Roosevelt legislation was passed to divide the functions of investment banks from those of commercial banks. In banks outside the United States commercial and investment functions are often still combined. Within the United States the division mandated by Congress began to break down during the s.
Depending on their country location, merchant banks serve different purposes. In the United Kingdom and Europe, merchant banking evolved as a means of providing capital for traders involved in acquiring, shipping, and distributing goods. Contemporary merchant banks earn fees by arranging financing, underwriting securities for businesses, or participating in mergers and acquisitions.
When arranging business financing, they typically sell the resulting loans to other investors. Merchant bankers may also use their own funds to purchase businesses; many such deals are structured as leveraged buyouts. Savings banks or mutual savings banks , despite their name, are considered nonbank thrift institutions, similar to savings and loan associations and credit unions.
The first savings banks were founded in the United States in the early 19th century as institutions for smaller savers. See also cooperatives. Whereas commercial banks are corporations that issue stock, savings banks are owned by the savers who make deposits in them. Any profits left over after expenses have been paid are credited to the depositors as dividends. In function, the savings bank is quite similar to a commercial bank.
It receives deposits for both checking accounts and savings accounts. By far the larger amount of money is put into the savings accounts; however, a savings bank also makes loans. Among these are mortgage loans, loans to individuals and businesses, and loans to other financial institutions. A savings bank also invests its assets in various kinds of securities.
See also saving and investment. These institutions originated with 18th-century British building societies, in which workmen banded together to finance the building of their homes. The first U. No longer required to rely on individual deposits for funds, they are instead permitted to borrow from other financial institutions and to market mortgage-backed securities, money-market certificates, and stock.
Credit unions are cooperatives formed by groups of people with some common bond who, in effect, save their money together and make low-cost loans to each other. The loans are usually short-term consumer loans, mainly for automobiles, household needs, medical debts, and emergencies.
Credit unions generally operate under government charter and supervision. Institutions that are responsible for national monetary policy are known as central banks. Examples of central banks include the Bank of England in the U. Federal Reserve System. Central banks regulate the money supply and the costs of credit. International development banking is carried out by a number of institutions in order to assist the many areas of the world that are underdeveloped.
Less developed countries need to borrow funds to increase their productive capacities. Such projects as building hydroelectric power facilities, irrigating arid lands, developing mineral resources, and constructing transportation systems are expensive for countries that have thrown off the yoke of colonialism.
To provide other long-term loans the major industrialized nations formed the International Bank for Reconstruction and Development, usually called the World Bank. It is concerned with short-term credit for the purpose of stabilizing foreign-exchange rates in international trade. The Inter-American Development Bank was founded in Its first members were the United States and 19 Latin American countries, but its membership grew to encompass 26 borrowing countries and 20 nonborrowing countries.
The African Development Bank was established in and began operating in It derives capital from more than 50 regional member countries and more than 20 nonregional member countries. The Asian Development Bank began operations in Its broadly based membership represents more than 50 nations of South, Southeast, and East Asia and the South Pacific.
Several development banks have been set up outside the auspices of the UN. The Islamic Development Bank, with membership from the Organization of the Islamic Conference, began operations in Throughout the world, microbanks such as the Grameen Bank, Opportunity International, and the Foundation for International Community Assistance extend small loans, also known as microcredit, to borrowing groups.
These lending organizations depend on local ties to promote business growth and to manage loan repayment. The money listed as deposits in banks typically represents more than four times the amount that exists as real currency in the economy. Although deposits were once recorded in ink on a ledger page, today deposits are more likely to be recorded electronically. In either case, the deposit is simply a bookkeeping entry, but because it represents money it is treated in banking as if it were real money.
The transfer of an entry from one account to another produces what is called deposit currency. Deposit currency is created in the following way. Smith puts 1, dollars into a savings account. The bank keeps dollars of this sum in reserve. It lends the remaining dollars to Klein, who uses it to pay a debt to Reilly.
Reilly then deposits the dollars into his own bank account. His bank has now acquired a new deposit. It keeps dollars in reserve 20 percent of the dollars and lends the remaining dollars. After passing through several hands, this amount is deposited again. As this process continues, the original 1, dollars eventually may be listed in various banks as deposits of up to 4, dollars or more.
All the sums mentioned in this paragraph, apart from the original 1, dollars, were in the form of cash equivalents such as checks or bookkeeping entries. To the average person, these sums seem more imaginary than real, but economically they are real sums that can be put to real use.
Income usually returns to the banking system in the form of a deposit. There is a reverse process called money destruction. If Reilly returns to the bank to get 1, dollars, it will be given to him. But to do so the bank must take cash from its reserves because the original 1, dollars has been dispersed as described above.
Since dollars of the original 1, dollars was still present in required reserves, this leaves a deficiency of dollars. To make this up, the bank may sell some securities. The banks that purchase the securities do so by diminishing their own cash reserves.
Also known as reserve assets, bank reserves consist of cash or assets that are easily converted to cash. All financial institutions are required to keep a cash balance on hand in order to pay depositors who may want money from their accounts or who wish to convert checks into cash. The keeping of reserves is one means by which confidence in the banking system is maintained. Reserves are of two kinds—primary and secondary.
Primary reserves consist of cash on hand in the bank and deposits owed to it by other banks. These are also called the legal reserves. From this cash on hand tellers are able to meet customer demands for withdrawals, exchanges, and loans. Any excess reserves may be invested in larger banks in the form of the loans; in the United States these are called federal funds. Part of the primary reserves comprises cash on hand as mandated by the federal government.
Federal Reserve system. Securities purchased by a bank for investment purposes are known as secondary reserves. In the United States, much of this investment is in municipals—bonds and notes issued by local or state governments. Banks also buy bills, notes, and bonds issued by the United States Treasury and securities issued by other federal agencies. All such securities are low-risk investments. Some banks also buy higher-risk securities, such as corporate stocks and bonds, which are often held as collateral for loans to businesses.
All of these securities can be considered reserves because they can be converted to cash with relative ease. Toward the end of the 20th century, a trend of deregulation, particularly in the United States, made it possible for banks and financial institutions to conduct an increasing variety of businesses in a greater number of regions.
The loosened regulations gave wider powers to such institutions as savings and loan associations, but they also allowed other financial institutions to accept deposits and grant credit, meaning that banks immediately found themselves competing with brokerage firms and other financial services corporations. Such competition increased as each firm pursued the more profitable business of selling products like stocks and mutual funds.
The money to be made by offering savings or checking accounts was, by comparison, minimal. Banks consequently introduced services meant to attract new customers. Regulatory changes also permitted banks to provide investment banking, which involved originating, underwriting, and distributing new securities issues of corporations or government agencies. One of the most convenient of the new banking services arrived with the advent of automated teller machines ATMs.
Networking agreements with participating banks made it possible for customers to make transactions at distant installations-even in other cities-at all times of day or night. While increasing the availability of money, ATMs make money more convenient to use by accepting transactions even when banks are closed. In many parts of the world, ATMs overcome geographic and national boundaries by allowing travelers to conduct intercontinental transactions.
The exchange of checks among banks has long been done through a clearinghouse, an establishment maintained by the banks in a particular locality. Although an increasing proportion of these transactions are executed electronically, all such settlements were originally completed through the physical handling of checks or other forms of payment. Each day messengers from the member banks delivered to the clearinghouse checks that had been drawn upon other banks; they would then pick up their checks that were received at the clearinghouse from other banks.
The cash amounts represented by the checks were totaled and recorded. Clearinghouse officials kept track of how much each bank owed the others and how much each should receive so that a settlement could be made on the differences. Contemporary transactions are cleared through the same means, although electronic transactions do not involve the physical exchange of printed checks.
Any organization that handles these electronic settlements is known as an automated clearinghouse, or ACH. The direct deposit of payrolls, Social Security benefits and mortgage payments are examples of ACH transactions. In the United States, each Federal Reserve bank is a check-clearing and collection center for the banks located in its district.
Banking institutions were leaders in the development of electronic commerce. The use of automated clearinghouses began transforming the way interbank business was handled as early as the s. Through the ACH information between accounts can be transferred from bank to bank by means of computers. The ACH may eventually eliminate the need for paper transfer altogether, just as electronic bookkeeping and online bill payments may eliminate the need for written checks.
Increasingly, however, the use of electronic funds transfer EFT between institutions created opportunities for theft. Computer experts, or hackers, who can gain access to bank computer systems—either from within or from outside the bank—can manipulate funds and accounts to their own benefit. Many such incidents are not publicized because banks fear risking their reputations as safe havens for money.
Functions performed by banks today have been carried out by individuals, families, or state officials for at least 4, years. Clay tablets dating from about bc indicate that the Babylonians deposited personal valuables for a service charge of one 60th of their worth. Interest charges on loans ran as high as one-third. The widespread commerce of Rome required a well-developed banking system. Roman authorities set aside the Street of Janus in the Forum for money changers.
The Justinian Code of the 6th century included laws that governed the lending and trading in money. During the Middle Ages banking activities were curbed by severe restrictions on lending practices. But during the early Renaissance, as international trade revived, Italian money changers once again flourished in Italy, conducting business in the streets from a bench banca in Italian; hence the word bank.
Florence, Italy, became a great banking center, dominated by the Medici family. Banking as it is now practiced dates from the Banco di Rialto, founded in Venice in It accepted demand deposits and permitted depositors to transfer their credits by checks. It could not make loans, however, or pay interest on deposits. Its services were free since its expenses were paid by the city. The Banco Giro was formed in Venice in The two banks merged in and continued to operate under the name Banco Giro until Napoleon liquidated it in The development of banking accompanied the growth of commerce and trade in Northern Europe.
The Netherlands became an international financial center, especially after the establishment of the Bank of Amsterdam The bank played a crucial part in Dutch economic growth by bringing order to the currency and facilitating transfers. A chartered public bank was opened in Sweden in It was probably the first financial institution in the world to issue standard-size payable-on-demand bank bills, which eliminated the handling of copper coins.
This bank was merged with the Bank of Sweden in Organized banking did not spread to England until the end of the 17th century. They kept money and other valuables in safe custody for their customers. They also dealt in gold bullion and foreign exchange. They profited from acquiring and sorting coins of all kinds.
To attract coins, the smiths were willing to pay interest. The goldsmiths noticed that deposits remained at a fairly steady level over long periods of time. Deposits and withdrawals tended to balance each other because customers wanted only enough money on hand to meet everyday needs. This allowed the smiths to lend at interest cash that would otherwise stand idle. From this practice emerged the modern customs of banking: keeping deposits, making loans, and maintaining reserves.
Another practice of the goldsmiths, by which a customer could arrange to transfer part of his balance to another party by written order, developed into the modern check-writing system. These customs eventually changed with the establishment of the Bank of England in Modeled after the Bank of Hamburg and the Bank of Amsterdam, it was founded as a private company and was soon to have a relationship of mutual dependence with the state.
Banks of the 17th century also began to issue bank notes as a form of money. The notes had monetary value because they could be exchanged for specie: hard cash in the form of gold or silver. Bank notes were probably first issued in the s by the Bank of Stockholm in Sweden; the practice soon spread to England. The Bank of France was founded in For most of the 19th century the money markets of Europe were dominated by the House of Rothschild.
Alexander Hamilton , the first secretary of the treasury, was largely responsible for founding the first Bank of the United States. It was chartered by Congress on Feb. By the War of there were 88 banks in the United States. During the war nearly all the state banks suspended payment of specie against their notes.
The second Bank of the United States prospered until its officers mixed in politics. The monopoly angered President Andrew Jackson , who vetoed the bill to renew its charter. In either case, there is still potential for capital loss as described above, if the company providing the guarantee runs into trouble.
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