All banks are financial institutions; yet, all financial institutions are not considered to be banks-Discuss
Introduction
In the broadest sense, banks are institutions that provide the security of people’s money and return them after a specific time period or whenever required by the depositor, with a certain rate of interest. All the banks charge a specific rate of interest, most often fixed by the Central Bank of the country. They also lend out money to potential borrowers; however, in this case they charge a higher rate of interest than the rate charged by them for deposits. Banks earn their profits mostly through interests.
On the other hand, broadly defined, financial institutions provide financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries.
Although the terms “banks” and “financial institutions” are often used interchangeably and more often than not, financial institutions are referred to as banks only; however, these two bodies are very much separate and have distinct features of their own, which is the key purpose of this research paper.
2“Financial Institution” (2012), available at http://en.wikipedia.org/wiki/Financial_institutions accessed on 10 October 2012Background
Financial institutions
According to financial dictionary, a financial institution is “any institution that collects money and puts it into assets such as stocks, bonds, bank deposits or loans is considered a financial institution. There are two types of financial institutions: depository and non-depository institutions”.3
Depository financial institutions are those entities which accept cash and use it for lending purposes, that is, they offer deposit accounts. Depository accounts are accounts where individuals or companies can keep their money for safety, and in return they earn a certain rate of interest. This rate of interest is most often determined by the central bank of the country. These deposits (money) are lend out by the institutes to potential borrowers against appropriate mortgage. In short, depository financial institutions find out channels for using the deposits for lending activities. Examples: banks, savings associations and credit unions.
Non-depository financial institutions are those entities which are funded through other means than depositing money, that is, they are not entitled to manage deposits through savings accounts and current accounts. This function is performed by the depository financial institutions such as banks. However, they do provide various types of financial services that are not entitled to offer a saving account. These institutes mainly serve as investment tools or to fulfill the financial needs of individuals and companies. Examples of non-depository entities include mutual funds, insurance companies and brokerage firms.
3“Financial Institutions” Dictionary of financial terms (2008), available at http://financial-dictionary.thefreedictionary.com/Financial+institutions accessed on 11 October 2012.
In spite of the large number of depository institutions in the US, the number have actually been decreasing significantly from 1996 – 2006. On the bright side, although number of depository institutes decreased, their amount of assets escalated due to mergers. “The passage of the Deposit Institutions Deregulation and Monetary Control Act of 1982 and the Garn – St. Germain Depository Institutions Act of 1982 had an impact on the asset distribution of financial institutions. These laws allowed credit unions to offer share draft accounts and long term mortgage loans. In addition, savings associations could issue credit cards and now accounts, offer trust services, purchase municipal revenue bonds, and offer consumer loans”.4 Because of this Act, the difference in services between depository and non-depository institutes have declined to a great extent. Moreover, this Act was termed by Senator William Proxmire as the most significant banking legislation since 1913.5
Banks
As described before, banks are a part of the whole financial institutions sector. They are a form of depository financial institutions, because they function by opening up deposit accounts for companies and individuals willing to keep money with them. The key function of bank is to lend out the money deposited with them to potential borrowers against appropriate mortgage, from where they earn a higher rate of interest than the amount of interest given to the depositors. Generally through this mechanism majority of the banks earn their profit.
4 “Financial Institutions – Similarities and Differences” n.d., p. 30, paragraph 1, available at http://wwwdev.cuna.org/download/23398_ch4.pdf, accessed on 16 October 2012.
5 Timberlake, R., “Legislative Construction of the Monetary Control Act of 1980”, The American Economic Review, p. 97., paragraph 2, available at http://www.jstor.org/discover/10.2307/1805578?uid=3737584&uid=2129&uid=2&uid=70&uid=4&sid=21101325880777, accessed on 16 October 2012.
It is most often unfeasible to keep all of our money with ourselves. This is one of the major features of banks, that they keep people’s money with the security of paying it back when required by the depositor. They offer an interest rate every month, which in economics is known as the reward for savings. Banks operate on what is known as “fractionalized deposits”6, that is they do not only keep the depositors money with themselves, they lend out that money to other borrowers, by charging a higher interest rate than the rate of interest given to the depositors. Through this higher rate of interest earned by the banks from the lenders, the banks make their profit.
Banks charge fees and service charges. Although the amount and purpose of fee charged varies from bank to bank and from country to country (for example, in Bangladesh, UCB charges BDT 30 plus VAT from their customers if they withdraw cash from any ATM booths other than UCB’s; whereas Bank Alfalah charges BDT 15 plus VAT for the same service) the basic factors are often same. The banks usually charge fees for ATMs, credit and debit cards, opening accounts, closing accounts, and so on.
Different types of banks:
Commercial banks: These are the most common form of banks. Their tasks vary from accepting deposits to lending out loans to potential borrowers against appropriate securities and credit creation (while lending out a certain amount of money banks creates accounts through which the lender can withdraw).
6 “Fractionalized Deposits” Banks (2001), available at http://www.socialstudieshelp.com/Eco_Bank_Types.htm accessed on 10 October 2012.
7 Akrani, G., (2011) “Commercial Banks – Definitions, Primary Secondary Functions” Primary Functions of Commercial Banks, paragraph 7, available at http://kalyan-city.blogspot.com/2010/09/commercial-banks-definitions-primary.html accessed on 10 October 2012.
Deposits are generally accepted in three forms:
i. Fixed deposit – Money is deposited for a definite period of time, usually for a long term, and cannot be withdrawn before the time of the deposit is matured. Fixed deposits usually carry a high rate of interest.
ii. Savings deposits – This type of deposit usually have a low rate of interest. Money can be withdrawn to a certain amount for a certain time.
iii. Current deposits – From this type of deposit, money can be withdrawn anytime for any amount. Since it is very flexible, they carry very low or no interest rate. It is most often useful for big traders who have to make and accept payments many times a day
Loans:
i. Cash credit: Cash credit is a facility through which borrowers can borrow more than a certain amount. For example, if a borrower wants to borrow BDT 5 million, the bank would open up a deposit account and give in that account 10 million. This amount can be withdrawn by the lender any time. After a certain period of time the lender would return the BDT 10 million along with interest. This service is most helpful to large traders who require transacting large amount of money.
ii. Short-term Loans: Often banks come up with short term loan schemes, such as car loan, education loan, personal loans, and so on. These are known as short-tern loans.
8 Upadhyaya, K., n.d. “7 main functions of a commercial bank” Current Deposits paragraph 7, available at http://www.preservearticles.com/201104115277/7-main-functions-of-a-commercial-bank.html accessed on 10 October 2012.
iii. Demand loans: Money lend immediately on demand by borrowers is known as demand loans. The entire loan amount is paid in lump sum by crediting it to the loan account of the borrower, and thus the entire loan becomes chargeable to interest with immediate effect.9
Other major functions of commercial banks include: issuing bonds and bills, collecting diviends and shares for their customers, pays insurance premiums and income taxes of their customers as per instructions, arrange to send money for the convenience of their customers, facilitates foreign trades, sell and purchase foreign exchange, and so on.
Central Bank:
According to Investopedia a central bank of a country is “an entity responsible for overseeing the monetary system for a nation (or a group of nations)”10. The central bank of United States is known as the Federal Reserve System, and the central bank of Bangladesh is Bangladesh Bank.
9 Akrani, G., (2011) “Commercial Banks – Definitions, Primary Secondary Functions” Primary Functions of Commercial Banks, paragraph 16, available at http://kalyan-city.blogspot.com/2010/09/commercial-banks-definitions-primary.html accessed on 10 October 2012.
10 “Central Bank (2012), available at
http://www.investopedia.com/terms/c/centralbank.asp accessed on 11 October 2012.
Bangladesh Bank acts as a banker to the Government and performs a wide variety of functions for the development and stability of the monetary system and economy of our country. Among the many functions, some of the important roles played by our central bank are “issuing currency, maintaining reserves, formulating and managing the monetary policy, regulating the credit system of Bangladesh, and managing the country’s foreign exchange and gold reserve”11
In addition to commercial banks and the central bank there are many other types of banks as well, such as savings banks, mutual savings banks, Islamic banks (banks functioning according to the Shariah law), investment banks, merchant banks and so on. In spite of the variety, in most cases, the basic functions and features of all the banks remain almost same.
11 .“Functions of Bangladesh Banks” (2008), available at http://www.scribd.com/doc/24853805/Functions-of-Bangladesh-Bank accessed on 10 October 2012.
Summary of Research Findings
Financial institutions and banks, although belongs to the same sector, however, there is still a fine line of distinction between them. Financial institutions include all those organizations which provide financial services such as providing deposit and savings accounts, investment services like, investment decisions, analysis regarding issuing stocks, shares and bonds, issuing and offering services of credit cards, ATMs and so on. However, all these services are not provided by all the organizations. Depository institutes, such as banks, provide services related to deposits and savings. Non-depository entities provide the remaining services related to finance, except for deposit services. Therefore, we can see that banks are a part of financial institutions. As a result, we can deduce that banking is a financial institution but all financial institutions are not banks.
However, with the introduction of many laws, such as the Deposit Institutions and Monetary Control Act of 1980, the distinction between banking and non-banking financial institutions have blurred to a great extent. Nowadays, banks can offer investment services and non-banks can offer check-writing privileges, credit cards and savings accounts. Moreover, with many mutual funds and brokerage firms, checks can be written against their accounts.12
12 “Know the Different Types of Financial Institutions” Personal Finance, n.d., available at http://personalfinance.byu.edu/?q=node/583, accessed on 16 October 2012.
Conclusion
Through this research we have found that banks are only a part of the financial institutions. Therefore, all banks can be called financial institutions, but all financial institutions are not banks.
However albeit the differences the distinctions between depository and non-depository are financial institutions are gradually getting blurred. Laws such as, Monetray Act 1982 are also helping in the process. These days, many non-depository financial institutions are also offering services of banking sector and banking sector are also diversifying in terms of their products.
Bibliography
1. Sushant, “Banks and Financial Institutions”, Chartered Financial Analyst, (2011), paragraph 2, available at http://www.cfa.co.in/?s=Banks+and+financial+institutions accessed on 12 October 2012.
2. “Financial Institution” (2012), available at http://en.wikipedia.org/wiki/Financial_institutions accessed on 10 October 2012.
3. “Financial Institutions” Dictionary of financial terms (2008), available at http://financial-dictionary.thefreedictionary.com/Financial+institutions accessed on 11 October 2012.
4. “Financial Institutions – Similarities and Differences” n.d., p. 30, paragraph 1, available at http://wwwdev.cuna.org/download/23398_ch4.pdf, accessed on 16 October 2012.
5. Timberlake, R., “Legislative Construction of the Monetary Control Act of 1980”, The American Economic Review, p. 97., paragraph 2, available at http://www.jstor.org/discover/10.2307/1805578?uid=3737584&uid=2129&uid=2&uid=70&uid=4&sid=21101325880777, accessed on 16 October 2012.
6. “Fractionalized Deposits” Banks (2001), available at http://www.socialstudieshelp.com/Eco_Bank_Types.htm accessed on 10 October 2012.
7. Akrani, G., (2011) “Commercial Banks – Definitions, Primary Secondary Functions” Primary Functions of Commercial Banks, paragraph 7, available at http://kalyan-city.blogspot.com/2010/09/commercial-banks-definitions-primary.html accessed on 10 October 2012.
8. Upadhyaya, K., n.d. “7 main functions of a commercial bank” Current Deposits paragraph 7, available at http://www.preservearticles.com/201104115277/7-main-functions-of-a-commercial-bank.html accessed on 10 October 2012.
9. Akrani, G., (2011) “Commercial Banks – Definitions, Primary Secondary Functions” Primary Functions of Commercial Banks, paragraph 16, available at http://kalyan-city.blogspot.com/2010/09/commercial-banks-definitions-primary.html accessed on 10 October 2012.
10. “Central Bank (2012), available at
http://www.investopedia.com/terms/c/centralbank.asp accessed on 11 October 2012.
11.“Functions of Bangladesh Banks” (2008), available at http://www.scribd.com/doc/24853805/Functions-of-Bangladesh-Bank accessed on 10 October 2012.
12. “Know the Different Types of Financial Institutions” Personal Finance, n.d., available at http://personalfinance.byu.edu/?q=node/583, accessed on 16 October 2012.