THE TWO LEVEL STRUCTURE OF THE

BANKING SYSTEM

Learn the two Level Structures of Banking Systems

Types of Commercial Banks What assets held by retail banks Key role of Central banks Relationship between the central Bank and

commercial banks

LEVEL STRUCTURE OF BANKING SYSTEMS

Commercial Banks

Financial institutions that receive money from businesses and individuals and lend money to them.

Commercial banks are open to the public and serve individuals, institutions and businesses.

Banks are regulated by state laws depending on how they are organized and the services they provide.

Commercial banks are also monitored through independent authorities.

Central Bank

A central bank is an institution responsible for supervising the monetary system of a nation or a group of nations. Their usual duties are to issue currency , regulate the money supply and control interest rates .

Their decisions affect the financial markets in general and the currency markets in particular. Sometimes, they also supervise the commercial banking system in their country.

TYPES OF COMMERCIAL BANKS Investment bank / Corporate Banking

Investment banks, sometimes called wholesale banks, provide financial services to other financial institutions and corporates, and occasionally to countries.

A key role is to provide loans, often for millions of dollars, to companies that prefer debt as a means to raise capital. This is also known as merchant banking.

Other tasks include providing investment advice to and broking on behalf of institutional investors, and acting as an intermediary where a client is engaged in mergers and acquisitions.

They also manage pension funds and other large investments.

Investment banks are usually regulated by the central bank of the country in which they operate and/or a specific regulatory authority.

TYPES OF COMMERCIAL BANKS Retail banks

Retail banks "high street" banks, provide banking services to members of the public. It encompasses the services offered to consumers by commercial banks. The term "retail" refers to the almost storefront-shopping nature of commercial banking services.

Characteristics of Retail Banking

1. Multiple products (deposits, credit cards, insurance, investments and securities)

2. Multiple channels of distribution (call center, branch, internet)

3. Multiple customer groups (consumer, small business, and corporate)

TYPES OF COMMERCIAL BANKS Retail banks

Examples of retail banking services:

Fixed, current / savings accounts on the liabilities side; Mortgages, loans (e.g., personal, housing, auto, and educational)

on the assets side. Related ancillary services include credit cards, or depository

services. Retail banking refers to provision of banking services to individuals

and small business. accepting salaries and wages into a current account acting as intermediary to pay bills through direct debits and

standing orders providing cheque books, credit and debit cards providing cash withdrawal facilities managing savings

TYPES OF COMMERCIAL BANKS Retail banks

Many retail banks also offer a wide range of other financial services to their customers, such as insurance, pension funds, mortgages, overdrafts and broking investments in the stock markets. All these services, plus business loans, are also available to small and medium-sized businesses.

Regulation applies to retail banks, too. They are usually overseen by the appropriate regulatory authority, but the central bank may still set policy for them.

A balance sheet (statement of financial position)

is a financial report that shows the value of a company's assets, liabilities, and owner's equity at a specific period of time.

An asset is anything that can be sold for value.

A liability is an obligation that must eventually be paid, and, hence, it is a claim on assets.

The owner's equity in a bank is often referred to as bank capital, which is what is left when all assets have been sold and all liabilities have been paid.

The relationship of the assets, liabilities, and owner's equity of a bank is shown by the following equation:Bank Assets = Bank Liabilities + Bank Capital

ASSETS HELD BY RETAIL BANKS

ASSETS HELD BY RETAIL BANKS

Assets: Uses of Funds Assets earn revenue for the bank and includes cash, securities, loans, and property and equipment that allows it to operate. CashA major service is to supply cash on demand, whether it is a depositor withdrawing money or writing a check, or a bank customer drawing on a credit line. A bank also needs funds to pay bills, but while bills are predictable in both amount and timing, cash withdrawals by customers are not. SecuritiesThe primary securities that banks own are bonds that can be sold quickly in the secondary market when a bank needs more cash, so they are often referred to as secondary reserves. LoansLoans are the major asset for most banks. They earn more interest than banks have to pay on deposits, and, thus, are a major source of revenue for a bank.

ASSETS HELD BY RETAIL BANKS

Liabilities: Sources of Funds Liabilities are either the deposits of customers or money that banks borrow from other sources to use to fund assets that earn revenue. Checkable DepositsDeposits where depositors can withdraw the money at will. These include all checking accounts. Depositors use checking accounts for payment services, which, nowadays, also includes electronic banking services. Nontransaction DepositsSavings accounts and time deposits. Savings accounts are not used as a payment system, which is why they are categorized as nontransaction deposits and is also the reason why they pay more interest. BorrowingsBanks also borrow money, usually from other banks.

ASSETS HELD BY RETAIL BANKS

Bank CapitalBanks can also get more funds either from the bank's owners or, if it is a corporation, by issuing more stock. For instance, 19 of the largest banks that received federal bailout money during the credit crisis raised $43 billion of new capital in 2009 by issuing stock because their reserves were deemed inadequate in response to stress testing by the United States Treasury.

KEY ROLE OF CENTRAL BANKS

Central Banks differ from country to country in their structure and organization, in their policies and techniques. But their functions are very similar. The Central Bank renders the following important functions in almost all countries: (i) Issuing of notes and regulating the volume of currency.(ii) Banker to the Government.(iii) Banker to the banks.(iv) Act as custodian of National reserves.(v) Acts as Lender of last resort.(vi) Functions as National clearing house(vii) Act as the controller of credit.(viii) Publishes economic statistics and other information.(ix) Development functions.(x) Supervise the activities of financial institutions

KEY ROLE OF CENTRAL BANKS

(i) Issuing of notes and regulating the volume of currency

Whatever may be the system three basic principles are to be followed. They are (i) Uniformity (ii) Security and (iii) Elasticity.

The currency issued must be uniform and a single authority must be vested with the power of note issue to achieve uniformity.

There must be security for the currency without any dangers of over issue. Public must have confidence in the currency, which to some extent, depends upon the gold and foreign exchange reserves it holds. At the same time the currency supply must be elastic.The Central Bank must be able to expand or to contract the supply of currency according to the changing needs from time to time.

KEY ROLE OF CENTRAL BANKS(ii) Banker to the Government:

The Central Bank acts as the banker, financial agent and advisor to the government.

The surplus money of the government is kept with the Central Bank. It lends money to the government. It helps the government to tide over the time gap between their expenditure and collection of taxes.

The Central Bank also undertakes to provide the government with necessary foreign exchange for making payments abroad.

The government is the ultimate authority for laying down the broad monetary policies of the country and Central Bank is the institution for carrying out of such policies.

KEY ROLE OF CENTRAL BANKS

(iii) Banker to the banks: It performs the following functions for Commercial banks:

Custodian of cash reserves of commercial banks: The commercial banks of the country are required to keep a certain percentage of their deposits with the Central Bank. This has the following advantages:

1. The centralization of cash reserve is a source of great strength to the banking system of the country as it strengthens the confidence of the public

2. Centralized reserves can be used effectively and quickly in times of emergency.

3. This ensures liquidity and imparts economy in the credit structure of the country.

4. These reserves promote liquidity of commercial banks as they enable the Central Bank to undertake rediscounting of bills on a more extensive scale for the purpose of meeting the requirements of the money market.

5. The Central Bank can control credit by varying the cash reserves that commercial banks should keep with it.

KEY ROLE OF CENTRAL BANKS

(iv) Act as custodian of National reserves:

Central Bank is the custodian of nation's gold and foreign exchange reserves. Previously, to some extent, the value of a currency depends upon the gold reserves or foreign exchange reserves held as the backing for the currency. As such, it is the responsibility of the Central Bank to maintain sufficient reserves and to prevent their depletion.

The Central Bank manipulates the bank rates and takes other steps to conserve the reserves of gold and foreign exchange. Some Central Banks have absolute powers to control the foreign exchange reserves and to license the various uses to which the foreign exchange is put to use. In modern times, the foreign exchange control has become the essential function of the Central Bank.

KEY ROLE OF CENTRAL BANKS(v) Acts as Lender of last resort:

The commercial banks approach the Central Bank for its financial needs as it is the lender of the last resort or the ultimate source of finance.It lends to the commercial banks by rediscounting the eligible bills. The rediscounting facilities given by the Central Bank impart elasticity and liquidity to the entire credit structure of the country. It helps the commercial banks in a big way to prevent them from bank failures.

Moreover, a commercial bank is not entitled to financial accommodation simply be cause it has eligible paper or approved securities. Unless it is conducting its business ac cording to sound banking principles, the Central Bank refuses accommodation.

The Central Bank is also regarded as performing the function of last resort when it grants accommodation to the government in times of monetary stringency.

KEY ROLE OF CENTRAL BANKS

(vi) Functions as National clearing house:

The Central Bank acts as the national clearing house. The maintenance of accounts by all commercial banks with the Central Bank enables it to settle interbank indebtedness.

A clearing house is an institution where interbank claims, i.e., claims of banks against one another are settled. The net balances or differences called the clearing balances are settled by mere transfers between their respective accounts at the Central Bank.

KEY ROLE OF CENTRAL BANKS

(vii) Act as the controller of credit:

The credit creation by the commercial banks has a direct impact on the economy.

If the banks expand the credit limits that leads to inflation and if they unduly contract credit it leads to deflation. Thus, the central bank is empowered to control the credit creation of the commercial banks.

The commonly used methods of credit control are:

1. Bank Rate Policy2. Variation of cash reserves3. Credit rationing4. Selective credit control

KEY ROLE OF CENTRAL BANKS

(viii) Publishes economic statistics and other information: The Central Bank regularly collects and publishes the statistics regarding various economic activities of the government, banking system, etc.

Further it provides useful information regarding government policies.

KEY ROLE OF CENTRAL BANKS

(ix) Development functions:

The Central Bank Acts as the catalyst of economic growth of the country. It acts as an agency of economic growth. It renders various developmental functions such as:

1. Provision of credit facilities to agricultural industry and other priority sectors through commercial banks and cooperative banks.

2. Expansion of banking facilities in the country.

3. Maintaining price stability in the country.

KEY ROLE OF CENTRAL BANKS

(x) Supervise the activities of financial institutions

RELATIONSHIP BETWEEN THE CENTRAL BANK AND COMMERCIAL

BANKS The Central Bank is the head of the financial system. All financial institutions including commercial banks are regulated and monitored by the Central Bank. All commercial banks must keep an account with the Central Bank. These balances are used for cheque clearing purposes between banks.  Payments for cheques between banks are set off at the Central Bank’s clearing house. The Central Bank can also demand commercial banks to deposit a certain percentage of their total deposits with the central bank in order to control the money supply. The Central Bank dictates the interest rate that commercial banks can offer by setting the bank rate. This is the interest rate set by the Central Bank and the rate at which commercial banks and the Central Bank do business, e.g. loans offered by the Central Bank to commercial bank.