Text 4. Economic functions of banks

 

The economic functions of banks include:

 

1. issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customer's order. These claims on banks can act as money because they are negotiable and/or repayable on demand, and hence valued at par and effectively transferable by mere delivery in the case of banknotes, or by drawing a cheque, delivering it to the payee to bank or cash.

 

2. netting and settlement of payments -- banks act both as collection agent and paying agents for customers, and participate in inter-bank clearing and settlement systems to collect, present, be presented with, and pay payment instruments. This enables banks to economise on reserves held for settlement of payments, since inward and outward payments offset each other. It also enables payment flows between geographical areas to offset, reducing the cost of settling payments between geographical areas.

 

3. credit intermediation -- banks borrow and lend back-to-back on their own account as middle men

 

4. credit quality improvement -- banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from diversification of the bank's assets and the bank's own capital which provides a buffer to absorb losses without defaulting on its own obligations. However, since banknotes and deposits are generally unsecured, if the bank gets into difficulty and pledges assets as security to try to get the funding it needs to continue to operate, this puts the note holders and depositors in an economically subordinated position.

5. maturity transformation -- banks borrow more on demand debt and short term debt, but provide more long term loans. In other words; banks borrow short and lend long. Bank can do this because they can aggregate issues (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemptions of banknotes), maintain reserves of cash, invest in marketable securities that can be readily

 

converted to cash if needed, and raise replacement funding as needed from various sources (e.g. wholesale cash markets and securities markets) because they have a high and more well known credit quality than most other borrowers.

 

Text 5. Law of banking

 

Banking law is based on a contractual analysis of the relationship between the bank and the customer. The definition of bank is given above, and the definition of customer is any person for whom the bank agrees to conduct an account.

 

The law implies rights and obligations into this relationship as follows:

 

1. The bank account balance is the financial position between the bank and the customer, when the account is in credit, the bank owes the balance to the customer, when the account is overdrawn, the customer owes the balance to the bank.

 

2. The bank engages to pay the customer's cheques up to the amount standing to the credit of the customer's account, plus any agreed overdraft limit.

 

3. The bank may not pay from the customer's account without a mandate from the customer, e.g. a cheque drawn by the customer.

 

4. The bank engages to promptly collect the cheques deposited to the customer's account as the customer's agent, and to credit the proceeds to the customer's account.

 

5. The bank has a right to combine the customer's accounts, since each account is just an aspect of the same credit relationship.

 

6. The bank has a lien on cheques deposited to the customer's account, to the extent that the customer is indebted to the bank.

 

7. The bank must not disclose the details of the transactions going through the customer's account unless the customer consents, there is a public duty to disclose, the bank's interests require it, or under compulsion of law.

 

8. The bank must not close a customer's account without reasonable notice to the customer, because cheques are outstanding in the ordinary course of business for several days.

These implied contractual terms may be modified by express agreement between the customer and the bank. The statutes and regulations in force in the jurisdiction

 

 

may also modify the above terms and/or create new rights, obligations or limitations relevant to the bank-customer relationship.