Money & Banking

AlMoatassem Mostafa

Essay Two: Commercial

Banks

1. Definition of Commercial

Banks

2. Functions of Commercial

Banks

3. The Operation of Commercial

Banks

Lecture Outline

• Functions of Commercial Banks– Primary Functions– Secondary Functions

Pooling Fundsالنقود تجميع

• Commercial banks are mainly financial intermediaries between savers who wish to save their money and borrowers who wish to have loans.

• What commercially banks basically do is to combine several small deposits from a group of savers in order to make larger loans to borrowers. This process is known as pooling funds.

• The absence of banks would result in negative impacts on businesses and on the economy as a whole.

• Banks contribute in the expansion of businesses, the creation of employment opportunities, and the growth of the economy.

Primary Functions

Accepting Deposits

Granting Loans

Creating Credit

Clearing Checks

Accepting Deposits

• Deposits represent the main source of funds for commercial banks.

• Types of Bank Accounts– Transaction Accounts– Nontransaction Accounts

Types of Bank Accounts

Transaction Accounts

Nontransaction Accounts

Transaction Accounts

• NOW accounts are essentially checking accounts where you earn interest on the money you have deposited. With a NOW account, the bank has the right to require at least seven days written notice of a withdrawal. It also requires a minimum monthly balance.

• A money market account is an interest-bearing account that typically pays a higher interest rate than a savings account, and which provides the account holder with limited check-writing ability.

• Money market accounts invests in short-term debt securities such as US Treasury bills and commercial paper.

• They are able to offer a higher interest rate by requiring a higher minimum balance, and by placing restrictions on the number of withdrawals the account holder may take over a given period of time. This restriction makes them less liquid than a checking account

• Money market accounts may allow you to write checks, but they are not generally suited for day-to-day business, given the restrictions on their use.

Difference between Checkable Account, NOW Account, and Money Market Account

Checkable Account

NOW Account Money Market Account

Flexibility More flexible and more liquid because it is

related to transactions

Less flexible, requires

notification of withdrawal, and

minimum monthly balance

Less flexible, less liquid, limited

withdrawal ability, and

requires a higher minimum

monthly balance than a NOW

accountInterest Rate No interest Pays interest Pays higher

interest than a NOW account

Mechanism Offers checks Offers checks Offers limited-check ability

Granting Loans

• Granting loans– Loans• Short-term loans• Long-term loans

– Advances• Cash credit• Overdraft• Rediscounting of bills

Loans

• Banks grant loans to investors, entrepreneurs, and businessmen.

• Loans are granted for a specific period of time. • Commercial banks might grant short-term loans for

less than a year or long-term loans for more than one year.

• The interest that is paid by the borrower differs according to the period of the loan; interest rates are usually low in case of short-term loans, while they are generally higher in case of long-term loans.

Loans

• In addition, a loan can be granted to the borrower as a lump sum or in instalments. The borrower can, therefore, repay the loan when it is due either as a lump sum or in instalments according to the loan agreement between the bank and the borrower.

Advances التسليف

Cash Credit النقدي االئتمان

Overdraft سحبالمكشوف على

Discounting of bills خصم

المالية األوراق

Advances

• Advances are form of short-term financial assistance provided by commercial banks to their customers.

• This kind of financial assistance aims to fulfil daily and rapid transactions.

• Interests charged on advances are, therefore, much lower than those charged on loans.

• Advances may take the form of cash credit, overdraft, or discounting of bills.

Cash Credit

• Cash credit is a process in which a borrower is allowed to withdraw a specific amount of money using a credit card, for instance. The amount is then credited to the customer’s account.

• In this case, interests are charged on the amount withdrawn only.

Overdraft

• Overdraft is an arrangement that allows a transaction account holder at a commercial bank to withdraw an additional amount of funds above those available at his account balance.

• Overdraft is generally temporary and limited to a specific amount of funds.

• It is also granted on the security of assets or other property.

Discounting of Bills• Discounting of bills is a form of short-term financial

assistance offered by commercial banks to their customers whereby a bank pays its customer the amount stated in the bill before this bill is mature after deducting a certain rate of discount.

• The amount deducted represents a commission for the commercial bank, which is more like a fee for the rediscounting service.

• In case the bill was not paid when the bill is mature, the bank would recover the amount stated in the bill from the customer.

Creating Credit اإلئتمان خلق• Through this function, banks create credit as bank deposits

represent money or medium of exchange. • Checkable accounts could be used a medium exchange for

the purchase of goods and services and for debt payment.• Consequently, when a customer requests a loan from his

bank, the loan is not paid in cash, but instead, the bank credits the account of this borrower. The borrower can then withdraw the loan by issuing checks. Basically, a deposit was created by the bank without receiving cash. In the previous case, the bank created credit from nothing.

Clearing Checksالشيكات مقاصة

• Commercial banks promoted the use of checks as an efficient medium of exchange that addressed major complications of banknotes and coins.

• Through checkable accounts, commercial banks clear checks that were issued on these accounts.

• Clearing checks means paying the amount of money stated in the check to the holder of the check.

• Similarly, a bank customer can deposit in his bank a check issued to him on a checkable account in another commercial bank. The bank in this case recovers the amount stated in the check for his customer from the other commercial bank

Secondary Functions

Locker Facility Foreign ExchangeTraveller’s checks, credit and debit

cards, and (ATMs)Bank Transfers Letters of Credit

Statistics and Business

Information

Locker Facilityالشخصية األغراض خزائن مرافق

• Commercial banks offer protection for their customers’ valuable items and documents by providing safe deposit lockers.

Foreign Exchangeاألجنبية العمالت صرف

• Commercial banks offer their customers, especially those travelling abroad or importing goods from abroad, foreign exchange services.

• They can exchange local currency for foreign one from commercial banks according to the announced exchange rate of each currency.

Traveller’s checks, credit and debit cards, and (ATMs)

• commercial banks also offer instruments that facilitate transactions conducted by their customers.

• For instance, traveller’s checks and credit cards are issued in case of customers travelling abroad and who do not wish to carry much cash with them. These instruments are highly convenient in such case.

• Commercial banks, in addition, establish as many ATMs as they can in order to save their customers’ the time of heading to the bank to withdraw or deposit money.

Bank Transfersالبنكية التحويالت

• Commercial banks conduct bank transfers from and to their customers’ accounts both nationally and internationally. If a customer wishes, for instance, to transfer funds to his brother who is living overseas, he can simply asks the bank to conduct the transfer.

• Similarly, commercial banks notify their customers of any transfers received at their accounts.

Letters of Creditاإلئتمان خطابات

• Commercial banks issue letters of credit for their customers to confirm their credit worthiness اإلئتمانية especially those ,الجدارةengaged in foreign trade or those applying for a loan in another bank.

Statistics and Business Information

• commercial banks are regarded as a reliable source of statistics and information related to business, commerce, finance, and banking considering the numerous functions they perform.

Model Questions• Definition Questions (Factual):

- Define Money, Barter System, Indirect Exchange, Medium of Exchange, Unit of Account, Store of Value, Liquidity.

• Short Essay Questions (Factual/Convergent):– Explain the disadvantages of the barter system/commodity

money/fiat money/checks/e-banking and e-money.– What are the conditions of a commodity to serve as money?

Support your answer with examples.– Checks are regarded as a brilliant innovation that improved the

efficiency of the payment system. Explain– Explain why money contributes to improving economic efficiency

through supporting specialization and division of labour?

– Explain how the value of money affects its efficiency as a unit of account and/or store of value?

– What sometimes makes money a more successful store of value as compared to other assets?

• Comparison questions (Evaluative)– What is the difference between Money and

Wealth/Money and Income?

• Multiple Choice Questions (Factual/Convergent)– One of the forms of E-Money isa. Gold and Silverb. Currencyc. Checksd. Debit Cards

• Convergent Questions• There are three goods produced in an economy

by three individuals: Good Producer

Apples Farmer Shoes Shoemaker Chocolate Chocolatier • If the Farmer wants only shoes, the Shoemaker

wants only chocolate, and the chocolatier likes only apples, will any trade between these three persons take place in a barter economy? Why?

• Arrange the following assets from most liquid to least liquid:

a. Checkable account b. Housesc. Currency d. Golde. Savings deposits