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Whatisabank

By Grace Ford,2014-06-05 09:19
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    What is a bank?

    A bank is a financial intermediary that accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers with capital deficits to customers with capital surpluses.

    The definition of a bank varies from country to country. Under English common law, a

    :banker is defined as a person who carries on the business of banking, which is specified as

    ;conducting current accounts for his customers

    ;paying cheques drawn on him, and

    ;collecting cheques for his customers.

    Banks act as payment agents by conducting checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and ATM.

    Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending.

    Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account.

    Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings to.

    The economic functions of banks include:

    1.Issue of money, in the form of banknotes and current accounts subject to cheque or

    payment at the customer's order. These claims on banks can act as money because they are

    negotiable and/or repayable on demand, and hence valued at par. They are effectively

    transferable by mere delivery, in the case of banknotes, or by drawing a cheque that the

    payee may bank or cash.

    2.Netting and settlement of payments – banks act as both collection and paying agents for

    customers, participating in interbank clearing and settlement systems to collect, present, be

    presented with, and pay payment instruments. This enables banks to economise on reserves

    held for settlement of payments, since inward and outward payments offset each other. It

    also enables the offsetting of payment flows between geographical areas, reducing the cost

    of settlement between them.

    3.Credit intermediation – banks borrow and lend back-to-back on their own account as

    middle men.

    4.Credit quality improvement – banks lend money to ordinary commercial and personal

    borrowers (ordinary credit quality), but are high quality borrowers. The improvement

    comes from diversification of the bank's assets and capital which provides a buffer to

    absorb losses without defaulting on its obligations. However, banknotes and deposits are

    generally unsecured; if the bank gets into difficulty and pledges assets as security, to raise

    the funding it needs to continue to operate, this puts the note holders and depositors in an

    economically subordinated position.

    5.Maturity transformation – banks borrow more on demand debt and short term debt, but

    provide more long term loans. In other words, they borrow short and lend long. With a

    stronger credit quality than most other borrowers, banks can do this by aggregating issues

    (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and

    redemptions of banknotes), maintaining reserves of cash, investing in marketable securities

    that can be readily converted to cash if needed, and raising replacement funding as needed

    from various sources (e.g. wholesale cash markets and securities markets).

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