By Matija Šerić
The roles and functions of banks in every economy are extremely important. Banking and the economy are inseparably connected concepts. The state of the economy is reflected in the operations of banks, and vice versa. In the 21st century, banking operations have become increasingly fast, flexible, and dynamic, which makes it ever more difficult to clearly explain what banks actually are, how they function, and what their tasks are. And their tasks are indeed highly significant.
Definition of a Bank
To gain a clearer insight into the topic, it is useful to begin with some basic definitions. A generally accepted definition states: “A bank is a specific enterprise that trades in a specific commodity—money—which is why such an enterprise has greater social significance compared to other companies. Banks are financial institutions engaged in financial intermediation activities, particularly in collecting deposits and granting loans. The goal of establishing a bank is profit. Management creates the bank’s business policy. Market conditions, supply, and the size of the bank influence its business policy.”
Historical Origins of Banking
Historical sources indicate that banking originates from ancient Mesopotamia. In temples and palaces, large quantities of grain and other valuable goods were stored. In order to withdraw grain from a palace or temple, receipts confirming the issued quantity were distributed. These earliest banking transactions were later joined by private houses, while regulated activities were conducted under the famous Code of Hammurabi.
In the Middle Ages, banks first developed on the Apennine Peninsula, and their modern name derives from the Italian word banco, meaning bench or table. On these tables, compartments filled with various coins were kept in order to conduct currency exchange during fairs.
Over time, exchange operations in the first banks were supplemented by deposit-taking and the issuance of certificates or credits allowing money to be withdrawn from other bankers. Modern banking operations have their roots in currency exchange activities. Banking as a scientific discipline focused on the organization and operation of banks developed in the second half of the 19th century, with the aim of properly training bankers to successfully carry out banking tasks and objectives while taking into account liquidity, business reputation, and similar factors.
Principles of banking
Fundamental Principles of Banking Operations
As banks became the most important regulators of monetary flows, the need arose to define principles of banking operations. The basic principles include the principle of liquidity, the principle of business viability, the principle of security and efficiency in investing funds into reproduction, and the principle of profitability. The development of the national economy stimulates the development of banking, which is reflected in changes to legal regulations, organizational methods, and the structure of banks. In the modern world—today’s global money markets—large banking conglomerates are present, which avoid border and other limitations through capital consolidation.
A Key Factor of the National Economy
Banks perform numerous tasks related to the functioning of private ownership and thus represent an essential element of the national economy. They are the most important participants in the money market and are connected to the capital market through their investment departments, particularly when acting as underwriters for new issues of shares or bonds. For this reason, banks are a very important component of the capital market, even though it is traditionally assumed that the main banking activities—loans—are in direct conflict of interest with the issuance of shares as an ownership-based form of financing economic development.
Regardless of this conflict of interest (a bank will always prefer to place money as a loan rather than invest it in shares), the importance of banks in the capital market must not be overlooked. On the contrary, with the development of the overall financial market, special banking products and services have emerged that further influence the development of the financial market. Underwriting securities issues, various guarantees, and even the physical distribution of shares at bank counters can all contribute to strengthening trading activity and investor confidence in equity ownership.
Diversification of Banking
Banking can be national or international. Today, the banking system is diversified and subject to constant change and adaptation to the financial environment. From its beginnings to the present day, the banking system has undergone numerous transformations and shifts in priorities. Primarily, banks engage in collecting monetary funds and supporting the payment system. With the development of capital markets and the growing importance attributed to them, banks increasingly assume roles within investment banking.
Banking operations are subject to centralized supervision by central banks, which in the Republic of Croatia is the Croatian National Bank (HNB). In most European countries, including Croatia, banks are organized as universal banks. The most common complaint of clients of universal European banks is: “Universal banking makes European banks too inflexible and conservative—rather than ambitious and risk-oriented institutions.”
Banks form an important link between the money market and the capital market. Their function is to create and place financial services for which there is demand in the market. The three basic functions are the exchange function, the deposit-taking and transfer function, and the lending function. The exchange function is the first step toward activities related to dealer-broker operations. In connection with exchange operations, banks increasingly develop the deposit-taking function and the ability to conduct transfers, i.e., payments on behalf of depositors. Closely linked to the deposit function is the lending function.
Short-Term Financing
Bank loans are today an important source of short-term financing for companies. When applying for a loan, a business owner submits a request explaining the motives and objectives for taking out the loan. It is important to appropriately present the company to the bank. The loan applicant must prove creditworthiness. The most common method of securing loan repayment is a bill of exchange provided by the debtor as a guarantee, or a mortgage on real estate used as collateral.
Active Banking Operations
Active banking operations are those in which the bank assumes the position of a creditor. The most significant include overdraft loans, discount loans, Lombard loans, acceptance credits, and documentary (reimbursement) credits. Passive banking operations are those in which the bank appears as a debtor. These operations are very important because they allow the bank to collect funds for its business activities. The most significant passive operations include deposit operations, rediscount and relombard operations, the issuance of certificates of deposit and short-term notes, as well as the issuance of the bank’s own shares and bonds.
Other Banking Operations
Neutral banking operations are those in which the bank has neither the position of creditor nor debtor, but merely acts as an intermediary. Such intermediary services are performed for a fee. These include the execution of the state budget, maintaining public records and statistics, and other intermediary activities.
Proprietary banking operations are those conducted by the bank in its own name and for its own account. In such activities, the bank behaves as an independent entrepreneur. The most common proprietary operations include founding and issuance activities, securities trading, and money creation activities.
History of global banking
Financial Services
In addition to all the aforementioned banking services, a bank may provide other financial services if it obtains approval from the competent central bank. These services include issuing guarantees and other forms of security; factoring; financial leasing; lending (including consumer loans, mortgage loans, and financing commercial transactions); trading on its own behalf and for its own account or on behalf of clients; conducting domestic and international payment operations in accordance with special laws; collecting, preparing, analyzing, and forwarding information on the creditworthiness of legal and natural persons engaged in independent activities; mediation and representation in the sale of insurance policies in accordance with insurance law; issuing and managing payment instruments; renting safe deposit boxes; mediation in concluding financial transactions; services related to securities (in accordance with securities legislation); managing pension or investment funds; and advising on capital structure, business strategy, and related issues.
Risks
Banks are extremely important financial institutions that shape financial and economic conditions at both national and international levels. Two financial crises—the late 1920s and the late 2000s—shook the world. The greatest risks for banks are liquidity risk, credit risk, and interest rate risk. Money drives the world, and banks are at the center of monetary flows. And whoever controls banks controls a great deal.
Leading Banks
Among the top ten largest banks in the world by total assets are as many as four Chinese banks: the Industrial and Commercial Bank of China, the Agricultural Bank of China, China Construction Bank Corporation, and the Bank of China. Ranked from fifth to tenth are JPMorgan Chase & Co. (USA), Bank of America (USA), HSBC Holdings PLC (United Kingdom), BNP Paribas (France), Crédit Agricole (France), and Mitsubishi UFJ Financial Group (Japan).
These largest global banks demonstrate the power and influence of the countries from which they originate. It is well known that China, the United States, France, the United Kingdom, and Japan are global political and economic powers. They possess the financial power of money—and money is the god of capitalism. Those who have money, that is, nations with strong purchasing power, achieve economic progress and prosperity, while nations without money struggle to meet the basic living needs of their populations.
