Banking

Bank is a financial intermediary. It is a deposit-taking institution who acts as a repository for money deposited by other economic agents. Each country has a state owned Central Bank to regulate the banking system.

Commercial Banks 

Commercial Banks accept deposits of money for safekeeping and provide them with a payment transmission service (cheques), together with saving and loan facilities. 

Functions of Commercial Banks 

1. Accepting Deposits 

Bank deposits are of two types. 

a) Sight deposits/ Demand deposits/ Current Account deposits 

·         It is withdrawable on demand 

·         It is used to finance day-to-day transactions 

·         It can be used to make regular payments 

·         Most banks now pay interest on outstanding current account balance 

b) Time deposits/ Fixed deposits/ Deposit Accounts 

·         It is not withdrawable on demand 

·         It requires notice of withdrawal 

·         It is usually used to finance irregular one-off payments 

·         It gets interest in return 

·         It is deposited for a fixed period of time 

·         It provides the bank with a more stable financial base 

2. Making Payments 

Current Account holders have access to the following payment making services. 

·         Cheque System :

·         Standing Orders: It is an instruction given to the bank to make regular payments of fixed amounts. For example; rent. 

·         Direct Debits: It is an instruction given to the bank to make regular payments but varying amounts. Electricity, Gas, Telephone bills are examples. 

·         Bank Giro Credit: It enables to use only one cheque to pay several bills. 

·         Credit Cards: It helps the cardholders to buy goods and services from those shops who have joined the scheme. 

·         Cash Dispensers / ATM card: It enables the cardholder to get cash from the machine set outside walls of certain banks. It provides customers with 24 hours service in supplying cash. Each customer is given a secret code number and a plastic card which can be used to obtain cash up to an agreed limit. 

·         Travelers Cheque and Foreign Currency: Those traveling abroad and households and firms making payments to other countries can use travelers cheque. 

3. Advancing Loans 

Lending money is the most profitable activity of commercial banks. Interest charged on money lent is the source of their income. 

a) Bank Loans 

• Commercial banks provide short-term and long-term loans 
• It is not necessary to be an accountholder 
• Borrowers pay interest on the amount borrowed 

b) Bank Overdrafts 

• It is provided only to current accountholders 
• The accountholder is entitled to overdraw an agreed amount 
• Interest is charged only on the amount overdrawn 

4. Other Services 

Commercial Banks also provide the following services; 

• Advice on investment 
• Acting as Executors of will 
• Insurance Service 
• Unit Trust investment 
• Share purchase and sales etc.

Central Bank 

Maldives Monetary Authority (MMA) - The Central Bank

Each country has a central bank. It is the leading bank generally responsible for overseeing the banking system acting as a clearing banker for the commercial banks and for implementing monetary policy. In addition, many central banks are responsible for handling the government’s budgetary accounts and for managing the country’s external monetary affairs, in particular the exchange rate. 

Functions of Central Bank 

1. It is the government’s bank 

It receives government’s income from taxation and makes necessary payments on behalf of the government. 

2. It is the banker’s bank 

Commercial banks keep accounts at the central bank and use them to settle debts between themselves. 

3. It manages the national economy 

It influences the rate of interest and the amount of bank lending to achieve the objectives of the government. 

4. It is the sole note issuing authority 

In the UK Bank of England issues notes and its satellite Royal Mint issues coins. 

5. It is the lender of last resort 

It helps the commercial banks when there is a shortage in the banking system. 

6. It holds the official stocks of foreign currency and the gold reserves. 

Money Supply 

Money supply refers to the amount of money in circulation in an economy. The government tries to control the money supply for several reasons. The size of money supply is an important determinant of the level of spending in the economy and its control is a particular concern of monetary policy. An increase in money supply raises consumer spending and hence inflation. A fall in money supply reduces investment and hence economic growth. Therefore, the central bank has to adopt various policies to eliminate the drawbacks. 

1. Changes in the Bank Rate 

Bank rate is the rate of interest charged by the central bank on its loans and advances given to the commercial banks. A rise in bank rate reduces lending power of commercial banks and so does money supply and vice versa. 

2. Changes in the Rate of Interest 

Rate of interest is the cost of borrowing. Any changes in the rate of interest will influence consumer borrowing which in turn affect consumer spending. A rise in the rate of interest makes borrowing expensive. It reduces borrowing and hence money supply. On the other hand, a fall in the rate of interest makes borrowing cheaper. It raises borrowing and hence money supply. 

3. Changes in the Cash Reserve Ratio 

Cash reserve ratio is the proportion of commercial bank’s total assets that it keeps in the form of highly liquid assets to meet the day-to-day currency withdrawals by its customers and other financial commitments. The central bank can influence the cash reserve ratio of commercial banks to control the monetary base of the economy. 

4. Open Market Operations 

It refers to sale or purchase of government treasury bills and bonds as a means of controlling the money supply. Selling securities will reduce money in circulation. Buying securities from the general public will increase money in circulation. 

5. Special Deposits 

The central bank has the power to order commercial banks to make payments into a special account at the central bank. Payments into these special deposits reduce the commercial banks’ supply of liquid assets. It reduces their ability to lend and create bank deposits. Release of these special deposits increase commercial banks’ cash reserves. 

6. Making Directives 

The central bank also has the right to issue instructions to the commercial banks regarding their lending activities. It can request them to restrict certain types of lending when necessary.