ORIGIN AND GROWTH OF

COMMERCIAL BANKING
 Evolution of Banking

 What is bank?
 There are various views about the origin of the word ‘bank’. One view is
that it is derived from an Italian word ‘banque’ which means a
‘bench’.
 In the explanation of this view they are saying that in past in Italy the
money exchanger were sitting on benches and doing there businesses.
 Today banks are dealing in money so the work of today banks and work
of those money exchangers is the same, as both are dealing in money
that’s why they are saying that the word bank has derived from an
Italian word ‘banque’ which means a ‘bench’.
 Evolution of Banking

The other point of view is that it has originated

from the German word ‘banc’ which means a
‘joint stock firm’.
In the explanation of this view they are saying that
today banks are working as a joint stock firm that’s
why the word bank has been originated from the
German word ‘banc’ which means a ‘joint stock
firm’.
 Evolution of Banking

As regards the growth of modern commercial

bank, it can be traced to as early as 600 BC.
Crowther in his famous book “An outline of
money” has traced the history of modern
commercial banking. According to him the present
day banker has three ancestors.
1. The merchants
2. The goldsmiths
3. The money lenders
 Evolution of Banking

1. The merchants:

 The earliest stage in the growth of banking can be traced to

the working of merchants. These merchants were traders in
commodities.
 The trading activities were carried on by them from one
place to another.
 It was risky for traders to carry metallic money with
themselves for payment.
 The traders with high reputation begin to issue receipts
which were accepted as title of money.
 These receipts or letters of transfer also called hundi in indo
sub continents were the first mode of payments.
 The merchant banking thus form the earliest stage in the
evolution of modern banking
 Evolution of Banking

2. The Goldsmiths:
 The second stage in the growth of banking is normally
traced to the earlier goldsmith.
 These goldsmiths also called “seths” in India used to receive
gold and silver for safe custody.
 The goldsmiths begin to issue receipts for the metallic
money (gold and silver) kept with them.
 These receipts became payable to the bearer on demand.
 In this way the goldsmith note became a medium of
exchange and a mean of payment.
 The goldsmith thus can rightly be termed as the
forerunners of the modern bank notes.
 Evolution of Banking

3. The money lenders:

 The third stage in the development of banking arose when
goldsmiths became money lenders.
 By experience the goldsmith (who were called money lenders)
came to know that they could keep a small proportion of the total
deposits for meeting the demands of customers for cash and the
rest the could easily lend.
 They allow the depositors to draw over and above the money
actually standing to their credit (they allow overdraft facility).
 When every money lender/goldsmith issued receipts and many
of them allowed overdraft facilities there were then too much
confusion in the banking system.
 The money lenders/goldsmiths in order to earn more profits
could not keep adequate reserves for meeting the demands of the
customers for cash.
 Evolution of Banking
 The failure on the part of the money lenders/goldsmiths to return money
caused wide spread distress among the people.
 In order to create confidence among the people, steps were taken to
regulate the banking organization.
 A conference was held in Nuremberg in 1548. It was decided that a bank
should be set up by the state which should regulate the banking
organization and techniques.
 The 1st central bank was formed in Geneva in 1578. Bank of England was
established in 1694.
 The modern commercial banking system actually developed in
nineteenth century.
 With the passage of time the scope of the commercial banks have greatly
increased. They now deal with large number of matters such as obtaining
funds, advancing loans to the businesses, farmers, households, making
investments in stocks, discounting bill of exchange etc.
 The commercial banks are now multi service organizations and play a
very important role in the financial markets and economic development
of a country.
 What is a Commercial Bank?

According to Crowther;
“A bank is a firm which collects money from those
who have it spare. It lends money to those who
require it.”
In the words of Parking;
“A bank is a firm that takes deposits from house
hold and firm and makes loans to other households
and firms”.
 What is a Commercial Bank?

Commercial bank accepts deposits from individuals,

firms and companies at a lower rate of interest and
gives it at higher rate of interest to those who need
them.
The difference between the terms at which it
borrows and those at which it lends forms the source
of its profit.
 Functions of a Commercial Bank

A commercial bank performs a variety of functions.

These functions are classified under two main heads
1. Basic Functions
2. Secondary Functions
 1. Basic Functions

What are basic functions of a Commercial Bank?

The basic functions of a Commercial bank are
a. Accepting of Deposits
b. Advancing of money
 a. Accepting of Deposits

The 1st important function of a bank is to accept

deposits from those who can save but can not make
profitable use of their savings themselves.
In order to attract the savings from different
persons and institutions, The bank maintain the
following three types of accounts
1. Current Account
2. Saving Account
3. Fixed or Term deposit account
 Current account

The businesses and traders usually maintain their

funds in current account.
What is a current account?
“Current account is one where money is constantly
being drawn out and put in”.
Since the money is withdraw able at any time by
the customer, therefore the bank do not pay
interest on current deposits.
Current account holders receive a check book and
regular statements containing details of money
paid in and paid out.
 Features of current account

Approved parties:
The bank can open current account for approved parties.
The businessmen and individuals are entitled for opening
current account. But some banks don’t need approved
parties, they open account on the basis of NIC (Tazkeera)
only.
Service charges:
The bank has right to claim service charges if you did not
make any transection within 6 months in your account.
Moreover they inactivate your account if you did not
make any charges within one year.
 Continue…

Statement of account:
 The bank sends statement of account to their customers at
their addresses. The customer can ask for statement of
account for any particular period.

Standing Instructions;
 The bank accepts standing instructions. These instructions
are issued to pay expenses or collect income regularly on
behalf of customers.
 Continue…

Introduction;
Bank can open current account after proper introduction.
The old customers & bank employees can introduce new
customers. Some banks don’t need introduction even.
Pay-in-slip;
The customers can use pay-in-slip to deposit money and
cheques into bank accounts. The color of pay-in-slip for
current account is different from other accounts.
Minimum Amount;
The account can opened with any amount in Afghanistan.
But you should keep minimum balance of $100 or Afs
5000 in individual account and $ 300 or Afs 15,000 for
corporate account. (It varies from bank to bank).
 Continue…

Withdrawal of amount
The account holder can withdraw amount standing
to this credit. There is no limit on number of
withdrawal.

Cheque Book/Card;
A cheque book or card is issued to the account holder
at the time of account opening through which the
customer can withdraw amount from bank.
 Continue…

Interest is not allowed;

The bank do not allow interest on current account
balance because money is withdraw able any time
from this account.
Overdraft facility;
Overdraft are granted in current account against
securities. Interest on overdraft is calculated on daily
basis.
No notice of Withdrawal;
The customer can withdraw money from this
account during banking hours any number of times
without notice.
 Saving Account

The aim of this account is to encourage the savings

of the people.

“Saving account is generally opened by persons of

small income. The banks pay interest on this type of
deposits”.

However, the banks normally place restrictions on

their frequent withdrawal.
 Features of Saving Account
Account Holders;
Any person or persons who are competent to contract can
open single or joint saving account. The legal bodies like
associations, club, schools, local bodies etc can open such
accounts.
Introduction;

The saving bank is opened with proper introduction if it is

checking account. When cheque book is not used to
operate account there no need of such introduction. The
old customers of bank or employees of bank can introduce
new customers. Some banks don’t need introduction even.
 Continue…
Initial Deposit;
Saving account can be opened with any amount. The account
holder can deposit more amount.
Cheques/Card;
The customers can withdraw money from bank through
cheque or bank card, provided by bank.
Pass Book;
The customer can bring pass book for withdrawal, if pass
book is issued by bank. It is a type of book in which customer
maintain entries of their own deposit and withdrawal.
 Continue…
Interest;
The banks pay interest on the end of June or
December at fixed rate on minimum monthly balance.
Withdrawal;
Account holder is allowed to with draw money up to
Afs. 15,000 at a time. S/he can withdraw amount twice
in a week.
Notice;
A notice of 7 days is required for withdrawal of more
than Afs 15,000/-. Such notice should be in writing.
 Fixed or Term deposit account

Fixed or Long term deposits are kept with the banks

for a specified period of time. The rate of interest on
fixed deposits (also called term deposits) are high.

The longer the period of deposit, the higher is the

rate of interest and vise versa.
As well as the larger is the amount of the deposit, the
higher is the rate of interest and vise versa.
 Features of Fixed Deposit Account

No Introduction;
The bank accepts fixed deposit accounts without
introduction. A copy of identity card (Tazkeera) is
sufficient to open such an account.
Time of Deposit;
The customer can decide the time of deposit. It may vary
from three months to five years.
Rate of Profit;
The bank offers different rate of interest on different time
period. The fixed deposit account offers higher rate than
other accounts.
 Continue…

Fixed deposit receipt;

The bank provides receipt for deposit of money. The
receipt is called fixed deposit receipt.
Non-Transferable;
The fixed deposit receipt is not transferable from one
person to another. The owner is bound to keep receipt
till maturity.
Loan Facility;
The bank can provide loan facility to customer. The
amount of loan is 60-80% of fixed deposit.
 Continue…

Withdrawal of amount;
The customer can withdraw amount before due date.
The bank does not pay interest on the withdrawal of
amount on the request of depositor.
Interest rate on loan;
The bank can charge rate of interest on loan from 2-
2.5% per annum over and above rate of interest on
deposit. It may vary from 11-14%.
 Various Bank Accounts--- A
Comparison
Basis of Fixed or Term Saving Bank Current Deposit
Difference Deposit deposit Account Account
Account
1- Objective To Earn Interest. To Cultivate habit To provide the
of Saving. facility to
Industrialist and
businessman to
deposit or
withdraw the
money as and
when need.
2- Period of Deposits are made No fixed period for It is an open &
Deposit on fixed period. deposits. running account
for which there is
no fixed period for
deposits.
3- Frequency of Deposit is made Deposits can be No restriction on
deposits only at one time in made any number making deposits in
this account. of times here. this account.
 Various Bank Accounts--- A
Comparison (Continue…)
Basis of Fixed or Term Deposit Saving Bank Current Deposit
Difference Account deposit Account
Account
4- Restrictions The amount can generally There are There is no
on Withdrawal be paid at maturity. restrictions on restriction on
When withdrawal is made withdrawal. withdrawal in this
before maturity, interest account.
is either not allowed or
minimum interest is paid.
5- Interest As the cost of operation is Interest is No interest or only a
very low in this account allowed at a nominal interest is
so high rate of interest is rate lower than allowed as the cost of
allowed. fixed account. account is very high.
6- Cheque Not Permitted. Cheques are Cheques are used for
Facility used for withdrawal.
withdrawal.
 b. Advancing of money or Making loans

The second major function of a commercial bank

is to make loans to the businessmen, traders,
exporters, households etc
These loans are made against documents of title
to goods, marketable securities, personal security
of borrowers etc
A very large portion of bank’s total assets consist
of the advances (loans) of the bank.
 b. Advancing of money or Making loans
 “ Specific amount given by the bank for a specific time period for earning
profit is called loan”
 Secured/ Collateral/ Parallel Loan;
Loan given on the basis of securities i.e.
 Movable property (Gold, merchandise),

 Immovable property (Land, building),

 marketable securities (Bond, shares)

 Maturity of Loan;
 The total period of time in which the total loan along with interest will be
paid back to the lender is called maturity of loan.
 Short term loan (less than 1 year)

 Medium term loan (1-5 years)

 Long term loan (6-10 years)

 b. Advancing of money or Making loans

The lending of money may be in any of the following

forms.
1. Overdraft
2. Bank Loan
3. Cash credit
4. Discounting of bills
5. Letters of credit
 Overdraft

 It is a convenient form of short term financing by a bank.

Under this facility a customer may arrange with his bank to
permit him to overdraw on his current account known is
overdraft (O/D).
 The bank allows customer to overdraw his account up to a
certain limit on providing securities of shares, insurance
policies, deposits receipts etc.
 Interest is charged on daily basis on the overdrawn amount
only.
 An overdraft also called running finance & its allowed to
current account holder only.
 The difference between cash credit and overdraft is that cash
credit is given on regular basis and for relatively greater time
period. The overdraft facility is for short period.
 Cash Credit (C.C)

It is a very common form of borrowing by business

concerns. The banks advance long term loan to the
commercial and industrial units against the
security of goods.
The borrower has to open a new loan account for
cash credit.
Cash credit is given on the basis of securities of any
type.
The borrower is permitted to draw with in the cash
credit limit sanctioned by the bank.
The interest is charged only on the amount of
money withdrawn by the borrower.
 Bank Loan

The commercial banks grant short and long term

loans to individuals, firms and companies mostly
against securities.
The borrower has to open a new loan account.
Interest is charged on monthly, semi annually or
annual basis.
The borrower has to keep any type of securities with
the bank acceptable to the bank.
These loans are repayable either in periodic
installments or in lump sum at a fixed period of time.
 Types of bank loan
1. Demand loan;
As repayable to the bank as and when demanded by the bank as per
agreed agreement.
2. Fixed or Term loan;
It is advanced for a fixed period of time. It is repayable according to
repayment schedule or in lump sum after a fixed period of time.
3. Consortium Loan;
If a single loan is jointly granted by more than one bank, it is known
as consortium or participation loan.
4. Bridge loan;
The loan is granted to customer for meeting his temporary needs
until permanent funds are raised by him.
 Discounting of bills

Discounting of bills of exchange is another short term method

of profitable investment of bank funds.
Discounting of bills of exchange refers to making the payment
of bill before its maturity. The discount charge is the earning of
the bank.
The premature payment made is a loan to the holder of the bill.
Usually bank pay the 75 % of the bill in advance and the letter
25 % is paid when the bill is matured after deduction bank
charges.
 Letters of Credit

 Trade between countries is mainly financed by letters of

credit.
 The buyer who is an importer, applies to his bank for opening
a letter of credit.
 The bank issuing the letter of credit assures the exporter that
the payment will be made to him as soon as the documents
completed in all respect are received by it.
 The buyer bank thus makes payment in advance to the
exporter bank on fulfilling the terms and conditions of credit.
 The full amount is later on recovered by the importer along
with service charges.
 2. Secondary Functions

The secondary function of a bank are classified into

two categories,
a. Special Financial Services
b. Agency Functions
c. Utility Functions
 a. Special Financial Services

The business of today is highly competitive. It is not

enough for the banks now to accept deposits and
make loans only.
 Currency exchange
Letters of credit
Money transfer
 SWIFT (Society for world wide inter bank financial
telecommunication)
 Bank Draft
 Western union
 Money gram
 Cont…

Most of the banks offers ATM cards(Automated

Teller Machines) Master card ,Visa card ,Debit card
Credit card
Hajj application
Zakat deduction
Passport services
Collection of taxes and utility bills
Financing foreign trade by processing the documents
of trade between two parties
 b. Agency Functions

Banks act as agents of their customers in various

ways as:
(i) Collection of Checks
(ii) Collection of Dividends
(iii) Purchase or sale of Securities
(iv) Execution of standing instructions
(v) Acting as trustee or executors
 Agency Functions

(i) Collection of Checks:

Banks act as an agent in collection and payment of
checks for their customers.
(ii) Collection of Dividends:
The bank provide a very useful service in the collection
of dividends or interest earned on shares held by its
customers.
 Agency Functions

(iii) Purchase or sale of Securities:

The bank, if authorized by the customer, purchase or
sells securities on his behalf.

(iv) Execution of standing instructions:

The customer may order in writing to his bank to make
payments of regularly recurring nature to an individual
or firm.
The bank will make payments and charge a small
commission. The payments will be stopped on written
instructions of the customer only.
 Agency Functions

(v) Acting as trustee or executors:

If a client directs his bank to act as trustee or executor
in the administration of a will or in any business
settlement requiring a technical knowledge, the bank
will take this responsibility for the benefits of customer
and charge a small fee for providing this essential
service.
 Utility Functions

Provide information for starting international business

Underwriting (the process of purchasing the shares by the
bank from the company for the 1st time and reselling it back
to the people).
Status report (for foreign trips we need bank statement)
Lockers facility
Relief fund
Investment of funds in shares and bonds
Bill of exchange
Bank accepts Shares application for subscription of shares
on behalf of company.
END OF CHAPTER