulate the availability of credit The central bank regulates the availability of credit by setting margin requirements on various activities of commercial banks and credit rules for consumer spending. They controlled by: Setting the terms of credits for different types of loans, including percentage of money that investor should pay when investing in stocks or shares Setting the credit rules for consumer spending by regulating the amount of minimum payment to be settled by consumers with their credit card companies.

Supplying currency and processing cheque Central Bank is the sole custodian of a nation’s supply of currency. Supplied currency in form of coins and bills, to ensure that there is sufficient supply of currency to fuel healthy economic activities. Plays the role of a clearing house for cheque which is not very apparent to the public but serves as an indispensable function of the central bank

International Services Commercial banks are providing international financial services to companies and individuals in dealing cross border trades and financial transactions. Several options to pay the transactions, e.g. Good faith : direct bank transfer Letter of Credit (LOC): a guarantee from the bank that bank will the seller if the conditions of payment is fulfilled Cost of LOC is higher than direct transfer

‘Fountain Pen’ Money Money that is not physically produced but rather created by the banking system into the economy Assumption: You have deposited 1,000 into your bank and the bank has reserve requirement of 10%. This means the bank can lend 90% of your 1,000 (= 900) to another person After 5 rounds of lending 1,000, in fact created ‘fountain pen money worth 4,685.59   Round 1 Round 2 Round 3 Round 4 Round 5 Money deposited by depositor 1,000 900 810 729 656.10 Money kept in reserve by bank (10%) 100 90 81 72.9 65.61 Money lent to borrowers 590.49 Total Amount of money surplus (assumption deposits + money lent) 1,900 2,710 3,439 4095.10 4685.59

Importance of good banking structure In order for a country’s economic development to achieve stability and growth, 3 fundamental requirements must exist: A politically stable government A stable currency A solid banking infrastructure A solid banking infrastructure with an effective central bank will be able to bring stability to a country’s currency Asian 97-98 Financial Crisis Shorter period of recovery e.g. Malaysia, Singapore & South Korea Argentina 2002 Collapse of confidence and banking system had resulted economic and social turmoil Lost of FDI & instable currency fluctuation

IMF & World Bank International Monetary Fund (IMF) World Bank Set up in 1947 by United Nation Possessed a fund comprises of currrencies of various countries as well as international reserve To loan money to any countries that not able to meet their international debt repayment obligations World Bank Carries out another role in establishing economic stability and growth in the world by obtaining funds from developed nations to provide economic assistance and soft loans to developing countries.