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DISCUSSION 1. Can you name any major foreign banks where one could open an

account? 2. What sort of services do banks provide?


The operations of individual banks (how they acquire, use, and manage funds to make a profit) are roughly similar throughout the world. In all countries banks are financial intermediaries in the business of earning profits.

Banks today accept checkable deposits such as a demand deposit or a NOW (Negotiable Order of Withdrawal) account as well as time deposits, and use their depositors' funds mainly to make loans and buy securities.

Banks thus operate as financial intermediaries standing between the primary lenders (depositors) and the ultimate borrowers. In this way they provide many services. One is the pooling of risks. A bank that makes many loans is spreading its risks. It is highly likely to experience losses on a few loans but most unlikely to experience losses on all or most. (In con­trast someone who makes only a single loan faces an all-or-nothing situa­tion.) Another service of banks is providing liquidity. Someone who opens a checking account in a bank can get his or her money back whenever required. The bank meanwhile can make loans with his or her deposits and others' deposits while keeping only a small fraction of such deposits as a liquid reserve. Because it has many depositors who usually want to with-


draw deposits at different times a bank normally can meet the demands of those depositors who want to withdraw their deposits.

Another service that banks provide is expert judgment in making loans. Most savers cannot evaluate the creditworthiness of those who wish to borrow. Hence, instead of lending directly to the ultimate borrowers they 'lend' their savings to banks by depositing them, and the banks then use those savings to make loans to the ultimate borrowers.

Banks have an incentive to take risks because risky loans have a higher rate of return. All of these higher earnings accrue to the banks. But most of the funds at risk belong to depositors. Accordingly much of the risk that banks take is borne by depositors and by the Federal Deposit Insurance Corporation (FDIC), which insures their deposits in the USA. This is one reason why banks are heavily regulated by the government. Another, per­haps even more important reason is that banks are custodians of the checkable deposits that make up most of society's circulating medium of exchange. If banks fail and there is no deposit insurance, then depositors have to reduce their expenditures. As a result sales fall and firms have to throw employees out of work.

The banking system can create more than one dollar of deposits for every dollar of reserves it has. This is possible because deposits are not physical objects but rather abstract property rights documented by entries on computer. No physical object is created, it is all a matter of accounting. Suppose someone deposits $1,000 of currency in a bank. The bank credits the $1,000 to the depositor's account and then lends most of it out. It can­not lend all of it, however. The law and prudence require that it keeps a reserve against the deposit - say 10 percent. It therefore lends out only $900. The borrower then buys something with this $900 and the seller deposits his or her $900 check in the bank. The bank then keeps $90 as a reserve against this $900 deposit and lends out $810, which then becomes a deposit and so on. Ultimately all of the original $1,000 is held in reserves in one bank or another. And because reserves are 10% of deposits, total deposits will then be ten times the original deposit or 10,000. This hypo­thetical example overstates the actual case - the actual 'deposit multiplier' is closer to 2 than to 10 - in large part because at each stage the public withdraws some of its deposits in order to hold more currency.


VOCABULARY to acquire funds - брати кошти,

NOTES мобілізувати кошти

checkable deposits - банківський

депозит, по якому можливі розрахунки


NOW (Negotiable Order of Withdrawal) -

рахунок НАУ (рахунок з наказом про

вилучення коштів)

ultimate borrower - безпосередній


pooling of risks - об'єднання ризиків

liquidity - ліквідність

to evaluate - оцінювати

creditworthiness - кредитоспроможність

rate of return - норма прибутку

to accrue - накопичувати

Federal Deposit Insurance Corporation

(FDIC) - Федеральна корпорація страхування депозитів custodian - фінансова установа, що управляє чужими капіталами entry - бухгалтерське проведення prudence - обачливість ultimately - урешті-решт to overstate - перебільшувати multiplier - мультиплікатор



SECTION A. Banking in Great Britain.

DISCUSSION What is the role of banks and banking system in the life of any country?


The British banking system has developed over the past few hundred years to become one of the most highly specialized financial centers in the western world. The head offices or main branches of banking institutions are concentrated in the City of London.

The Bank of England is the central bank in the British banking system. Its functions are as:

a) issuer of currency;

b) banker to the government;

c) banker to the banks;

d) supervisor of the banking industry;

e) lender of last resort;

f) management of gold and foreign currency reserves;

g) a means of liaising with overseas central banks and financial institutions, and

h) implementation of government monetary policy.

A useful way of analysing bank financial intermediaries (i. e. banks) in the UK is to divide them into two categories:

Primary banks are the banks which operate the payments mechanism (i. e. the money transmission service in the economy). These are often referred to as the commercial banks, retail banks, or clearing banks. Com­mercial banks can be divided into three groups: the London clearing banks ("The Big Five"), the Scottish and Northern Ireland banks and the British overseas banks and foreign banks.

The clearing banks include Barclays, Lloyds, the Midland, National Westminster, the Trustee Savings Bank (TSB), the Co-operative Bank, Royal Bank of Scotland, Girobank and the Bank of Scotland. They are called 'clearing banks' due to the fact that they are responsible for 'clear­ing' cheques. In addition to these, there are several other banks which are not full members of the clearing house (such as Standard Chartered). The banks dominate the market in the UK, holding over 50% of sterling deposits. They are particularly strong at the retail level.

Most of overseas banks were set up in the 19th century to provide bank­ing facilities to their customers throughout the world but mainly in the British overseas territories. These banks facilitate movement of resources between London and abroad, as well as attracting deposits to London from overseas customers.

The number of foreign banks in London and in other major cities in recent years has rapidly expanded. US and Japanese banks are the most numerous group of foreign banks in the UK.

Secondary banks consist of the accepting houses (also known as mer­chant banks), other British banks and consortium banks. These are banks


whose liabilities consist mainly of term deposits, and so the secondary banks are not a significant part of the UK payments mechanism. In other words, they do not themselves carry out cheque clearing, nor are they members of the Committee of London Clearing Banks, although one of the retail (clearing) banks may clear cheques on their behalf.

Retail banking is the banking activity of the traditional 'high street' bank, dealing with relatively small deposits and small loans to customers. Such banks have extensive branch networks and the bulk of their business is in sterling.

Wholesale banking involves small numbers of customers with larger deposits or requiring larger loans. Because large sums are involved, cus­tomers expect the banks to trim their profit margins and offer a cheaper, more competitive service:

a) wholesale deposits might attract higher rates of interest for depositors;

b) wholesale loans might be at a lower rate of interest, not necessarily related to the bank's base lending rate.

Wholesale banking is essentially the merchant banking area of opera­tions and in the UK, wholesale banking is conducted principally in Lon­don. Merchant banks rarely have more than 1 or 2 branches. The clearing banks also carry out wholesale banking operations, but again, mainly in London.

You should by now understand that the High Street banks are:

a) bank financial intermediaries;

b) primary banks; and

c) retail banks.

The main functions of the retail banks can be summarised as follows:

a) providing a payments mechanism - i. e. a way in which individuals, firms and government organisations can make payments to each other. The banks are also a source from which individuals and firms can obtain notes and coin;

b) providing a place for individuals, firms and government organisa­tions to store their wealth, e. g. in current accounts or deposit accounts. Banks compete with other financial institutions to attract the funds of individuals and firms:

c) lending money in the form of loans, overdrafts or other specialised schemes.

The banks also provide a wide range of services to customers, some of which are not strictly 'banking' activities. In other words, banks do much more than banking.


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