Tweet

Banks

Written by: David Weusten

Article Overview: What is a Bank, how did they come about, what makes them tick?

Banks

With the introduction of money, mainly in the form of gold and silver shapes (early coins), it was not long before people started accumulating more than they could carry around with them. The problem then became one of keeping money safe from thieves when stored.

 Banks began as a safe place to keep money

Traditional banking functions such as safeguarding deposits, lending, guaranteeing loans, and exchanging money, can be traced to the early days of recorded history. In medieval times the Knights Templar, an international military and religious order, conducted banking by not only storing valuables and granting loans but they also arranged for the transfer of funds from one country to another.

The great banking families of the Renaissance, such as the Medici in Florence, were involved in lending money and financing international trade. The first modern banks were established in the 17th century, notably the Riksbank in Sweden (1656) and the Bank of England (1694).

 Banks lending money started in the 17th century

History records that in the 17th century goldsmiths in England laid down the foundation of modern banking. They stored gold for safekeeping, and promised to return the gold to the owners on demand. The goldsmiths soon discovered that the amount of gold actually removed by the owners was only a fraction of the total stored. They realized that they could lend out some of this gold to others on a short-term basis, obtaining a promissory notes (loan agreements) for principal and interest (their profit) from those that borrowed the gold. They knew the expected demand on their gold deposits and made sure they only lent a specific proportion of the gold they held in safe keeping (this is known as liquidity management).

 Banks have liquidity ratios they have to abide by.

Today the banks still use ratios to determine what proportion of their assets they can lend, and central banks around the world often dictate these ratios.

 Banks cannot create money.

In time, paper certificates, redeemable in gold coin, were circulated instead of gold. Ultimately, the total value of these banknotes in circulation exceeded the value of the gold held to meet any demand. Consequently governments soon removed the promise of exchange for gold, as they could not satisfy their obligations. This was the forerunner of inflation and when governments continued to print paper money to satisfy demand they introduced hyperinflation to their economies. Germany had this problem just after World War One where the absurd situation occurred where their people had to wheelbarrow their paper money to the baker to buy a loaf of bread.

 Inflation erodes the value of money

It is just as important now for the governments, via their central banks, to preserve the value of their money and that is why The Governor of The Reserve Bank of New Zealand has one of his major goals keeping inflation between 1 & 3 % pa.

So why would you use a bank today?

The most obvious answer to the question above is based on the origins of banking itself - keeping your money safe. Keeping your money under the mattress or in a tin buried in the garden are not smart options these days. With the advent of computers and the Internet, convenience is also a major factor now. The major negative about using a bank today is its fees. With the banks’ lending margins under attack by competition they can no longer make an acceptable return on the money they have on deposit and lend out, so they have introduced fees to compensate. Building Societies and Money Clubs should be explored as reasonable alternatives to banks.

 Banks keep your money safe and make it easy to access.

Generally students and Superannuitants are not charged fees. You should shop around for a bank that suits you.

How does the bank make its money?

A bank makes its money from a vast array of products and services today, but the two main ones still are net interest income and fees for processing.

All the money the bank has deposited with it has an average cost to the bank. This average comes from free money, referred to by the banks as CANBI, Current Accounts Not Bearing Interest (the banks love this money), to term deposits/investments - this money is their most expensive. The banks then lend money out in mortgages, business loans, credit cards etc at a much higher rate and this too, has an average return, the difference between their average cost and their average return is their margin, their profit. The banks like to achieve a margin better than 2 %

As an example, let’s see what happens when I borrow $1,000 from you for a year at a rate of 4 % and then lend it to your friend for a year at 10%.

At the end of the year I receive from your friend $1,100 and pay you $1,040, I make on the deal $60. This is my margin, my profit.

 Banks make the majority of their income from interest earned and fees charged.

The other major income generating area for the banks is its fees and I believe we are all very familiar with seeing this on our bank statements. It is a commonly held view that the banks under-charge on the paper items they have to process but over-charge on the electronic transactions and that more than covers their losses on the paper items.

If you are under 18 you will have to have a parent act as guarantor for a credit card. A word of warning: it is very easy to loose track of your spending if you use a credit card.


You have to be over 18 (or married), to borrow money in your own name, as lenders have no legal recourse to recover debt provided to a minor unless it was for basic living essentials.

 If you are under 18 you will find it very hard to borrow money.

Related Articles
  SMEs - SMEs and South African banks
  9.3.4 Commercial banks: Support for Growth-oriented Women Entrepreneurs in Tanzania, 2005
  SME's - a link between funding and a compliance model
  In 2010, 157 banks were closed, a pace of about 3.0 banks per week
  Having the Soundest Banks is for Weenies

Article Tags:



Related Forum Posts
Raising Capital for an Invention - There have been alot of great ideas and concepts already discussed here but I will add that love money is a great way to get the ball started. Family and friends that believe in you and your concept can asked and should be asked first. Banks and other lenders are always more eager to give you more - but getting the start up investment proves to be the most difficult. Remember ACRES of Diamonds and look in your own backyard first. Jude
Re: Invest in Real Estate or Stocks? - I would say real estate. I've recently attended a real estate buyer's workshop (which are available in many many cities!- Look in Craigslist or major real estate company events) because my partner and I are thinking of investing in a income property. I am not so sure about the U.S now, but in Canada the value of real estate is rising- depending on locations of course. On top of that, Canadian Banks are offering excellent interest rates. With the way the economy has been, one can say that trust in stocks has diminished a lot..
re: restaurant start-up - I'm not sure about government grants for restaurants, but my recommendation would be to approach a lender that offers loans under the Canadian Small Business Financing Loan program where the government will guarantee 85% of the loan. You can borrow up to $250,000 to finance equipment and renovations under this program. Restaurants are very risky business, however some of the Chartered Banks will look at restaurants if there is enough of an initial equity investment and you have a solid business plan (experienced management team, good concept and strategic location).
Best banks for business loans? - Just as there are "chain banks" -- like Suntrust, where I bank here in VA, and which has at leat five banks here in the Tidewater area alone -- there are "stand alone banks." (Don't know if that's the proper technical term!) Banks that are small and have only one location or two at the most in any big city. "Local" banks rather than "national" banks, I guess. I would trust a national bank more than a local bank... I'd assume the smaller banks would be able to go bankrupt easier. (Although considering what has happened to Bear Stearns, who knows where the "little guy" can put there money and have it be safe!)
Re: Raising Capital for an Invention - [quote="TheRainmaker":1226ijtz]There have been alot of great ideas and concepts already discussed here but I will add that love money is a great way to get the ball started. Family and friends that believe in you and your concept can asked and should be asked first. Banks and other lenders are always more eager to give you more - but getting the start up investment proves to be the most difficult. Remember ACRES of Diamonds and look in your own backyard first. Jude[/quote:1226ijtz] Hi Jude, When you're dealing with angel investors in the form of family and friends, what kind of interest rates do you offer them or are their contributions just considered to be donations (or at least interest free loans)?


Share this article with your friends. Fund someone's dream.

Leave a comment below or share on the left and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

Tweet

Newsletter

Get advice & tips from famous business
owners, new articles by entrepreneur
experts, my latest website updates, &
special sneak peaks at what's to come!

Name:
Email:

Popular Articles

African Technology Development

Four Reasons Why Entrepreneurs Should Blog

10 Steps to Excelling at Franchise Sales

Suggestions

Email us your ideas on how to make our
website more valuable! Thank you Sharon
from Toronto Salsa Lessons / Classes for
your suggestions to make the newsletter
look like the website and profile younger
entrepreneurs like Jennifer Lopez.