Business of Banking (Volumul I)

FOREWORD
The book The business of banking is addressing the students of the Economic Faculties, especially to those having a foreign affairs profile, focusing on the banking field issues. At the same time, the book intends to be a support for the future economists in the banking field, as well as for the bankers, the foundation upon which they can expand their technical knowledge of the Romanian banking system; money services; foreign exchange operations; international trade; payment methods and means of payment or settlement; lending, and risks. It is underlined the fact that the book is a very important work, especially for the beginners, for those which are studying for the first time the subject explained in the book. Various people must be thanked for the help given: my students and my sponsor the Commercial Bank of Greece.
Ligia GeorgescuGolooiu March 2002
Presentation The aim of Business of Banking is to equip the students of the Economic Faculties with the ability to take an active part in banking activities in English. The course is intended to be used by students at intermediate to advanced economic levels and is planed to get them actively understanding of economic and banking issues, not only during the classroom. At the same time, Business of Banking is addressing not only the Romanian students, but also the foreign students who are studying in Romania and are interested in expanding their technical knowledge of the banking system. The book consists of a variety of materials and is organized around seventeen chapters, divided into two volumes. The first volume ranks from The Banking System in Romania and England to Risk management and the second volume ranks from the exchange rates to Guarantees or Bonds. These seventeen are known to be frequently used by economists and bankers in the banking field. The material in each chapter contains a definition, descriptive passages or extracts about the topic. This provides the student with some of the structural items and vocabulary used when talking about the topic. Finally, the readers will be acquired the ability to argue, to discuss, to hear and say things they have not heard before, and to be aware of what reaction is hoping to provoke. In short they get a flexible ability to communicate (not only in Romanian, but in English too) in the give-and-take situation of real conversation on economic, trade or banking issues. For this reason we appreciate that the book represents a real support for all those who are on their way to become economists or bankers, as well as for people who intend to start a business in this period of transition.
Professor Gabriela Anghelache PhD in Finance Chief of Money Department
The Banking System in Romania
THE BANKING SYSTEM IN ROMANIA
Objectives: After studying this chapter you should understand: 1.1 The history of the Romanian banking system - brief presentation 1.2 The banking system in Romania after 1989 1.3 The National Bank of Romania and its role in the banking system 1.4 Banks a main part of the Romania banking system 1.5 The supervision and control of the National Bank of Romania 1.6 The balance sheet of the National Bank of Romania and of a bank, Romanian legal entity 1.7 Recent developments and perspectives
1.1 The history of the Romanian banking system brief presentation The first modern commercial bank was established in the Romanian Principalities in 1865 under the name of The Bank of Romania. The bank was organized as a limited joint-stock company, with subscribed capital worth FF 25,000,000. The Bank of Romania was initially set up as an issuing and commercial bank by the English and French investors who governed the Banque Imperial Ottomane. Four years later, the Romanian Government revoked the Bank of Romanias monopoly of issue. Accordingly, this institution operated further as a private commercial bank until its liquidation in 1948 by the communist regime. The establishment of a modern-type banking system, designed to replace money lenders and trade houses that had developed healthily before the mid of the 19th century, was a slow process until the setting up of the National Bank of Romania, on the 17th of April 1880. During 1866-1880, there were established only three credit institutions: the Rural Credit Bank (1873), the Urban Credit Bank (1874), and the Commercial Bank Marmorosch Blank&Co (1874). The National Bank of Romania was established at the initiative of the Liberal Party in order to grant credits in high demand after the Independence War (1877), and providing financial stability for the country. The National Bank of Romania was designed not only to play the role of state financing and note issuing, but also to perform purely commercial banking functions. In compliance with the provisions of the law governing its establishment, the new banking institution was a joint-stock company, with the Romanian government holding 1/3 of the capital stock (shareholders holding the remainder). These provisions precluded foreign shareholders from sharing the National Bank of Romanias capital, closely following the principle of domestic control over the national economy required by the liberals. In 1901, The National Bank of Romania became a private institution. Under the Liberal Partys control, the National Bank of Romania played a significant part in the foundation of the Romanian modern type banking system and contributed to the strengthening of the Romanian bourgeoisie economic position. The economic progress that accompanied the consolidation of the Romanian state and the support provided by the National Bank of Romania accelerated the establishment of private commercial banks, especially during the period that preceded the outbreak of World War I. The number of commercial
banks increased to 215 in 1914, from 3 banks existing in 1880. If the setting up of the National Bank of Romania and long-term credit institutions were done only with domestic capital, in turn, foreign capital would be involved substantially in the creation of the new private commercial banks. Accordingly, in 1914, German, Austrian, French, Belgian and English banking institutions held 40 percent of the Romanian commercial banks capital. On the eve of World War I, the Romanian banking industry was highly concentrated, being dominated by 9 leading commercial banks, called the big Romanian banks. In 1913, these banks held 70 percent of the total commercial banks resources, while 188 small and middle-sized banks held the remainder of the total resources. Taking into account the origin of the capital, the composition of the group of the big Romanian banks was the following: 4 banks with national capital (Banca Agricola, Banca Comertului from Craiova, Banca Romana de Scont, Banca Romaneasca), 4 banks with foreign capital (Banca Generala Romana, Banca de Credit Romanesc, Banca Comerciala Romana, Banca Romaniei), and one bank with foreign and domestic capital (Marmorosch Blank &Co. Bank). After World War I, under national oriented policies promoted by the Liberal governments, the weight of the foreign capital in the banking system declined in relative terms. Despite this capital trend, the banks with foreign interests maintained significant positions in the banking system and were able to better identify profitable investments than their Romanian-controlled competitors. During 1931-1932, the banking sector felt the repercussions of the economic crisis due to its close links with the industry. Banks supervision was almost nonexistent. This state of affairs contributed to the collapse of some large banks, but generally the banks with foreign interests withstood the shocks. In order to strengthen the banking system, the Romanian Parliament passed the Law on the organization and regulation of the banking commerce, on May 8, 1934. Under this law, The National Bank of Romania was deeply involved in drafting measures for recovering the banking system by liquidating non-viable credit institutions and merging institutions weakened by the crisis. Consequently, the number of banks was diminished from 893 in 1933, to 523 in 1937 and 246 in 1944.
After 1934, the state intervention in regulating the banking sector forced the foreign-controlled banks to comply with imposed requirements and to apply a policy in line with Romanias general interests. Soon, after the communists took the power in Romania according to the Decree Law no. 197/1948, all the Romanian and foreign-controlled banks were liquidated, except for the National Bank of Romania, the National Company of Industrial Credit and the Savings Bank. The 1934 banking law being abrogated, the remaining banks continued their activity under the provisions of the Commercial Code and their specific laws. In the years that followed, the Romanian banking system was organized as a mono-bank system, typical to a centralised economy. It is noteworthy that in the 70s, during a period of economic liberalization two foreign banks were allowed to establish branches in Romania: Manufacturers Hanover Trust (the branch being now part of the Chase Manhattan Bank network), and Societe Generale. 1.2 The banking system in Romania after 1989 The issuing of the Law on banking activities (33/1991) and the Law concerning the Statute of the National Bank of Romania (34/1991) represented the beginning of the organization of the banking system in accordance with the market economy principles. The banking system structures and functions were different during the former system. So, the National Bank, the agent of the State, had the functions of a central bank and of a commercial bank at the same time. There were three banks that were specialized in different fields of activity: Banca de Investitii which granted credits for the investment projects, Banca pentru Agricultura si Industrie Alimentara which granted credits for the agricultural activities, and Banca Romana de Comert Exterior which was specialized in foreign trade operations. The single institution to receive the savings of the population was Casa de Economii si Consemnatiuni. During that system, there were no financial markets and no competition between banking institutions, as the Romanian legal tender was not convertible and the interest rate had only a formal role.
The new banking system started its activity on December 1st, 1990. Its structure has been organized in two tier levels: the National Bank of Romania as the Central Bank of the state on one side, and the commercial banks on the other side. In accordance with the provisions of its Law, the National Bank of Romania has become a real central bank. It formulates and conducts monetary and credit policy within the framework of the countrys economic and financial policies, with the goal of preserving the stability of the national currency. The former commercial banks have changed themselves and have become real commercial banks for the market economy. In 1990, the former commercial banks have been established as follows: Banca Comerciala Romana SA, Banca Romana de Comert Exterior SA, Banca Agricola SA, Banca Romana pentru Dezvoltare SA and many other new commercial banks have also been established, such as: State capital: Banc Post SA; Private capital: Mind Bank SA.
Until December 31st, 20001, the National Bank of Romania has authorized 33 banks, Romanian legal entities, to render banking services in the national currency (Lei), as well as in foreign currency, and 8 branches of the foreign banks (see Annex no. 1). The structure of the capital of banks operating in Romania at the end of the year 2000 was the following:
Source: the National Bank of Romania Annual Report per 2000
Banks operating in Romania, by the type of the capital
Number I. Romanian banks, of which: a) fully or majority state-owned capital, out of which: - fully state-owned capital - majority stateowned capital b) fully or majority private capital, out of which: - fully or majority domestic capital - fully or majority foreign capital II. Foreign bank branches Total (I+II)
1994 1995 20 24
1996 31
1997 33
1998 36
1999 34
2000 33
1 6 13 8 5 7 27
1 6 17 9 8 7 31
1 6 24 14 10 9 40
1 6 26 13 13 10 43
1 6 29 13 16 9 45
1 3 30 11 19 7 41
1 3 29 8 21 8 41
Source: National Bank of Romania 1.3 The National Bank of Romania and its Role in the Banking System Generally, a central bank acts as a state institution in order to establish and co-ordinate the monetary and credit policy of the economy. It has an important role in maintaining the stability of the national currency/legal tender.
The main functions2 of a central bank may be the following: Establishing and implementing the monetary and credit policy; Issuing money; Monitoring of the foreign exchange rates; Managing the foreign exchange reserves; Supervising the financial and banking institutions; Bankers bank; Lender of last resort; Acting as the states agent and keeping the evidence of the States Treasury account; Performing analyses of the economic and monetary conditions. The Romanian transition to the market economy had a strong impact on the organization of The National Bank of Romania, its functions and role as a central bank. The National Bank of Romania is the only institution authorized to issue banknotes and coins throughout the country. Under its new law3, it establishes, implements, and is responsible for the monetary, foreign exchange, credit, and payments policy, as well as the banking licensing and prudential supervision in the framework of the general policy of the State; for this it pursues the normal operation of the banking system and the participation in the promotion of the financial system to market economy. The National Bank of Romania uses procedures and instruments specific to the monetary market, lending to the banking companies, assures liquidity to the banking system, and at the same time, it is responsible for licensing and supervising all entities operating as bank entities in Romania. Under the provisions of the law concerning the Statute of the National Bank of Romania, it formulates and conducts the credit policy within the
2 3
Sometimes these responsibilities are shared with other governmental bodies. Law no.101/1998 concerning the Statute of the National Bank of Romania, issued in Monitorul Oficial al Romaniei, Part I, no. 203//June 1998
framework of the countrys economic and financial policy with the goal of preserving the stability of the national currency. The main functions of the National Bank of Romania are in the monetary and credit field, banking supervision, foreign exchange operations, operations with the state treasury, foreign exchange control. The National Bank of Romania alone has the right to determine the nominal value, size, weight, design and other technical characteristics of banknotes and coins. It elaborates the banknote and coin issue program so that the countrys requirements for cash are met strictly according to the real needs of money circulation. The National Bank of Romania distributes the money issue and manages the banknotes and cash reserves. It may decide to cancel or withdraw any banknotes or coins it issued, and to replace them with others of a different kind. The National Bank of Romania uses procedures and instruments specific to the monetary market, lending to banks and controlling their liquidity through minimum compulsory reserves operations. The National Bank of Romania may discount, acquire, accept as collateral or sell bonds, securities or other claims to the state, banks, or other legal entities. The National Bank of Romania establishes the minimum compulsory reserves that banks must keep in accounts opened with the National Bank of Romania. For the minimum compulsory reserves, the National Bank of Romania will grant interests at least as high as the level of the average interest rate granted for sight deposits by the banks. As a part of its monetary, foreign exchange, lending and payments policies, the National Bank of Romania may lend to banks on up to 90 days term against securities that include: Government bonds which are part of public issues redeemable within no more than a year from the time of their acquisition by the National Bank of Romania;
Bills of exchange or promissory notes drawn or endorsed for commercial, industrial or agricultural purposes by eligible legal entities in accordance with the rules of the National Bank of Romania; Warrants or warehouse receipts issued for fungible goods or other goods dully insured against loss, damage or destruction; Deposits with the National Bank of Romania or other legal entity acceptable to the National Bank of Romania consisting of any assets, which it may sell, buy or trade.
The National Bank of Romania elaborates and implements the foreign exchange policy, establishes and monitors the enforcement of the foreign exchange regime on the Romanian territory. Managing the foreign exchange regime, the National Bank of Romania is responsible for: Issuing rules and regulations for gold and foreign exchange operations to protect the national currency; Setting up the balance of payments and foreign assets and liabilities position of the country; Setting up and publishing the exchange rates at which the National Bank of Romania and other legal persons are authorized to conduct gold and other foreign exchange operations; Licensing and working licenses as well as regulating and supervising the legal persons who are authorized to conduct foreign exchange transactions; Setting up the ceiling value of gold and foreign exchange assets which the authorized legal persons can hold in deposits; Maintaining and managing the states international foreign reserves; Setting up limits on the net foreign position of the banking companies.
The National Bank of Romania sets and holds international reserves. These reserves are made up of the following elements: Gold holdings at the Treasury or in deposits abroad; Foreign assets under the form of banknote and coins or reserves in accounts opened with foreign banks and other foreign financial
institutions which are denominated in such currencies and held in such countries as the National Bank of Romania may decide; Any other internationally recognized reserve assets, including the right to buy from the International Monetary Fund within the reserve instalment, and special drawing rights holdings; Bills of exchange, cheques, promissory notes and other securities, negotiable or not, issued or guaranteed by non-resident legal persons classified in the first categories by internationally recognized rating agencies, denominated and payable in foreign exchange at such places accepted by The National Bank of Romania; Treasury notes, bonds and other government securities issued or guaranteed by foreign governments or intergovernmental financial institutions, which are negotiable or not, and denominated and payable in foreign exchange at places accepted by The National Bank of Romania.
The National Bank of Romania has exclusive competence for granting banks the license and it is responsible for the prudential supervision of the banks. In order to ensure a viable and operational banking system, the National Bank of Romania has been empowered to: Issue regulations, take measures to enforce their observance and rule lawful penalties for non-compliance; Check and verify on the basis of reports and field inspections the books, accounts and any other documents.
The National Bank of Romania takes part on behalf of the State in the external issue. It may negotiate and conclude agreements concerning shortterm loans and swap operations with central banks and international monetary institutions on the conditions those loans and operations are repaid within the period of one year and are reported in the annual report of National Bank of Romania. The National Bank of Romania is vested by the Parliament with the authority to participate in and become a member of international organizations concerned with financial, banking and monetary matters.
Under the provisions of its law, the National Bank of Romania is entitled to request all financial and credit institutions documents and information that may be required in connection with conducting its functions. The National Bank of Romania may undertake studies and analysis on currency, credit and transactions of the banking system for its own needs and those of public authorities. Once the studies and analyses are made, the National Bank of Romania can establish the monetary survey in accordance with the credits and monetary resources in the economy. The National Bank of Romania together with the Ministry of Finance pursues to keep the stock of international reserves at a level assessed as appropriate for the foreign transactions of the State. The National Bank of Romania is authorized to perform the following operations: Purchase, sell and otherwise trade in gold and other precious metals ingots and coins; Purchase, sell and perform other foreign exchange transactions; Purchase, sell and otherwise trade in Treasury notes, bonds and other securities issued or guaranteed by foreign governments or intergovernmental financial organizations; Purchase, sell and otherwise trade in securities issued or guaranteed by central banks, international financial institutions, banking and nonbanking companies; Open and keep accounts with central banks and monetary authorities, banking companies and international financial institutions; Open and keep accounts and make counterpart operations for international financial institutions, foreign central banks and monetary authorities, financial and banking companies, international financial organizations abroad and for foreign governments and their agencies.
Organization of the National Bank of Romania A Board of Directors heads the National Bank of Romania. The governor exercises the executive management of the National Bank of Romania, together with the prime-vice governor and two vice governors. The Board of Directors consists of nine members: The Governor of the National Bank of Romania as the president;
The prime vice Governor as vice president; Seven members out of which two are also vice Governors of the National Bank of Romania and five are not employed by the National Bank of Romania.
The Board of Directors of the National Bank of Romania decides, according to the law, on: Monetary, foreign exchange, credit and payments policies and monitors their enforcement; Measures in the field of licensing and prudential supervision of the banks licensed by it; Internal organization, staff salaries and profits, etc.
The members of the Board of Directors are appointed by the Parliament on the recommendation of the permanent specialty commissions of the two Chambers of the Parliament. The auditing commission comprises five auditors, out of which one is the chairman. The auditors committee verifies the compliance with the legal provisions concerning valuation of the National Bank of Romanias assets, the elaboration of the balance sheet and the profit and loss account, according to the books, vault cash, and securities owned or received in bail, or in custody, as well as of the revenue and expenditure budget. Annually, the auditors committee prepares a report on the balance sheet and profit and loss account of the National Bank of Romania. The National Bank of Romanias own capital is ROL 100 billion and belongs entirely to the State. The banks own capital may be increased using part of the annual net profit up to the equivalent of five per cent of the aggregate monetary liabilities in the balance sheet as at the end of every fiscal year. The ROL 100 billion own capital is made up of the ROL 5 billion own capital as of December 31, 1996 plus ROL 95 billion allocated from the reserve fund of the National Bank of Romania.
The reserve fund of the National Bank of Romania is built up within the limit of a 20 per cent share of gross profit until it equals the own capital, when the share drops to 10 per cent until the reserve fund is twice the National Bank of Romanias own capital at which point the share is set at 5 per cent. The National Bank of Romanias internal organization has been changed from one year to another according to the market economy conditions. The National Bank of Romania internal organization on the 31st of December 2000 is presented in the chart (see Annex no.2). 1.4 Banks - A Main Part of the Romanian Banking System Under the provisions of the Romanian Banking Law, with subsequent amendments, a bank represents a credit institution4 authorized to perform mainly the activity of collecting funds from both legal and natural persons through deposits or negotiable instruments payable on demand or on maturity as well as that of granting credits. The European Union countries utilize the concept credit institution in order to define the above activity. The credit institution represents an undertaking whose business is to receive deposits or other repayable funds from public and to grant credits for its own account5. No entity is allowed to perform any banking business within the Romanian territory, without the National Bank of Romanias previous authorization. Banks, Romanian legal entities, as well as branches of foreign banks may perform, within the limit of the authorization granted, the following operations6:
4
Open accounts in ROL and in foreign currencies;
Including: banks (Romanian legal entities), branches of foreign institutions and credit cooperatives. Directive 2000/12/EC of the European Parliament and of the Council of 20 March 2000 relating to the taking up and pursuit of the business of credit institutions, published in the Official Journal L 126, 26/05/2000; Law no.58/1998 - Banking Law issued in Monitorul Oficial al Romaniei, Part I, no. 121/1998.
Receive demand, time and notice deposits; Loan agreements (grant short, medium and long term loans and credit lines in ROL and in foreign currency), factoring operations and discounting of trade bills, including forfeiting; Carry out banking operations in Romania and abroad; Issuance and management of the instruments of payment and credit; Payments and settlements; Financial leasing; Funds transfers; Issuing guarantees and assuming commitments; Issue and operate credit cards; Buy and sell government securities; Transactions on their behalf or in their clients account with: negotiable money instruments (cheques, bills of exchange, certificates of deposit), foreign currencies, financial derivatives, precious metals, securities; Management of clients portfolios; Securities custody and management; Renting of security safe boxes; Financial and banking consulting; Electronic banking.
Banks, as Romanian legal entities, are allowed to operate only based on the authorization issued by the National Bank of Romania, in compliance with the legal provisions in force. The National Bank of Romania may withdraw the authorization granted to a Romanian bank or a subsidiary, to a subsidiary or branch of a foreign bank: upon the banks request, as a sanction, etc.
The organization and management of banks are established through their incorporation documents, according to the commercial legislation in force and in compliance with the banking law. The minimum share capital of a bank is ROL 250 billion.7 In all its official documents, the bank must identify itself clearly through a minimum of data: the company under whose name the bank is registered in the Trade Register, its share capital, the address of its headquarters premises, number and date of incorporation in the Trade Register, number and date of incorporation in the Bank Registry. Every bank must have its own operating regulations, approved by the statutory bodies through which they have to establish at least: The organizational structure of the bank; The tasks of every bank department and the relations among them; The tasks of the branches and other secondary offices of the bank; The tasks of the risk committee, of the credit committee; The competence and responsibility of the bank managers, executive managers, heads of branches other subsidiaries of the banks as well as other employees who are engaged in financial and banking operations on behalf and account of the bank; The internal audit of the bank.
The administrators of the bank may be only individuals, in a number of maximum 11. The term of their mandate cannot be more than 4 years, with the possibility of being re-elected. Each bank is a legal entity, organized as a joint stock company. The network structure of a bank may consists of the following: Headquarter; Branches; Subsidiaries;
7
The National Bank of Romanias Norms No.9/2000 regarding the minimum capital of banks and of branches of foreign banks, published in Monitorul Oficial al Romniei, Part I, No. 474/2000.
Agencies. The branches, subsidiaries and agencies are operational units of the bank, and there are in a direct connection with the customers (individuals or legal entities). The following bodies generally, manage the bank: o The General Meeting of the Shareholders it decides the general tasks concerning the banking activity; o The Board of Directors it includes: the president, the vicepresidents, and the members elected by the General Meeting of the Shareholders; o A committee nominated by the Board of Directors; it realizes the Operational Management of the bank. This committee accomplishes all the decisions of the Board. The committee is made of the president, the vice-president and members. o The headquarter president; vice-presidents and the directors of the directions/departments of the bank realize the Current Management of the bank. o The independent auditors commission. The headquarters of a bank co-ordinates the activity of the branches, subsidiaries and agencies and supervises the compliance with the banking norms, rules and laws. Some of the main departments of a bank (see Annex No.3a) may be the following: Synthesis (Co-ordination and strategy) department; Treasury department; Cash department; Methodological and control department; Foreign commercial transactions department; Foreign non-commercial department; Credit department; International department;
Capital markets department; Own Investments department; General Secretariat; Consulting department; IT department; Human Resources department; Legal department; Accounting department;
The activity of a headquarters is organized in departments, divisions, and offices. The headquarters departments have some similar attributions resulting from their co-ordination activity. Thus, the main attributions are: Elaborating the methodological norms for each department; Guiding and controlling the activity of the territorial units; Making analysis concerning the banking activity.
The Synthesis/Co-ordination department issues the credit plans and obtains the approval of the Board of directors of the bank; it distributes the resources to the branches, etc. The Treasury department ensures the resources to the banks and obtains credits from the inter-bank market, it participates in the auctions organized by the National Bank of Romania in order to obtain refinancing credits, and it elaborates drafts of issue for securities and co-ordinates their placements. The Cash department ensures and co-ordinates all the operations with cash and other values. It analyses with other departments the main trends in the cash circulation, co-operates with the National Bank of Romania in order to establish the cash flow in the economy, etc. The Foreign commercial and non-commercial transactions department ensures the processing of the documents concerning the export and the import of goods, and of rendered services to and from abroad by economic agents, institutions and other legal entities, as well as the settlement of the operations in the favour of the individual or legal entities (budgetary institutions, non-profit institutions, etc.).
The Credits department. Taking into consideration the destination, the term and the beneficiary of the loans, the loans department participates in: Establishing the size of the monetary survey and of the credit on short, medium and long term for the state and private field; Analysing the credits application that surpass the competencies of the units in the country; Establishing the loans documentation/file; Proposing the issue of the letter of guarantee; Analysing the evolution of the short, medium and long term loans; Analysing the banking indicators, etc. The International department realizes, under the legal framework and the Board of Directors decisions, the attributions in the external payments and credits field, such as: To negotiate the payments agreements drafts concluded with other countries; To contact the corresponding banks on the carrying out of the payments agreements; To administrate the foreign exchange portfolio of the bank; To negotiate the external banking credit lines; To analyse and, if the case, to modify the banking corresponding network. The branch of a bank has the organizational structure as that presented in Annex No. 3b. The operations of the banks are subject to the regulations and orders issued by the National Bank of Romania (see the list in the Annex No. 4), in order to implement the monetary, credit, foreign exchange, payment policies, banking prudence and the banking supervision policies. Banks have to organize all their operations according to the rules of a prudent and healthy banking practice and the requirements of the law. The whole share capital of a bank must be paid up in monetary form, when it is subscribed.
The National Bank of Romania establishes the minimum share capital. Banks should permanently maintain a minimum level of their share capital, in monetary form, according to the regulations of the National Bank of Romania. Banks may also increase their share capital, besides subscriptions of new contributions in monetary form, according to the current laws in force, using the following sources: Share premiums and other capital premiums; Dividends from the net profit due to the shareholders after paying the tax on dividends, according to the laws in force; Foreign reserves left from the exchange rates influences related to the appreciation of the reserves, which represent the share capital in foreign currency, etc.
Banks will distribute 20% of their gross profit to set up a reserve fund until this fund equals the share capital, then maximum 10%, until the moment when the fund reaches twice the amount of the share capital. After reaching this goal, the distribution of amounts to the reserve fund shall be done from the net profit. Banks have to distribute from their gross profit, the amounts designated to build up the general reserves for the credit risk, within the limit of 2% from the balance of granted loans. Under the provisions of the Banking Law, banks operating in Romania may not perform the following operations: Engagement in transactions with chattel and real estate assets; The acquisition of the bank s own equity or their pledging, on the account of the banks debts; Loan granting or other services rendered to clients, conditioned by the sale or purchase of the banks shares; Granting loans secured with the shares issued by the bank; Receiving deposits, securities or other valuables, when the bank stops payments;
Deposits receiving, if most of the deposits come from the banks employees.
Banks have to keep their accounting ledgers according to the provisions of the accounting laws and the regulations specific for their implementation, and they must also draw up appropriate financial statements in order to show, truly and fairly, their operations and their financial position. The National Bank of Romania establishes rules regarding bookkeeping and balance sheets, following approval by the Ministry of Finance. Banks are obliged to present to the National Bank of Romania their financial statements made up by the elements of their balance sheet, as well as other data requested by the National Bank of Romania, in the terms and in the formats established through regulations. Banks are forbidden to provide insurance, brokerage and leasing services, but they are allowed to hold shares of such companies. * * * Other institutions that co-operate with the Romanian banking system are the following: The Bank Deposit Guarantee Fund. It ensures the reimbursement of the deposits held by individuals in the case that a bank becomes insolvent. Deposits are reimbursed within a ceiling, which is periodically modified in line with the inflation rate published by the National Institute of Statistics and Economic Studies. The Bank Asset Recovery Agency. It was established in 1999, and is specialized in taking over non-performing loans and off-balance sheet items from majority state-owned banks, aiming at recouping them from the debtors. In the last 2-3 years, three state-owned banks were privatised (Banca Romana pentru Dezvoltare, Banca Postei and Banca Agricola), while Banca Comerciala Romana is now undergoing a privatisation process.
Some of the most prestigious European banks (Societe Generale, ABN AMRO, ING Bank, and HVB Bank) are already established and operate in Romania. 1.5 The Supervision and Control of the National Bank of Romania When granting loans, banks must be careful that applicants are credible in repaying them at maturity. Therefore, banks have to ask the applicants to guarantee the loans under the conditions established by their lending norms. Banks must comply with the following prudential requirements as stated in the regulations of the National Bank of Romania: The minimum level of solvency, determined as a ratio between the level of the banks own capital and the total assets and off - balance sheet items, weighted according to their risk level; Maximum exposure to a single debtor, expressed in percentage as a ratio between the total value of the maximum exposure and the level of the banks own capital; Maximum exposure aggregate, expressed in percentage as a ratio between the total value of large exposures and the level of the bank s own capital; Minimum level of liquidity determined according to the deadlines of the amounts receivable and the banks commitments; The classification of granted loans and of uncased interests related to them and the setting up of specific risk provisions; Currency position, expressed in percentage according to the level of the banks own capital; Resource management and investments of the bank; Enlargement of the branch network and other subsidiaries of the bank. The total amount of the long-term investments of a bank in securities issued by a company that is not engaged in one or more financial businesses will not exceed:
20% of the share capital of the respective companies, and 10% of the banks own capital.
The total amount of the long term investments of the bank in the securities issued by such companies will not exceed 50% of the banks own capital. The total amount of a bank s investments in securities, performed in the bank s name and account, will not exceed 100% of the banks own capital, except for investments in government securities. Any entity that intends to purchase a participation of at least 5% of a banks share capital must get the prior approval of the National Bank of Romania. The National Bank of Romania supervises the operations performed by banks, Romanian legal entities and the branches of foreign banks, on the basis of the prudential reports drawn up according the law and implemented regulations of the National Bank of Romania, as well as through on-site and off-site inspections: At the headquarters of the banks, branches and other subsidiaries in the country and abroad; At the headquarters of the branches of foreign banks and their subsidiaries. The National Bank of Romania launched a bank-restructuring program targeted at preventing systemic risk, with an immediate impact on the soundness of the banking sector. The program focused on the following issues: Solving the situation of problem banks; Improving the quality of the banks prudential supervision, materialized mainly in: The introduction of an early-warning and bank-rating system aimed at detecting the negative trends in the banking system; Improving the legal framework for the regulation of prudential conduct in the banking sector; Reorganizing the supervision activity; Increasing the exigency in sanctioning banks, and Maintaining a prudent licensing policy for the new banks; Improving the functioning of the deposit guarantee mechanism.
In 1999, the National Bank of Romania adopted a coherent program in order to reorganize and strengthen the prudential supervision by introducing an early warning and banking system (which ensures an efficient bank supervision, in line with the international standard and practices) and by improving the legal framework concerning the prudential behaviour in the banking sector. One of the main objectives of the National Bank of Romania was the further transposition of the acquis communautaire in its regulations. In this context, the Law No. 58/1998 the Banking Law is to a great extent harmonized with the provisions of the Directive No. 2000/12/EC on the establishment and operation of credit institutions. 1.6 The balance sheet of the National Bank of Romania and of a bank, Romanian legal entity The annual balance sheet of the National Bank of Romania was prepared in accordance with the provisions of: Law no.101/1998 the National Bank of Romania Act, the Accounting Law no.82/1991, with subsequent amendments and additions, the Chart of Accounts and the Methodological Norms specifying the use of the National Bank of Romanias accounts, and the guidelines of the Ministry of Finance on actions for closing the fiscal year. Since January 1st, 1999, the National Bank of Romania adopted a new Chart of Accounts and the Methodological Norms for its implementation, prepared in accordance with the provisions of the Law no. 101/1998, and with the national accounting standards. The changes that the new Chart of Accounts brought about consisted mainly in the distinct classification of monetary assets and liabilities depending on their maturity. For taxation purposes, the deductibility of certain expenses (e.g. protocol-related and social expenses) is limited by law to the share in the profits. The balance sheet of the National Bank of Romania was drawn up consistent with the accounting assumptions, such as: prudence, consistency, the going concern, the matching principle, periodicity, and non-set-off assets against liabilities.
The majority part of the total assets of the central bank is represented by the foreign assets (see Annex No. 5), such as: SDR holdings with the International Monetary Fund, monetary gold, foreign securities, foreign investments etc. The balance sheet of the National Bank of Romania shows the international reserves, which consist of foreign exchange reserves (of which: at sight, deposits, investments); gold reserves (of which: at sight, deposits), and total reserves (of which: at sight, deposits, investments). The structure of the liabilities of the National Bank of Romania is the following: currency in circulation, foreign liabilities (bonds issued and deposits taken by the National Bank of Romania), General Account of State Treasury, banks current accounts, capital funds, reserves, etc. The profit and loss account of the National Bank of Romania (see Annex No.6) consists of: revenues (operating revenues, other revenues) and expenses (operating revenues, overheads etc). The operating revenues include the following items: interest on government securities, interest on loans granted and revenues from commissions and fees for inter-bank settlements, interest on foreign exchange deposits, dividends on foreign investments and revenues from foreign exchange securities operations, interest revenue in gold and silver and exchange rate differences arising from operations with precious metals. The main operating expenses include: interest paid/due to banks and the Treasury, foreign exchange interest, commissions and fees for loans taken from the International Monetary Fund, interest for inter-bank loans and commissions in foreign exchange etc. Overheads consist of the following: provisions, salaries and wages etc. In comparison with the financial statements (the balance sheet and profit and loss account) of the National Bank of Romania, a bank, Romanian legal entity records differences in this field, as you can see in the Annexes No. 7 and 8. The balance sheet of a bank, Romanian legal entity A bank conducts its business in compliance with the regulations of the central bank regarding the classification of loans, constitution of provisions, solvency ratios, compulsory minimum reserves and foreign position. The banks assets mainly consist of: cash, current accounts and ROL and currency term deposits of individuals, and private or public enterprises, loans etc.
The banks liabilities mainly consist of: deposits (demand and term deposits) of individuals, and private or public enterprises, other borrowed funds, share capital, reserves, etc. The profit and loss account includes two big parts: incomes and expenses. Incomes include: interest income on loans, interest on interest bearing deposits, interest on trading securities, dividends, etc. Expenses include: interest for demand and term deposits, salaries, social insurance, operating expenses (amortization), advertising, etc. 1.7 Recent developments and perspectives During the previous years, The National Bank of Romania had the following objectives8: Achievement of lasting macroeconomic stabilization together with the revitalization of the financial market for an efficient allocation of the resources, transparency of information, and achievement of economic equilibrium. The National Bank of Romania considers that the well functioning of a complete market system in Romania is a condition for a lasting economic growth. The foreign exchange market liberalization by allowing all the authorized banks to be dealers in transactions and via exchange rate liberalization.
Large foreign exchange purchases by the National Bank of Romania made in order to avoid nominal appreciation of national currency led to the increase of the foreign exchange reserves: The National Bank of Romania changes its position, from a net creditor into a net debtor of the banking system, by drawing into the deposits from the banks in order to reduce the excessive liquidity, liquidity that results from the important entrance of the foreign capital on the monetary market. The capital market experienced a large increase in trading on both levels of The Stock Exchange, and of RASDAQ. The main reason for the development of the capital market was the increase of the shares
8
The National Bank of Romania Annual Report per 1998-2000
demanded from the non-resident corporate investors, bolstered also by the increasing number of listed companies. The monetary policy conducted by the National Bank of Romania aimed to ensure macroeconomic stabilization, specially the decrease of the inflationary effect of price liberalization, the restoring the central banks credibility to regain the confidence in the national currency and, to achieve the remonetization of the economy. The efficiency of the monetary policy was sustained by the following achievements: a) Release of the monetary policy from the quasi-fiscal constraints consisting of directed and preferential credits; b) Integration of the monetary policy in the macroeconomic policies: c) Achieving of a healthy currency issue based on improving of the National Bank of Romania portfolio by increasing the net foreign assets and the foreign reserves; d) Improvement in the transmission of the monetary policy measures by the liberalization and development of the financial markets, especially of the money market; e) Achieving real-positive interest rates and maintaining those levels; f) Improvement and completion of the legal framework for the regulation of the banking and central banks activity by drafting of the Banking Act, the Bank Insolvency Act, Bank Privatisation Act, and the National Bank of Romania Act. In the next years, the National Bank of Romania will focus its efforts on carrying out a stable policy and a macroeconomic stability, as well as on correlating the macroeconomic policies with measures taken in the privatisation and structural adjustment areas. The orientation of the National Bank of Romania reflects also important performance concerning: a) Guiding the monetary policy towards price stability;
b) Creation and development of financial markets; c) Carrying out the open account convertibility of the national currency; d) Increase the international reserves; e) Consolidating its formal and operational independence. Concerning the monetary policies, the program of the National Bank of Romania is a part of the economic program of the Government. This program has as major objective to reduce the inflation rate and to achieve lasting macroeconomic stability. Other objectives of the program are: To improve the quality of the banking sector by supervision and regulation; To improve the banking information and payments system, by: Modernization of the settlement and clearing system; Harmonization of the payment system operational procedures with the new banking legislation; Modernization and expansion of the services rendered by the banking information system. The National Bank of Romania will pay a special attention to the developments in the Euro-area and will monitor the consequences of starting stage III of the Economic Monetary Union. As a central bank of a country candidate for the European Union, the National Bank of Romania will strive both to carry on implementation of domestic reform and to ensure the legal, institutional and procedural harmonization with its correspondent entities in the European Union.
The National Bank of Romania supervision program for the future stipulates9: 1. Dealing with problem banks: Restructuring of the state-owned banks balance-sheet assets; Insulation and exit of banks generating disruptions on the money market. 2. Strengthening of the supervision:
9
Specific regulations in line with European standards on:

Source: The National Bank of Romania
Classification of loans and investments, and risk provisioning; Registration of executor loan agreements; Bank liquidity; Containment of credit risk; Bringing credit co-operatives under the supervisory authority of the NBR. Minimum capital requirements updated periodically as follows: ROL 150 billion as of 31 May 2001; ROL 250 billion as of 31 May 2002. Rigorousness in approving banks management; Reduction in frequency of inspections from every two years to at least one a year.
Increased rigorousness in bank licensing and supervision by: -
Enhancing prudential supervision through the introduction of earlywarning indicator system; Improved co-operation between the National Bank of Romania and: The Romanian Bankers Association; Banks executives; and Independent auditors
3. Smooth-functioning of the Bank Deposit Guarantee Fund.
At the same time, the National Bank of Romanias Governor, Mr. Mugur Isarescu, mentioned10 what are the main problems that the National Bank of Romania intends to solve in the next period of time, such as: o to prepare the strategy concerning the privatisation of Banca Comerciala Romana SA; o to integrate the credit co-operatives in the banking field and issue regulations in the appliance of the Emergency Ordinance No. 97/2000; o to harmonize the accounting regulations with the EU legislation, as well as with the international accounting standards; o To improve the early warning and banking system;
10
During the Romanian Government Meeting of January 18, 2001 source the NBR.
o To co-operate with the Justice Ministry, and with other governmental bodies in order to eliminate the frauds from the banking and financial system, the money laundering, and the corruption; o To introduce to the Romanian Government draft of the law concerning the Guarantee Fund of the legal entities deposits in banks etc. * * * As a conclusion, it should be mentioned the following: 1. In Romania, the financial system consists of: banks (Romanian legal entities and branches of foreign banks), credit co-operatives, mutual funds, credit unions, brokerage houses, insurance companies, financial investment companies, leasing companies and investment management companies. 2. The European Central Bank made a List of the Monetary Financial Institutions subject to minimum reserves in accordance with Article 3.2 of the amended Regulation of the European Central Bank of December 1st, 1998 concerning the consolidated balance sheet of the monetary financial institutions sector (ECB/1998/16)11 and with Article 2.3 of the amended Regulation of the European Central Bank of December 1st, 1998 on the application of minimum reserves (ECB/1998/15)12. The List of the Monetary Financial Institutions comprises institutions resident in the European Union, which comply fully with the Monetary Financial Institutions definition13. The objective of the List of the Monetary Financial Institutions includes facilitating the production of a comprehensive and consistent balance sheet of the money-creating sector in the euro area and ensuring that the statistical reporting population is as complete, accurate and homogeneous as possible. In addition to the national central banks of the European Union and the European Central Bank, the List of the Monetary Financial Institutions includes credit institutions,
11 12
Official Journal L356, 30.12.1998. Official Journal L356, 30.12.1998. 13 Monetary Financial Institutions comprises resident Credit institutions as defined in Community Law, and all other resident Financial Institutions whose business is to receive deposits and/or close substitutes for deposits from entities other than Monetary Financial Institutions, and, for their own account (at least in economic terms), to grant credits and/or to make investments in securities.
money market funds and other institutions fulfilling the Monetary Financial Institutions definition. 3. The International Monetary Fund has a different classification14 of the financial system. The main sectors and sub sectors are the following: Financial corporations Central bank; Other depository corporations; Other financial corporations Insurance corporations and pension fund; Other financial intermediaries Financial auxiliaries Non-financial corporations Public non-financial corporations Other non-financial corporations General government Central government State government Local government Social security funds Households Non-profit institutions serving households Central Bank In the International Monetary Funds opinion the central bank represents the national financial institution (or institutions) that exercises control over key aspects of the financial system and carries out such activities as issuing currency, managing international reserves, transacting with the International Monetary Fund, and providing credit to other depository corporations. Central banks in some countries also accept deposits from non-financial corporations or provide credit to non-financial corporations.
14
IMF Money and Financial Statistics Manual, Washington, 2000
The central bank sub-sector includes the following: Central banks, which in most countries are separately identifiable institutions that, across countries, are subject to varying degrees of government control, engage in differing sets of activities, and are designated by various names (e.g. central bank, reserve bank, national bank, or state bank); Currency boards or independent currency authorities that issue national currency that is fully backed by foreign exchange reserves; Government-affiliated agencies that are separate institutional units and primarily perform central bank activities. If an institutional unit is mainly engaged in central banking activities, the entire unit is classified in the central bank sub-sector. Many central banks regulate or supervise other depository and other financial corporations, and central bank activities in these areas are also included in the central bank sub-sector. However, units that are affiliated with the government or with other sectors and are mainly engaged in regulating or supervising financial units are classified as financial auxiliaries rather than as units in the central bank subsector. Private units that perform activities such as check clearing operations are assigned to other financial corporations sub-sectors depending on their activities, rather than to the central bank sub-sector. Other Depository Corporations The other depository corporations sub-sector consists of all resident financial corporations (except the central bank) and quasi-corporations that are mainly engaged in financial intermediation and that issue liabilities included in the national definition of broad money. Examples of the designations given to institutional units in the other depository corporations sub-sector are: Commercial banks; Merchant banks; Savings banks, savings and loan associations, building societies, and mortgage banks; Credit unions and credit co-operatives;
Rural and agricultural banks, and Travelerscheque companies that mainly engage in the financial corporation activities. Other Financial Corporations Insurance Corporations and Pension Funds This sub-sector includes resident insurance corporations and quasi-corporations and autonomous pension funds. Insurance corporations consists of incorporated mutual and other entities whose principal function is to provide life, accident, health, fire, or other forms of insurance to individual institution institutional units or groups of units. The pension funds included in this sub-sector are those that are constituted as separate from the units that have created them. They are established for purposes of providing retirement benefits for specific groups of employees. They have their own assets and liabilities, and they engage in financial transactions on their own account. These funds are organized, and directed, by individual private or government employers, or jointly by individual employers and their employees, and the employees and/or employers make regular contributions. Other Financial Intermediaries. This sub-sector of other financial intermediaries covers a diverse group of units constituting all financial corporations other than depository corporations, insurance corporations, pension funds, and financial auxiliaries. Units in the other financial intermediaries sub-sector generally raise funds by accepting long-term or specialized types of deposits and by issuing securities and equity. These intermediaries often specialize in lending to particular types of borrowers and in using specialized financial arrangements such as financial leasing, securities lending, and financial derivative operations. Finance companies are institutional units primarily engaged in the extension of credit to non-financial corporations and households. Financial leasing companies engage in financing the purchase of tangible assets. The leasing company is the legal owner of the goods, but ownership is effectively conveyed to the lessee, who incurs all benefits, costs, and risks associated with ownership of the assets.
Investment pools are institutional units that are organized financial arrangements, excluding pension funds that consolidate investor funds for the purpose of acquiring financial assets. Examples are mutual funds, investment trusts, unit trusts, and other collective investment units. Securities underwriters and dealers include individuals or firms that specialize in security market transactions by: assisting firms in issuing new securities through the underwriting and market placement of new security issues and; trading in new or outstanding securities on their own account.
Vehicle companies are financial entities created to be holders of secured assets or assets that have been removed from the balance sheets of corporations or government units as part of the restructuring of these units. Financial derivative intermediaries consists of units that engage primarily in issuing or taking positions in financial derivatives recognized as financial assets. Specialized financial intermediaries include holding corporations, companies that provide short-term financing for corporate mergers and takeovers, export/import finance firms, factors and factoring companies etc. Financial Intermediaries. The most common designations for financial corporations classified as financial auxiliaries are: Public exchanges and securities markets are organized exchanges and entities such as security depository companies, accounting and clearing offices, and other companies providing exchange-related services. Depositories and electronic clearing systems operated by financial corporations fall into this sector, too. Brokers and agents are individuals or firms that arrange, execute, or otherwise facilitate client transactions in financial assets. Included are brokers and agents handling the purchase and sale of securities or other financial contracts for clients, and financial advisory services that provide specialized services to brokers and their customers.
Foreign exchange companies comprise units that buy and sell foreign exchange in retail or wholesale markets. Financial guarantee corporations insure customers against losses to specified financial corporations or against financial loss on specific contracts. Insurance and pension auxiliaries include agents, adjusters, and salvage administrators. Other financial auxiliaries comprise all other auxiliaries not classified elsewhere.
Progress Test
1. Present a brief description of the history of the Romanian banking system. 2. When did the new Romanian banking system start its activity? 3. Describe the structure and functions of the former banking system. 4. List five banks, Romanian legal entities authorized by the National Bank of Romania to render banking services. 5. List five branches of foreign banks authorized by the National Bank of Romania to render banking services. 6. What are the banking laws, which marked the beginning of the organization of the Romanian banking system in accordance with the market economy principles? 7. How was the new banking system organized after December 1990?
8. Enumerate the main functions of a central bank. 9. List the main functions of the National Bank of Romania. 10. What are the National Bank of Romanias responsibilities in the foreign exchange field? 11. List the elements of the international reserves. 12. What operations is the National Bank of Romania authorized to perform? 13. List the securities that the National Bank of Romania requires as guarantees for the loans granted to banks. 14. Describe the executive management of the National Bank of Romania, as well as its internal organization. 15. Define the concept bank under the provisions of the Law No. 58/1998 the Banking Law. 16. What operations can a bank perform within the authorization granted by the National Bank of Romania? 17. In what ways can the banks increase their share capital? 18. What operations are banks not allowed to perform? 19. What prudential requirement banks must comply with? 20. List the bodies involved in the management of a bank. 21. Enumerate the main departments of a bank, and detail their attributions. 22. List the main foreign assets of the National Bank of Romania. 23. What are the main items included in the liabilities of the National Bank of Romania?
24. List the main assets and liabilities from the balance sheet of a bank. 25. List the main items from the profit and loss account of a bank. 26. List the operating revenues from the profit and loss account of the National Bank of Romania. 27. List the operating expenses from the profit and loss account of the National Bank of Romania. 28. What are the recent developments and perspectives of the National Bank of Romania? 29. What are the main directions of the supervision program? 30. List the main problems that the National Bank of Romania intends to solve in the future.
31 What is the National Bank of Romania responsible for:
a b c d e
setting up the balance of payment; maintaining and managing the State's international foreign reserves; can take sight and term deposits in cash and in the form of securities; a + b; b + c;
32 Which of the following forms represent the National Bank of Romania refinancing:
a b c d e
credit granted with derogation from regulations; small business loans; fixed interest rate loans; special credit; a + d;
33 Under its law, the National Bank of Romania is responsible for:
a maintaining compulsory reserves in accordance with applicable regulations;
b taking sight and term deposits from both the physical and juridical persons; c setting up the ceiling of gold and foreign exchange assets which the authorized legal persons can hold in deposits; d a + b; e a + c;
34 As a part of its monetary, foreign exchange, lending and payments policies the National Bank of Romania can:
a lend to banks on up to 90 days term against securities; b verify, on the premises, records, accounts, and any other documents of the banking companies c buy, sell, and conduct other transactions with, coins, gold bars, and other precious metals; d a+b
35 Besides deposits other sources of Romanian banks' funds are:
a b c d e
borrowings from the National Bank of Romania; borrowings from other banks; notes and debentures; a + b; b+c
ANNEX No 1 BANKS OPERATING IN ROMANIA

No BANK BANCA NAIONAL A ROMNIEI I 1 Banca Comercial Romn HEAD OFFICE Bucureti, Str. Lipscani nr.25, sector 3 LEGAL STATUS CAPITAL TYPE Central Bank of Romania state-owned capital LICENCING DATE
BANKS - ROMANIAN LEGAL ENTITIES Bucureti, Bd. Regina Elisabeta nr.5, sector 3 Bucureti, Bd. Mircea Vod nr.44, bl. M17, tronson II, sector 3 Bucureti, Calea Victoriei nr.13, sector 3 Bucureti, Str. Doamnei nr.4, sector 3 Bucureti, Calea Victoriei nr.15, sector 3 Bucureti, Bd. Libertii nr.18, bl.104, sector 5 Bucureti, Str. Ion Cmpineanu nr.16, sector 1 Bucureti, Bd. Expoziiei nr.2, World Trade Center, unit.2.23, sector 1 Bucureti, Spl. Independentei nr.15, sector 5 Bucuresti, Bd. Iancu de Hunedoara nr.8 sector 1 Bucureti, Piaa Gh. Cantacuzino nr.6, sector 2 Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company majority stateowned and domestic private capital majority stateowned and domestic private capital state-owned capital majority foreign and domestic private and stateowned capital foreign and domestic private capital state-owned and majority foreign private capital state-owned and foreign private capital foreign private capital majority stateowned and domestic private capital foreign private capital foreign private capital 1990
Banca Agricol1 Casa de Economii i Consemnaiuni (CEC)2 Banca Romn pentru Dezvoltare (BRD) Banca Comercial "Ion Tiriac" BANC POST
1990
1949
1990
5 6
1991 1991 1994
7 Banca Turco - Romn3 ABN AMRO Bank (Romnia) Banca de Export-Import a Romniei (EXIMBANK) Citibank Romnia
1995
1992
10
1996
11
Alpha Bank Romnia
1994
31 Decembrie 2000 Subject to operational and financial restructuring, administration regime ahead of privatisation 2 Reorganised as joint stock banking company pursuant to Law No. 66/1996 3 Banned from participating in final settlement of securities operations
(continued) No 12 BANK Banca Transilvania FINANSBANK (Romnia) Banca Comercial "ROBANK" Banca Daewoo (Romnia) Banca pentru Mic Industrie i Liber Iniiativ MINDBANK Banca Romneasc Banca de Credit i Dezvoltare ROMEXTERRA PIRAEUS BANK ROMNIA Banca Comercial West Bank Banca Romn pentru Relansare Economic LIBRA BANK HEAD OFFICE Cluj-Napoca, Bd. Eroilor nr.36 Bucureti, Str. Doamnei nr.17-19, sector 3 Bucureti, Bd. Unirii nr.59, sector 3 Bucureti, International Business Center, Bd. Carol I nr. 34-36, et.1, sector 2 Bucureti, Calea Grivitei nr.24, sector 1 Bucureti, Bd. Unirii nr.35, bl. A3, sector 3 Trgu Mure, Piata Trandafirilor nr. 21 Bucureti, Bd. Carol I nr.34-36, et.VI, sector 2 Arad, Str. Revoluiei nr.88 Bucureti, Bd. Aviatorilor nr.46, sector 1 LEGAL STATUS CAPITAL TYPE Joint stock company Joint stock company Joint stock company Joint stock company foreign and domestic private capital majority foreign private capital foreign and domestic private capital foreign and domestic private capital foreign and domestic private capital foreign and domestic private capital majority domestic private and stateowned capital foreign and domestic private capital foreign and domestic private capital domestic private capital domestic private capital domestic private capital foreign and domestic private capital foreign private capital foreign private capital foreign private capital LICENCING DATE 1994
13
1993
14
1995
15
1997
16
Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company
1990
17 18 19 20 21
1993 1994 1995 1996 1996 1996 1996 1997 1996 1997 1998
22 Banca Romn de Scont Brasov, Str. Turnului nr.5 23 24 25 26 27 Banca Comercial "UNIREA"4 DEMIRBANK (Romnia) Commercial Bank of Greece (Romnia) Raiffeisenbank (Romnia) Bank-Austria Creditanstalt Romnia Bucureti, Str. Johann Strauss nr.1, sector 2 Bucureti, Splaiul Unirii nr.16, sector 4 Bucureti, Str. Berzei nr.19, sector 1 Bucureti, Bd. Unirii nr. 74, bl. J3B, aripa 2-3, sector 3 Bucureti, Str. Grigore Mora nr.37, sector 1
Subject to special settlement regime of interbank operations

(continued) No 28 BANK ROMANIAN INTERNATIONAL BANK BNP - Dresdner Bank (Romnia) Banca Comercial "CARPATICA" HEAD OFFICE Bucureti, Str. Iuliu Teodori nr.1, sector 5 Bucureti, Str. C.A. Rosetti nr.36, sector 2 Sibiu, Bd. Mihai Viteazu, bl. 42 LEGAL STATUS CAPITAL TYPE Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company Joint stock company foreign private capital foreign private capital domestic and foreign private capital domestic private capital foreign private capital foreign and domestic private capital LICENCING DATE 1998
29 30
1998 1999
31 32 33 II 1
BANCA DE Bucureti, INVESTITII I Bd. Dimitrie Cantemir nr.2, DEZVOLTARE (BID) bl. P3, tronson 2, sector 4 VOLKSBANK (Romnia) Banca "Dacia Felix" Bucureti, Str. Coltei nr.8, sector 3 Cluj-Napoca, Str.Memorandumului nr.28
2000 2000 1991
BANKS - FOREIGN LEGAL ENTITIES Bucureti, Sos. Kiseleffnr.11-13, sector 1 Banque Franco Bucureti, Roumaine P-ta Charles de Gaulle nr.3- Bucharest Branch 5, sector 1 Bucureti, MISR Romanian Bank Bd. Unirii nr.66, bl.K3, - Bucharest Branch sector 3 Frankfurt Bukarest Bank Bucureti, AG Bd. Carol I nr.34-36, - Bucharest Branch sector 2 National Bank of Bucureti, Greece Splaiul Unirii nr.4 - Bucharest Branch bl. B3, tronson 3, sector 4 Banca Italo Bucureti, Romena SpA Bd. Carol I nr.34-36, - Bucharest Branch sector 2 United Garanti Bank International N.V., Bucureti, Amsterdam Str. Paris nr.30, sector 1 - Bucharest Branch Banca di Roma SpA Bucureti, Italia Str. Dr. Staicovici nr.75, - Bucharest Branch sector 5 ING Bank NV - Bucharest Branch Branch 1994
Branch
1990
3 4 5 6
Branch Branch Branch Branch
1987 1979 1996 1996
Branch
1998
Branch
2000
Source: National Bank of Romania Annual Report 2000
Organization Chart of the NATIONAL BANK OF ROMANIA as of 31 December 2000

BO ARD O F D I REC TO RS
ANNEX No 2
GOVERNOR
VICE - GOVERNOR
FIRST VICE - GOVERNOR
VICE - GOVERNOR
HUMAN RESOURCES DEPARTMENT
M o n e ta ry P o lic y C o m m itte e
MONETARY POLICY DEPARTMENT
S u p e rv is io n C o m m itte e
BANKING REGULATION AND LICENSING DEPARTMENT
MARKET OPERATIONS DEPARTMENT
Human Resources Management Division Professional Training Division LEGAL DEPARTMENT
Monetary Analysis Division Monetary Forecasting Division International Relations and EU Integration Division RESEARCH AND PUBLICATIONS DEPARTMENT
Monetary Policy Operations Division State Treasury Operations Division Foreign Reserve Management Division BANK OPERATIONS DEPARTMENT
Analysis and Strategy Division Banking Regulation Division Licensing Division Banking Risk Division SUPERVISION DEPARTMENT
Legal Documentation and Advisory Division Contract Assistance and Disputed Claims Division INTERNAL AUDIT AND CONTROL DEPARTMENT
Research Division Publications Division Documentation and Library Division STATISTICS DEPARTMENT
Issuance Division Settlements Division ACCOUNTING DEPARTMENT
Synthesis Division Inspection Division I Inspection Division II Inspection Division III LOGISTICS DEPARTMENT
Internal Audit Division Internal Control Division
BRANCHES
Statistical Reporting Division Data Processing Division Statistical Analysis and Information Division IT DEPARTMENT
Financial Division Accounting Division Internal Financial Audit Division SECRETARIAT
IT Systems Division Network Administration Division
Board Secretariat Division Bank Correspondence Division Public Relations and Protocol Division Archives and Museum Division
CENTRAL OFFICE FOR PAYMENTS AND BANKING SETTLEMENTS
Investment and Procurement Division Transport Division General Administration Division Technical Services and Maintenance Division Bank Security Division Social Services Division
Settlements Division Gross Settlement Division Settlement Monitoring and Databases Bureau Design, Informatics and Communications Division Resources Management Division Logistics Division
Organizational Chart of a Bank

RISK COMMITTEE
Members
ANNEX No 3a
CREDIT COMMITTEE
Members
GENERAL ASSEMBLY OF SHAREHOLDERS

BOARD OF DIRECTORS President Members
COMMITTEE FOR THE MANAGEMENT OF ASSETS AND LIABILITIES

Members
FORFEITING COMMITTEE
Members
MANAGEMENT COMMITTEE
General Manager Members METHODOLOGY AND CONTROL
ASSETS AND LIABILITIES MANAGEMENT (C) RISK CONTROL (C)
CHIEF EXECUTIVE OFFICER

BANKING OPERATIONS COUNSELORS
LEGAL DEPARTMENT
VICE-PRESIDENT
VICE-PRESIDENT
VICE-PRESIDENT
VICE-PRESIDENT
INTERNATIONAL DEPT.
PROJECTS EVALUATION AND FINANCING
GENERAL ACCOUNTING DEPT..
GENERAL SECRETARY OF THE BANK
BANKING SERVICES FOR THE POPULATION
CREDIT DEPARTMENT
PERSONNEL TRAINING AND DEVELOPMENT
OWN INVESTMENTS DEPT.
FOREIGN EXCHANGE OPERATIONS
NON-PERFORMING CREDITS RECOVERY
CAPITAL MARKETS DEPT.
HUMAN RESOURCES DEPT.
TREASURY DEPT.
SYNTHESIS DEPT.
BANKING OPERATIONS WITH COMMERCIAL PAPERS
PRIVATIZATION DEPT.
IT DEPARTMENT
MARKETING DEPT.
ECONOMIC DEPARTMENT
FINANCIAL MANAGER
IT DEPARTMENT PAY OFFICE DEPARTMENT ACCOUNTING DEPARTMENT SUBSIDIARIES AGENCIES FOREIGN EXCHANGE OPERATIONS ADMINISTRATIVE, SECRETARY EVALUATIONS AND CONSULTANCY OWN INVESTMENTS CREDITS, BANKING SERV. FOR POP. CAPITAL MARKETS RECOVERING NONPERFORMANT CREDITS HUMAN RESOURCES DEPARTMENT INCOMES & EXPENDITURE BUDGET LEGAL DEPARTMENT
ORGANIZATIONAL CHART OF A BRANCH OF A BANK
ANNEX No 3b
CREDIT COMMITTEE
RISK COMMITTEE
DEPUTY GENERAL MANAGER
GENERAL MANAGER
ANNEX No 4
BANKING REGULATIONS THE BANKING ACT Law No. 58/5 March 1998 (modified by Emergency Ordinance No.24/25 March 1999) (Published in Monitorul Oficial al Romniei, part I, No. 121/23 March 1998) (modified by Emergency Ordinance No. 137 of 18 October 2001) THE NATIONAL BANK OF ROMANIA ACT Law No. 101/26 May 1998 (modified by Law No.156/12 October 1999) (Published in Monitorul Oficial al Romniei part I, No.203/1 June 1998) (modified by Emergency Ordinance No. 136 of 18 October 2001) LAW ON BANKS' PRIVATISATION Law No. 83/21 May 1997 on privatisation of banks in which the state is shareholder (Published in Monitorul Oficial al Romniei part I, No. 98/23 May 1997) BANK INSOLVENCY ACT Law No. 83/15 April 1998 (Published in Monitorul Oficial al Romniei part I, No.159/22 April 1998) (modified by Emergency Ordinance No. 138 of 18 October 2001) CURRENCY REGULATION (including the norms NRV1-NRV9) Regulation No. 3/23 December 1997 (Published in Monitorul Oficial al Romniei part I, No.395/31 December 1997) (modified by Circular No. 26 of 20 November 2001)
REGULATION ON OPEN MARKET OPERATIONS Regulation No. 1/30 March 2000 on open market operations performed by the NBR and on lending and deposit facilities granted to banks (Published in Monitorul Oficial al Romniei part I, No.142/5 April 2000) REGULATION ON RESERVE REQUIREMENTS Regulation No. 4/16 July 1998 (republished) (Published in Monitorul Oficial al Romniei part I, No.121/24 March 1999) REGULATION ON CREDIT INFORMATION BUREAU Regulation No. 1/21 May 1999 regards the organization and operation of the Credit Information Bureau. It sets the information system, organization and management of the Central Credit Register and the Overdue Credit Register, and disclosure of information to the users. (Published in Monitorul Oficial al Romniei part I, No.614/16 December 1999)

ANNEX No 5
Balance Sheet of The National Bank of Romania

as of December 31, 2000 and 1999
(Amounts in billions of ROL) Dec 31, 1999 Dec 31, 2000 ASSETS Cash & similar items Precious metals and stones Interest Receivable Foreign Assets Interest Receivable on Time Deposits Interest Receivable on Securities Securities Interest Receivable Government loans Loans granted to banks Interest Receivable Specific provisions for credit losses Specific provisions for interest losses Other loans Accrued interest Interest Receivable - Total Settlement from operations with the IMF Other Assets Provisions for other assets Total Assets LIABILITIES Notes and coins in circulation Bonds issued by NBR Interest Payable Foreign Liabilities Interest Payable on Time Deposits Interest Payable on Borrowings Interest Payable on SDR allocations by the IMF Deposits of State Treasury Banks deposits with the NBR Interest Payable Other deposits with the NBR Interest Payable - Total Other Liabilities Capital, funds and reserve accounts Total Liabilities 18,676.4 5,365.8 68.3 34,731.6 28.2 96.7 2,846.7 30,963.4 17.5 11.7 210.7 337.5 5,596.6 98,780.4 28,108.8 6,771.3 76.8 44,236.6 90.4 134.7 20.1 1,015.6 48,921.6 153.9 22.7 475.9 380.6 17,426.6 147,359.7 150.5 126.2 112.5 127.4 320.6 139.3 X 35.6 158.0 879.4 194.0 225.9 112.8 311.4 149.2 42.2 1,066.7 16.1 71,330.1 324.1 556.0 16,838.9 1,472.8 2,181.6 647.5 383.7 305.5 32.1 32.9 2,743.9 908.6 3,596.3 98,740.4 45.0 1,371.3 4.0 115,994.1 709.0 919.1 16,176.1 1,151.0 6,952.7 197.6 802.6 60.7 25.5 39.1 2,959.1 3,835.9 152.2 147,359.7 2000/1999 % 106.6 128.6 24.8 162.6 218.8 165.3 96.0 78.1 x 318.7 30.5 209.2 19.8 79.4 118.8 107.8 x 106.7 X 149.2
Source: National Bank of Romania Annual Report for year 2000

ANNEX No 6
Profit and Loss Statement of The National Bank of Romania

as of December 31, 2000 and 1999
(Amounts in billions of ROL) Dec 31, 1999 Dec 31, 2000 REVENUS Operating revenues Interest on credit lines Revenues from commissions and fees Revenues from ROL-denominated securities operations Interests and revenues in foreign exchange Revenues from operations with forex-denominated securities Revenues from operations with precious metals Revenues from provisions Other revenues I. TOTAL REVENUES (1+2) EXPENSES Operating expenses Interests paid to the banks and State Treasury Interests and commissions on IMF borrowing Interests and commissions in foreign exchange for NBR borrowings from other sources and other expenses in foreign exchange Expenses for operations with forex-denominated securities Expenses for operations with ROL-denominated securities Note printing and coin mintage-related expenses Expenses for operations with precious metals Losses from non-recoverable claims Other Overheads Salaries and wages Expenses for provisions Other TOTAL EXPENSES (1+2) Profit/Loss (I-II), out of which: Reserve fund Profit Tax Net profit 10,915.6 1,308.9 719.9 6,427.4 1,185.3 1,192.4 81.7 136.1 11,051.7 8,314.6 4,599.6 439.8 1,552.6 1,057.1 279.4 233.8 124.2 10.1 1,579.2 521.3 731.2 326.7 9,893.8 1,157.9 4.4 956.0 197.5 14,804.4 709.4 881.2 9,176.1 1,115.9 2,315.6 49.1 557.1 134.3 14,938.7 11,993.8 7,203.2 658.7 1,667.1 373.9 759.8 379.1 84.9 808.7 58.4 1,827.1 667.8 883.3 276.0 13,820.9 1,117.8 46.5 892.9 178.4
2000/1999 35.6 -45.8 22.4 42.8 -5.9 94.2 -39.9 X -1.3 35.2 44.2 56.6 49.8 7.4 -65.2 171.9 62.1 -31.6 X 478.2 15.7 28.1 20.8 -15.5 39.7 -3.5 956.8 -6.6 -9.7
Source: National Bank of Romania Annual Report for year 2000

ANNEX No 7 Balance Sheet for the years ended December 31, 2000 and 1999 B.R.D.
(Amounts in millions of ROL in terms of purchasing power as of December 31, 2000 unless otherwise indicated)
Note ASSETS Cash & cash equivalents Current accounts and deposits at banks Reserves at the National Bank of Romania Treasury securities Loans, net Loans Club Loan to NBR Government and public sector loans Allowance for loan losses Total loans, net Interest receivable and other assets, net Accrued interest receivable, net Other assets, net Total interest receivable and other assets, net Equity investments, net Premises and equipment, net Goodwill, net Other intangible assets, net Total Assets LIABILITIES AND SHAREHOLDERS EQUITY Deposits Demand deposits Term deposits Total deposits Other borrowed funds Accrued interest payable Deferred tax liability, net Other liabilities Total Liabilities Share capital - nominal Share capital restatement reserve Reserve for general banking risks Revaluation surplus Accumulated deficit Total ShareholdersEquity Total Liabilities and ShareholdersEquity 17 18 19 20 21 22 23 24 25 26 6 7 8 9
December 31, 2000 593,687 7,329,295 9,100,107 1,104,371 15,132,853 --297,669 (593,974) 14,836,548 390,406 456,093 846,499 519,074 5,676,130 430,859 227,038 40,663.608
December 31, 1999 444,431 4,852,889 5,852,624 2,147,496 15,055,379 256,863 60,800 (759,366) 14,613,676 366,367 290,801 657,168 480,572 5,871,207 407,989 81,268 35,409.320
10 11 12 13 14 15 16
10,053,218 20,152,048 30,205,266 1,189,740 381,361 614,101 983,494 33,373,962 1,742,253 9,483,352 77,618 917,523 4,931,100 7,289,646 40,663,608
7,730,868 17,073,140 24,804,008 1,101,783 447,098 500,672 1,150,648 28,004,209 1,742,253 9,843,352 77,618 1,092,382 (4,990,494) 7,405,111 35,409,320
The accompanying notes are an integral part of these financial statements
Source: BRD Annual Rep. 2000

The financial statement on this page was approved by the Board of Directors, and was signed on its behalf on April 9, 2001 by Bernard Caussignac, general manager.

ANNEX No 8
Profit and Loss Account for the Year Ended December 31, 2000 and 1999
(Amounts in millions of ROL in terms of purchasing power as of December 31, 2000 unless otherwise indicated)
Note Interest income Interest income on loans Interest on interest bearing deposits Interest on trading securities Total interest income Interest expense Interest for deposits Interest for funds borrowed Total interest expense Net interest income Provisions for losses Net results related to loans written-off Net interest income after provisions for losses Non-interest income Foreign exchange income, net Service charges and commissions, net Income on investments Other income Total non-interest income Income before non-interest expense Non-interest expense Salaries and related expenses Operating expenses Other expenses Provision expenses for impairment of assets Total non-interest expense Net operating profit Hyperinflation adjustment Profit before income taxes Current income tax expense Deferred income tax expense Income taxes Net profit Earnings per share (348,450,670 equivalent shares as of December 31, 2000) Earnings per share (60,929,768 equivalent shares as of December 31, 1999) Net profit Distributed dividends * Net retained profit (deficit)
December 31, 2000 4,527,921 1,714,368 783,095 7,025,384 (4,216,092) (144,540) (4,360,632) 2,664,752 (371,716) 2,293,036
December 31, 1999 15,737,523 1,046,210 763,505 7,547,238 (4,597,969) (105,648) (4,703,617) 2,843,621 (782,809) 2,060,812 937,870 971,854 81,334 86,223 2,077,281 4,138,093 (1,060,524) (401,116) (649,264) (2,110,904) 2,027,189 (935,441) 1,091,748 (445,383) (160,119) (605,502) 486,246 0.00140 0.00798 486,246 (639,979) (153,733)
28
29 30 27 32 31 33 34
937,318 1,062,521 54,679 56,130 2,110,648 4,403,684 (1,167,826) (734,092) (761,028) (20,653) (2,683,599) 1,720,085 (415,711) 1,304,374 (253,480) (258,279) (511,759) 792,615 0.00227 792,615 (752,173) 40,442
35 36 37 13
38
21 46 46 39
* Dividends are distributed from statutory net profits (1,354,824 and 766,596 nominal as of December 31, 2000 and 1999 respectively).
Source: Annual Report 2000
The Banking System in England
THE BANKING SYSTEM IN ENGLAND
Objectives: After studying this chapter you should be able to understand: 2.1 The evolution of the Bank of England The hub of the banking system; The establishment of the bank; The nationalisation of the bank; 2.2 Functions of the Bank of England Governments bank; Bankers' bank; Lender of last resort; Carrying out the governments monetary policy; Control of the currency issue; 2.3 2.4 Present - day role of the Bank of England Banking today
2.1 The evolution of the Bank of England The hub of the banking system In every country where there is a developed banking system, the main bank, the hub of the system, is the Central Bank. In the United Kingdom, the central bank is the Bank of England, which was established in 1694. Most of the central banks functions are quite different from those of the commercial and other banks and, being the Governments bank and the bankers bank, it has a controlling influence over all the other banks as a whole. The history of the Bank is naturally one of interest, but also of continuing relevance to the Bank today. Events and circumstances over the past three hundred or so years have shaped and influenced the role and responsibilities of the Bank. They have moulded the culture and traditions, as well as the expertise, of the Bank, which are relevant to its reputation and effectiveness as a central bank in the early years of the 21st century. At the same time, much of the history of the Bank runs parallel to the economic and financial history, and often the political history in a broader sense, of the United Kingdom. In the 19th Century the Bank took on the role of lender of last resort, providing stability during several financial crises. World War I: 1914 - 1918 - During World War I the National Debt jumped to 7 billion. The Bank helped manage Government borrowings and resist inflationary pressures. Gold - In 1931 the United Kingdom left the gold standard; its gold and foreign exchange reserves were transferred to the Treasury. But their management was still handled by the Bank and this remains the case today. The establishment of the Bank of England The Bank of England was established under charter with the very privileged position of being the first joint-stock banking company.1
D.P. Whiting - Elements of banking, Macdonald & Evans Ltd., London 1985, p. 42
This meant that it could have a large number of shareholders and was not restricted to being a partnership, as were the other banks. From the beginning, the Bank of England accepted money on deposit, issued its own notes and made loans in the same way that the other banks did and was able to increase its business more rapidly than them. Because many banks had to close their doors, confidence in the banking system and in the system of credit creation was greatly affected, and legislation was introduced, especially, to encourage the establishment of larger banking units on the one hand and to control the note issue on the other. Its law2, had three provisions: a) To divide the Bank of England into two separate departments, the Banking Department and the Issue Department. b) To permit the Bank to make a fiduciary issue of 14 million of notes to be backed by Government securities. c) Ultimately to centralise the note issue in the hands of the Bank of England by gradually extinguishing private note issues as the private banks became bankrupt or amalgamated with other banks. Thus, the Bank of England gradually assumed responsibility for the currency supply and as the holder of the countrys gold reserves, apart from the relatively small fiduciary issue, it had to hold gold as backing for the note issue. The Bank of England started in 1694 as a commercial bank and then in the second half of the nineteenth century gradually stopped competing with the other banks and concentrated on its new role as the first central bank in the world. Nationalisation of the Bank of England The Bank was nationalised in 1946, when the conduct of the Bank was placed in the hands of a Court of Directors headed by the Governor of the Bank of England. The Crown appoints the Directors and the Governor and senior officers work in close liaison with the Treasury.
The Bank Charter Act 1844
Operational independence May 1997 In May 1997 the Government gave the Bank responsibility for setting interest rates to meet the Government's stated inflation target. Managing the modern bank The 1998 Bank of England Act made changes to the Bank's governing body too. The Court of Directors, as it's known, is now made up of the Bank's Governor and 2 Deputy Governors, and 16 Non-Executive Directors. Channels of communication. There are regular channels of communication between the Bank of England and the other financial institutions in London, and through these, it is able to discuss problems as they arise and seek compliance with its wishes. These channels include the two Committees of the London Clearing Bankers, the Accepting Houses Association, the Discount Market Association, the Finance Houses Association and a number of other groups representing financial institutions. The Bank today The Bank of England is the central bank of the United Kingdom. Sometimes known as the 'Old Lady' of Thread needle Street, the Bank was founded in 1694, nationalised in 1946, and gained operational independence in 1997. Standing at the centre of the UK's financial system, the Bank is committed to promoting and maintaining a stable and efficient monetary and financial framework as its contribution to a healthy economy. The Bank's roles and functions have evolved and changed over its three hundred-year history. Since its foundation, it has been the Government's banker and, since the late 18th century, it has been banker to the banking system more generally - the bankers' bank. As well as providing banking services to its customers, the Bank of England manages the UK's foreign exchange and gold reserves and the Government's stock register. Interest rates decisions are taken by the Bank's Monetary Policy Committee. The Monetary Policy Committee has to judge what interest rate is necessary to meet a target for overall inflation in the economy. The Bank is also responsible for maintaining stability in the financial system - a healthy financial system is vital to the proper functioning of the economy. The Bank analyses and promotes initiatives to strengthen the financial system, and monitors financial developments in trying to identify
potential threats to financial stability. It also undertakes work on the arrangements for handling financial crises should they occur, and is the financial system's 'lender of last resort' in exceptional circumstances. In this task, the Bank co-operates closely with the Treasury and the Financial Services Authority, the regulator of banks and other financial institutions in the United Kingdom. Much of the Bank's work involves liaison and co-operation with the Government institutions and other central banks. Given London's position as a large international financial centre, the Bank's work addresses international as well as domestic developments. The Bank participates in many international forums involved in promoting the health of the world economy and global financial system. The Bank also works to ensure that the UK financial system provides effective support to the rest of the UK economy and that the UK remains an attractive location for the conduct of international financial business. This involves work on issues such as firms' access to finance and, over recent years, the introduction of the Euro and the evolution of the Euro financial markets and infrastructure. 2.2 Functions of the Bank of England The main functions3 of the Bank of England are: The Governments bank The Bank of England is responsible for running accounts for all of the Government Departments and it has been the Banks general policy not to maintain accounts for individuals and firms in the private sector (the nonGovernment sector of the community). The bankers bank By maintaining accounts with the Bank of England, the other banks are able to settle transactions with one another and with the institutions in the public sector, and also to maintain current account balances, which form part of their liquid reserves. Being able to draw cheques on the Bank or being able to pay with cheques that have been drawn on the Bank facilitates the day-to-day settlement of transactions through the London and Provincial Clearing Houses.
D.P. Whiting - Elements of banking, Macdonald & Evans Ltd., London, 1985, p.47
Lender of last resort If the London Money Market is short of funds, the Bank of England must always come to its aid, through it will do so at its own price, i.e. it will determine the rate of interest at which it is prepared to lend. The Bank may choose to give either direct or indirect assistance in the market or may force the Discount Houses to borrow at the Bank of Englands Minimum Lending Rate for a period of seven days. If the Bank decides to give direct assistance it will buy bills or Government stocks from the Discount Houses. Indirect assistance to the Discount Houses occurs when the Bank of England buys the bills or stocks from the banks and thus enables them to increase their lending to the Discount Houses. Carrying out the Governments monetary policy The Bank of England is the principal agent for the Government in pursuing its monetary policy. Not only is it responsible for the fiduciary issue, but also through its control and influence over the banks and other financial institutions, it is able to restrain or increase the total money supply. The main devices used by the Bank in carrying out the monetary policy are: a) Varying its minimum rate of interest; b) Open Market operations; c) Special Deposits; d) Adjustments to the reserve ratios of the banks and other financial institutions; e) Directives to the Banks. A) The minimum rate of interest. Since the early nineteenth century the Bank of England has been able to influence the level of interest rates in the money market by changing the minimum rate of interest at which it is willing to lend. Until recently, this minimum rate was known as Bank Rate and changes in it had strong psychological effects upon not only the money market but upon the community as a whole. A reduction in the Bank Rate was regarded as signal that restraints upon economic expansion were to be relaxed whereas a rise in Bank Rate heralded a period of credit restriction. If interest rates are raised then borrowing is discouraged and thus the credit creation process is slowed down. If
interest rates are reduced then borrowing becomes more worthwhile and this stimulates the creation of new deposits. B) Open Market operations. These amounts to the deliberate selling or buying of Treasury bills and Government stocks in order to mop up excess purchasing power on the one hand, or to increase purchasing power on the other. By selling securities in the open market the Government receives payment for them by cheques drawn by individuals, firms and institutions in the private sector. These cheques reduce the level of bank deposits and, as the deposits form the major part of the money supply, the latter is reduced. Conversely, if the Government buys securities cheques drawn on the Bank of England pay for its purchases, and these are paid in as deposits with the commercial banking system, thus increasing the money supply. When the Government sells securities and bank deposits are reduced, so are the cash holdings of the banks. They thus find it difficult to maintain their cash and liquidity ratios and may have to reduce their lending by way of loans and overdrafts, which will reduce bank deposits still further. Open Market operations can therefore be very effective in reducing the availability of credit to the community. C) Special Deposits. Since 1960 the Bank of England has used the device of Special Deposits in order to reduce the ability of the banks to lend by way of loans and overdrafts. A call for Special Deposits takes the form of a directive to the banks and some other financial institutions to pay over a set proportion of their eligible liabilities in cash, to be frozen as deposits with the Bank of England until such time as the bank decides to repay them. A call for, say, 2 per cent Special Deposits may cause the banks to reduce their less liquid assets in order to maintain their reserve ratios. When Special Deposits are repaid they have the opposite effect upon the liquidity of the banks, and upon their ability to create new deposits. D) Reserve ratios - Since the 70s, all banking institutions have had to keep, day by day, a minimum of 12 per cent of eligible liabilities in the form of eligible reserve assets. These assets are mainly those whose supply can be regulated by the Authorities and comprise balances with the Bank of England commercial bills, call money with the London Money Market, Treasury bills, Government stocks with less than a year to maturity, local authority bills and company tax certificates.
E) Control of the currency issue - In conjunction with the Treasury, the Bank of England determines the size of the fiduciary issue and is responsible for the coinage. The note issue must be increased to meet seasonal demands, e.g. at Christmas and during the summer holiday period. 2.3 Present - day role of The Bank of England The Bank of England is the national bank and central bank for Great Britain. In these capacities the Bank has the functions described: 1. Banker to Government; 2. Sole note issuing bank in England and Wales; 3. It is the bankers bank; 4. Lender of last resort to the London money market; 5. Administers Government monetary policy; 6. Supervises other banks and associated financial institutions; 7. Management of the national Debt. The Bank is organised into three main operational areas - Monetary Analysis and Statistics, Financial Market Operations and Financial Stability, supported by a Central Services area. This structure was introduced in June 1998 to reflect the Bank's new responsibilities in the light of the 1998 Bank of England Act. In addition, the Co-ordination Unit for Europe is responsible for co-ordinating the Bank's work on Europe, specifically in relation to the Euro. The Centre for Central Banking Studies offers teaching and technical assistance to other Central Banks and the Printing Works is responsible for the printing of all Banks of England banknotes. Monetary Analysis and Statistics This area is made up of the following Divisions: International Economic Analysis Structural Economic Analysis Monetary Instruments and Markets Monetary Assessment and Strategy Conjectural Assessment and Projections Monetary and Financial Statistics Regional Agencies.
The Monetary Analysis divisions are responsible for providing the Bank with the economic analysis it needs to discharge its monetary policy responsibilities. Its economists conduct research and analysis of current and prospective developments in the UK and international economies. The Monetary and Financial Statistics Division compiles, publishes and briefs on financial statistics; in particular the monetary aggregates and banking statistics. Special studies directed at international harmonisation and improvements to the statistics are also a feature of their work. Financial Market Operations This area is made up of the following Divisions: Gilt-Edged and Money Markets Foreign Exchange Banking Services Market Services Risk Analysis and Monitoring Registrar's Department The Market Operations divisions - Gilt-Edged and Money Markets and Foreign Exchange - plan and conduct the Bank's operations in the core financial markets, in particular the money market in order to establish shortterm interest rates at the level required by monetary policy. They also manage the UK's foreign exchange and gold reserves as agent for HM Treasury and they conduct the current programme of Government gold auctions. They contribute market analysis and intelligence to the Monetary Policy Committee and the Financial Stability Committee from their operational presence in the markets and, in line with the Bank's core purpose; they seek to promote efficient structures in these markets. The Banking and Market Services divisions provide banking services to the Government and other customers, principally banks and other central banks. They manage the note issue. They also play a key role in the provision of safe and efficient payment and settlement services for the UK markets and for the country as a whole. The Risk Analysis and Monitoring division is responsible for integrating management information on the risks arising from the Bank's operation in
the financial markets and for analysing the balance sheet implications of those operations. The Registrar's Department provides the principal stock registration service for the Government and an execution-only postal brokerage service for retail gilt investors. Financial Stability This area is made up of the following Divisions: Domestic Finance Financial Intermediaries International Finance Market Infrastructure Regulatory Policy The Financial Stability divisions have the main responsibility for discharging the Banks remittal to maintain the stability of the financial system as a whole. The Financial Stability Committee acts as a focus for the Bank's work in this area. The Governor chairs the Committee. The work of the Financial Stability divisions covers both UK and overseas financial systems and markets, and the functioning of the international financial system. The divisions identify, analyse and carry out research into developments relevant to the structure and functioning of the financial system domestically and internationally, make policy proposals and encourage changes designed to increase its safety and effectiveness. The divisions also contribute to the monetary policy process, for example through the Bank's Deputy Governor for Financial Stability as a member of the Monetary Policy Committee. The divisions' analysis is used to promote public understanding of issues in financial stability through, for instance, the regular Financial Stability Review. Co-ordination Unit for Europe The Co-ordination Unit for Europe is responsible for co-ordinating the Bank's work on Europe, specifically in relation to the Euro. It monitors the evolution of the Euro financial markets and supporting infrastructure; and provides information on this (and other Euro-related matters) in the biannual Practical Issues report. It leads the Bank's involvement in HMT's National Changeover Plan work, focusing on the financial sector preparations. It co-
ordinates the Bank's involvement in the main official and private sector Euro for; and provides a body of expertise on the European Central Bank. Working with the Agents, it also monitors the use of the Euro in the UK. Central Services This area is made up of the following Divisions: Personnel Secretary's Department Legal Unit Finance and Resource Planning Investment Unit Management Services Property Services and Security The Central Services divisions encompass a range of support functions that underpin the Bank's activities and help to ensure that the Bank's reputation is maintained. These include finance, IT, personnel, the Governors' private offices, and media and public relations, legal and information services. Printing Works The Bank of England Printing Works is located on a purposely-built high security site in Debden, Essex. It employs over 450 people and is responsible for the printing of over 1 billion notes annually, together with the manufacture of its own inks, printing plates and threads. In addition the Printing Works provides technical and specialised security advice to a number of central banks worldwide. The notes are produced in a highly developed printing process which combines high technology and quality craftsmanship, making the Bank one of the most cost effective note producers world-wide. The Printing Work's expertise has led to commercial sales in overseas markets through Debden Security Printing Limited, the Bank's wholly owned commercial subsidiary.
Audit Internal Audit is an independent function authorised by the Court of Directors to review the adequacy of the internal control systems within the Bank and to test compliance with agreed procedures. It aims to provide an independent view for senior management, to assist in the effective discharge of their responsibilities and to provide a service to the organisation as a whole. Centre for Central Banking Studies The Bank of England's Centre for Central Banking Studies offers technical assistance, courses, workshops, seminars and comparative research on and for central banks throughout the world. Its primary aims are to foster monetary and financial stability worldwide, to promote the Bank's core activities, and to provide opportunities for Bank of England staff to obtain broader perspectives on their own areas of expertise. Its goal is to be recognised internationally as a leading centre of intellectual excellence for the study of practical central banking. Governance of the Bank The Bank of England Act 1998 provides for the appointment by the Crown of the Governor, two Deputy Governors and 16 Non-Executive Directors of the Bank who collectively make up what is know as the Court of Directors. The Governor and Deputy Governors are appointed for five years and the Directors for three years. Under the Act, the responsibilities of Court are to manage the Bank's affairs other than the formulation of monetary policy, which is the responsibility of the Monetary Policy Committee. This includes determining the Bank's objectives and strategy, and aiming to ensure the effective discharge of the Bank's functions and the most effective use of the Bank's resources. The Monetary Policy Committee The Act establishes the Monetary Policy Committee as a Committee of the Bank sets a framework for its operations. The Act provides that the Bank's objectives in relation to monetary policy shall be to maintain price stability and, subject to that, to support the Government's economic policies, including its objectives for growth and employment. At least once a year, the Government specifies the price stability target and its growth and employment objectives in conformity with the Act. Audit Committee
The functions of the Audit Committee are to:

Keep under review the internal financial controls in the Bank. Receive reports from, and review the work of, the internal and external auditors. The Committee also considers and makes recommendations on the appointment of the external auditors, and their fees, reviews the annual financial statements prior to their submission to Court, including consideration of the appropriateness of the accounting policies and procedures adopted. The Committee reports its conclusions to Court.
Management structure Under the Court of Directors, the Bank's senior policy-making body is the Governor's Committee, comprising the Governors and Executive Directors. The internal management of the Bank is the responsibility of the Management Committee, comprising the Deputy Governor (Financial Stability), the Deputy Directors, the Finance Director and the Director of Personnel. 2.4 Banking today The banking sector in the United Kingdom has traditionally been highly segmented. In its February issue of the Bank of England Quarterly Bulletin every year the Bank of England lists all those banking institutions to which it has granted a licence to operate as a bank in the United Kingdom. The list (of over 450) is divided into seven sections, distinguished sometimes by function and sometimes by nationality of ownership. As regards functions, the major distinctions are between retail banks, British merchant banks, other British banks and discount houses. The first group provides deposit and loan facilities to the household or personal sector, together with small and un-incorporated businesses. The retail banks own the various payment mechanisms, and money transfer is a major part of retail bank operations. In recent years, they have offered an increasing range of financial services, based on the marketing idea of onestop shopping so that it is now possible, within an individual branch, to buy and sell foreign currency, buy an insurance policy, open a personal pension fund, invest in units trusts, and buy executor and other services. British merchant banks provide a complete range of corporate financial services. These range from accepting deposits and making loans, to advising
on alternative forms of finance, advising on risk management strategies, handling new securities issues and accepting bills issued by firms. Other British banks are banks, which offer a range of banking services, but usually limited in some way. Although they may be subsidiaries of retail banks, they do not usually deal directly with the retail sector. Discount houses perform a highly specialized and unique role in the UK financial system. They deal almost exclusively with other banks and with the Bank of England. They accept surplus funds on a very short-term, often on an overnight basis, from banks and use the funds to buy and hold treasury and commercial bills. They thus provide the first source of liquid assets to the rest of the banking sector, so that any shortage or surplus funds are immediately reflected in discount houses ability to buy bills, or need to sell them. At the centre of Britains banking and financial structure is the Bank of England (see Annex no. 1). The commercial banks, sometimes referred to as the high street banks or the clearing banks, are large public limited companies having many shareholders throughout Britain and in some cases in countries outside Britain. These banks operate through a network of branches covering the whole England and Wales. All commercial banks are profit-seeking companies and in order to earn money they provide various services to their clients. Another major group of banks is that of merchant banks sometimes called accepting houses or issuing houses. These banks are placed in the City of London, though some have branch offices in other cities and also some have offices in important overseas financial centres. The activities these banks perform are very diversified including trading activities, accepting financial commitments in exchange for a commission fee, company financial advice. Savings and lending institutions By the term of savings, we mean refraining from spending. Any money, which we have saved and set aside for use in the future, we refer to as our savings. Money is saved if it is not spent, and it does not necessarily have to be placed in a bank, a building society or any other financial institution or used to purchase stocks and shares in order to justify the use of the term.
Sources of savings. In the United Kingdom, each individual saves on average 8 per cent of his income. This may seem a very high proportion, but it is not always realised that an individual saves not only by depositing money and buying securities but also by paying premiums on an insurance policy or by contributing to a superannuating scheme. National savings. This term is used to identify or to name the part of personal savings which is deposited with the National Savings Bank and Trustee Savings Bank or is used to buy National Savings Certificates, Premium Savings Bonds, or British Savings Bonds or is saved through the Save as You Earn Scheme. Functions of a savings bank. A savings bank accepts deposits and pays interest on them. It may also provide payments mechanism, though this is not essential function. For instance, on request, the National Savings Bank will provide a depositor with a draft, which can be used in the same way a cheque to settle a transaction, and the Trustee Savings Banks now provide their customers with chequebooks. The National Savings Bank provides two types of account facilities: ordinary accounts and investment accounts. Ordinary accounts may be opened for or by anyone over seven years of age with a maximum deposit of 10000 pounds. The Co-operative and Trustee Savings Bank (mutual funds) offer a complete service for personal customers and a limited service to smaller business customers. These banks are primarily non-profit seeking organisations, being concerned with providing a service for their customers and seeking to cover only the costs of providing these services through the fees they charge. In a similar way to the National Savings Bank, the Trustee Savings Bank operates with two types of accounts, ordinary accounts and special investment accounts, but in addition, an ordinary account holder may also open a current account. Ordinary department depositors may open a special investment account if they have a minimum of 50 pounds on ordinary account. Whereas they receive a modest 4 per cent on ordinary account, considerably higher rates are paid on investment accounts depending upon the particular bank they are in account with and the yield earned on the securities in which deposits are invested. Ordinary account holders may have current account facilities if they wish, which involves opening a separate account and being provided with a chequebook. Cheques drawn for cash are free of charge but for others a charge may be made.
Building societies. A building society, like other financial institutions, borrows money and lends it out at higher rates of interest than it pays for it. It accepts funds in the form of shares and deposits. Shareholders actually participate in the affairs of the societies as much that in the event of financial difficulties the power to return their share capital would be restricted whereas depositors are creditors and, as such, have a prior claim over the shareholders in the event of liquidation. The rate of interest on deposits is usually per cent below that on shares and as there is comparatively little difference in practice in the ability to withdraw fairly sizeable sums on demand, the majority of money is on share account to attract the higher rate of interest. The shareholders are the owners of the societies but they are paid interest as mentioned above, not dividends. The societies are in effect mutual societies in as much many of the shareholders are also borrowers on mortgage. Commercial banks Types of deposits. In a similar way to the savings banks, the commercial banks accept deposits from their customers, but unlike the savings banks, the majority of the total sum deposited with them is from industrial and commercial depositors. This does not mean that the commercial banks have few private customers, but sums of money involved are much greater for firms than for individuals. Commercial banks offer two main types of account to depositors: current accounts and deposit accounts. Current account holders receive no interest on their accounts, but they can draw cheques on them and use the credit giro service, and they can withdraw some or all of their balances on demand. Deposit account holders, on the other hand, do receive interest on their accounts but do not normally draw cheques on the accounts or use the credit giro system for paying in credits, and technically, they are required to give seven days notice of their intention to make withdrawals from their accounts. Present - day commercial banks offer a wide range of services from those suitable for individual customers who have modest expectations and requirements of their bankers, through to the complicated requirements of the large multi-national companies with banking operations on a worldwide basis. Annex No. 2 illustrates the broad areas of operations and services offered by a large, modern banking company and its associated companies and subsidiary companies.
Progress test
1) When was the Bank of England established? 2) What were the provisions of the Bank Charter Act 1844? 3) Was the Bank of England always a Central Bank? 4) When was the Bank of England nationalised? 5) What are the channels of communication between the Bank of England and the other financial institutions? 6) List of functions of Bank of England. 7) What is meant by the term Lender of Last Resort? 8) Define (a) Direct and (b) Indirect assistance to the Discount Houses. 9) Which tools can the Bank of England use in carrying out the Governments monetary policy? 10) Define Open Market Operations. 11) What are Special Deposits? 12) What is the minimum reserve ratio? 13) What does savings mean? 14) In what ways does an individual save? 15) What are National Savings? 16) What are the functions of a savings bank? 12) What is a Trustee Savings Bank?
ANNEX No 1
BUILDING SOCIETIES Members of Building Societies Association Examples: Halifax, Abbey National Nationwide, Provincial
MERCHANT BANKS Members of Accepting Houses Committee Examples: Rothschid's, Hambros, Baring Brothers.
COMMERCIAL BANKS Barclays, Lloyds, Midland, National Westminster Wiliams and Glyn's and Scottish banks
NATIONALIZED BANKS
National Savings Bank and National Girobank
THE BANK OF ENGLAND
Members of Finance Houses Association. Examples: Forward Trust, UDT, Mercantile Credit.
FINANCE COMPANIES
Co-operative Bank and Trustee Savings Bank
Bank of Japan, Bank of America, Royal Bank of Canada, and around 300 other foreign bank offices BRIT. OFFICES FOR FRGN. BANKS
Grindlays Bank, Standard and Chartered Bank etc. BRITSH BASED OVERSEAS BANKS
MUTUAL BANKS
Types of financial organizations in Britain
ANNEX No 2
General management team at Head Office
Domestic
International
Merchant and wholesale banking

Specialized bank companies created to be able to operate in this highly specialized area
Installment credit services

Most banks now own a finance company which will offer both personal and company finance arrangements
Related financial services

Banks are now active in such areas as: insurance services unit trust sales computer services executor & trustee appointments
Bank branches throughout Britain including any subsidiary bank companies
Includes any overseas branches or subsidiary foreign banks owned by the British clearing bank
The broad areas of operations in a modern banking group
Other Banking Systems in the World
OTHER BANKING SYSTEMS IN THE WORLD

Objectives: After studying this chapter you should understand: 3.1 The United States of America banking system 3.1.1 Formal structure of the Federal Reserve System 3.1.2 The realities of power 3.1.3 The instruments of Central Banking 3.1.3.1 Reserve requirements 3.1.3.2 Discounting and the discount rate 3.1.3.3 Open Market operations 3.1.4 Financial institutions 3.1.5 The regulation and structure of depository institutions 3.1.5.1 The dual banking system 3.1.5.2 Multiple federal authorities 3.1.5.3 Deposit insurance and the FDIC 3.1.5.4 Bank size distribution and the McFadden Act 3.1.5.5 Savings banks and savings and loan associations 3.1.5.6 Mortgage-related financial institutions 3.1.6.7 Credit unions 3.2 The European System of Central Banks 3.2.1 Organisation of the European System of Central Banks (ESCB) 3.2.2 Objectives and tasks of the European System of Central Banks 3.2.3 The European Central Bank (ECB)
3.1 The United States of America banking system 3.1.1 Formal structure of the Federal Reserve System The statutory organisation of the Federal Reserve System is a case study in those currently popular concepts: decentralisation and the blending of public and private authority. A deliberate attempt was made in the enabling congressional legislation, the 1913 Federal Reserve Act, to diffuse power over a broad base geographically, between the private and public sectors, and even within the government so that no person, group, or sector, either inside or outside the government, could exert enough leverage to dominate the direction of monetary policy.
12 Federal Reserve Banks Each Bank with 9 Directors who appoint the President of the F. R. Bank
Board of Governors 7 Members appointed by the President and confirmed by the Senate
Appoint 3 Directors
Elect 6 Directors
5,000 Member Commercial Banks
Select
Federal Open Market Committee Board of Governors plus 5 Federal Reserve Bank Presidents Set (within limits) Review and Determine Direct
Federal Advisory Council 12 Members
Open Market Operatio Discount Rate
Establish
Reserve Requirements
Figure 1: The Formal Structure and Policy Organisation of the Federal Reserve System
As the above figure shows, the Board of Governors of the Federal Reserve System consists of seven members, appointed by the President with the advice and consent of the Senate. To prevent presidential board packing, each member is appointed for a term of fourteen years, with one board members term expiring at the end of January of each even-numbered year. Furthermore, no two board members may come from the same Federal Reserve district. The Chairman of the Board of Governors, chosen from among the seven by the President, serves a four-year term. However, the Chairmans term does not coincide with the presidential term, so an incoming President is usually saddled with an already appointed Chairman at the beginning of the new administration. The Board is independent of the congressional appropriations process and partly exempt from audit by the governments watchdog the General Accounting Office, because its operating funds come from the earnings of the twelve regional Federal Reserve Banks. The regional Federal Reserve Banks, one in each Federal Reserve District, are geographically dispersed throughout the country: New York Boston St. Louis San Francisco Philadelphia Atlanta Chicago Kansas City Richmond Dallas Minneapolis Cleveland
Technically, the member banks in its district privately own each Federal Reserve Bank, every bank is charged with supervising and regulating. Each member bank is required to buy stock in its district Federal Reserve Bank equal to 6 percent of its own capital and surplus. Of this 6 percent, 3 percent must be paid in and 3 percent is subject to call by the Board of Governors. However, law to a 6 percent annual dividend on paid-in capital stock limits the profits accruing to ownership. The member bank stockholders elect six of the nine directors of their district Federal Reserve Bank and the remaining three are appointed from Washington by the Board of Governors. These nine directors, in turn, choose the president of their Federal Reserve Bank, subject to the approval of the Board of Governors.
The directors of each Federal Reserve Bank also select a person, always a commercial banker, to serve on the Federal Advisory Council, a statutory body consisting of a member from each of the twelve Federal Reserve Districts. The Federal Advisory Council consults quarterly with the Board of Governors in Washington and makes recommendations regarding the monetary policy. Legal authority is similarly diffused with respect to the execution of monetary policy, as Figure 1 indicates. The Board of Governors has the power to set reserve requirements on bank time and demand deposits, for example, but it cannot set them outside the bounds of the specific limits imposed by the Congress. A body known as the Federal Open Market Committee (FOMC), composed of the seven-member Board of Governors plus five of the Reserve Bank presidents directs open market operations. Although open market operations are directed by the FOMC, a person who appears to be simultaneously an employee of the FOMC and of the Federal Reserve Bank of New York executes them at the trading desk of the Federal Reserve Bank of New York. Legal authority over discount rates is even more confusing. Discount rates are established every two weeks by the directors of each regional Federal Reserve Bank, but they are subject to review and determination by the Board of Governors. The difference between establishing discount rates and determining them is a fine line indeed, and it is not surprising that confusion arises as to precisely where the final authority and responsibility lie. 3.1.2 The realities of power Actually, the facts of life are rather different, as the more realistic Figure 2 illustrates.
Chairman of the Board of Governors Other Members Of the Board of Governors Federal Open Market Committee
President of FRB of New York Other Federal Reserve Bank Presidents
Board Staff
Set (within limits)
Set Advisory Direct
Discount Rate
Trading desk At FRB of NY Execute
Reserve Requirements
Open Market Operations
Figure 2. The realities of power within the Federal Reserve System By all odds, the dominant figure in the formation and execution of monetary policy is the Chairman of the Board of Governors of the Federal Reserve System. The Chairman is the most prominent member of the Board itself and the most influential member of the FOMC and is generally recognised by both Congress and the public at large as the voice of the Federal Reserve System. Although the Federal Reserve act appears to put all seven members of the Board of Governors on more or less equal footing, over the past fifty years strong personalities, outstanding abilities, and determined devotion to purpose have made the chairmen rather more equal than others. As adviser to the President, negotiator with Congress, and final authority on appointments throughout the system, with influence over all aspects of monetary policy as Chairman of both the Board of Governors and the FOMC, the Chairman for all practical purposes is the embodiment of the central bank in the United States.
The other six members of the Board of Governors also exercise a substantial amount of authority, more so is indicated in the formal paper structure of the system, because with the passage of time primary responsibility for monetary policy has become more centralised and concentrated in Washington. When the Federal Reserve Act was passed in 1913, it was though that the Federal Reserve System would be mainly a passive service agency, supplying currency when needed, clearing checks, and providing a discount facility for the convenience of the private commercial member banks. At that time there was no conceptual monetary policy as an active counter cyclical force. Since then, the central bank has shifted from passive accommodation to active regulation, from the performance of regional service functions to the implementation of national economic policy. This shift has been accompanied, naturally enough, by the rise in the power of the centralised Board of Governors in Washington and a corresponding decline in the role of the regional Federal Reserve Banks and their owners, the commercial banks. It would not be unrealistic to describe the central bank today as headquartered in Washington, with twelve field offices throughout the nation. These field offices may be known by the rather imposing name of Federal Reserve Banks, and they do indeed retain considerable authority in expressing their views on the wisdom of various policies. But even so, they essentially amount to little more than branches of the Washington headquarters. Aside from the Board of Governors, its Chairman, and its staff, the only other body playing a major role in the Federal Reserve policy-making is the FOMC, which meets about every five or six weeks in Washington. Of the twelve members on the FOMC, a majority of seven is the Board of Governors themselves. The other five are Reserve Bank presidents. The President of the Federal Reserve Bank of New York is a permanent member of the FOMC, and the other eleven Federal Reserve Bank presidents rotate the remaining four seats among themselves.
3.1.3 The instruments of Central Banking The Federal Reserve exercises control over the bank lending and the money supply by altering the reserves of commercial banks and of other deposittype institutions and by influencing the deposit creation multiplier. The Fed accomplishes these objectives by changing reserve requirements relative to deposits and by changing the actual amount of reserves that financial institutions hold. The Fed varies the actual amount of reserves through the discount rate and open market operations. 3.1.3.1 Reserve requirements Within limits established by the Congress, the Federal Reserve can specify the reserve requirements that banks and other deposit-type institutions must hold against deposits. Congressional limits for bank reserves were first established in the Federal Reserve Act of 1913 and have been reset a number of times since, most recently in the Banking Act of 1980 and the Garn-St. German Depository Institutions Act of 1982. This most recent legislation provides that all depository institutions savings banks, savings and loans, and credit unions, as well as all commercial banks, whether members of the Federal Reserve System or not are subject to the Feds reserve requirements. As of 1993 each depository institution had to hold reserves (in the form of vault cash or deposits in a regional Federal Reserve Bank) as follows: 1. Against demand deposits and similar checking-type accounts, reserves equal to 3 percent of its first $46.8 million of demand deposits. 2. Against business-owned time and savings deposits. 3. Reserve requirements against personal time and savings deposits, which used to exist, have been eliminated. Lowering the required reserve ratio for demand deposits e.g. from 12 to 10 percent does two things. First, it instantly and automatically increases banks excess reserves, sine fewer reserves are now required against any given volume of demand deposits. More excess reserves, of course, enable banks to make more loans, buy more securities, and expand demand deposits.
In addition, lowering the required reserve ratio also increases the demand deposit expansion multiplier for the entire banking system. The multiplier is the reciprocal of the required reserve ratio; the smaller the ratio, the larger its reciprocal. Thus a decrease in the required reserve ratio from 12 (or about 1/8) to 10 percent (1/10) would raise the deposit expansion multiplier from about eight to ten. Raising the required reserve ratio for example, from 10 to 12 percent would have the opposite effects. It would create reserve deficiencies, or at least reduce excesses, and lower the potential for multiple expansion. Putting banks into a deficit reserve position would force them to call in loans and sell securities, bringing about a reduction in demand deposits, while smaller excesses would at least restrain lending and deposit creation. How crucial are reserve requirements for monetary policy? What would happen if the Federal Reserve eliminated reserve requirements entirely in order to increase bank profits? Actually, even without formal reserve requirement the Fed would still be in business. Financial institutions would still need both cash to meet customer withdrawals and balances in the Fed to clear checks. As long as they have a demand for claims against the central bank, and as long as the central bank controls the supply of such claims, monetary policy can still work. While the Fed would lose one tool of monetary policy if it could no longer change reserve requirements, it could still influence the behaviour of financial institutions. 3.1.3.2 Discounting and the discount rate The Federal Reserve can also alter the excess reserves of banks and other depository institutions by changing the actual amount of reserves that financial institutions hold. One way this is accomplished is through the discount mechanism, by which the Fed lends reserves, temporarily, to the banks. The Fed charges an interest rate, called the discount rate, on such loans. In other words, banks faced with reserve deficits can temporarily borrow reserves from their regional Federal Reserve Bank at a price (the discount rate).
When a manufacturer borrows from a bank, he receives a brand-new deposit at the bank. A bank is in the same position relative to the Federal Reserve: when it borrows from its district Reserve Bank, it receives a brand-new deposit at the Fed, which increases its legal reserves. The ability to borrow these reserves to discount from the Fed means that when a bank is faced with reserve deficiency, the bank does not have to call in loans or sell securities an thus the money supply can remain unchanged. The Federal Reserve tries to influence the willingness of banks to borrow reserves by changing the interest rate it charges on such loans (the discount rate). A lower discount rate will make the borrowing of reserves more attractive to banks, and a higher discount rate will make it less attractive. The effectiveness of the discount mechanism as a means of injecting or withdrawing reserves is limited by the fact that the initiative of borrowing from the Fed rests not with the Fed but with the banks. Banks will want to borrow reserves only when they need them. If they already have ample reserves, there is no need for them to borrow more, no matter how low the discount rate. It has been recognised for a long time that discount policy has two dimensions: the first is price, the discount rate, the rate of interest the Federal Reserve charges financial institutions when they borrow from the Fed. The second dimension has to do with the quantity of the Federal Reserve lending, including Fed surveillance over the amount that each institution borrows and the reasons why it borrows. Let us examine quantity first and price second. Historically, the primary function of a central bank has been to stand ready to supply funds promptly and in abundance whenever the economy is in danger of coming apart because of cash storage. While that is no longer its sole function, it is still one of its most important. The central bank is the ultimate source of liquidity in the economy, because with its power over bank reserves it can increase (or decrease) the ability of the banking system to create money. Since no one else can do the job, it is the central bank that must be responsible for supplying funds promptly on those rare but crucial occasions when liquidity shortages threaten economic stability: financial panic, the history books call them. Because of this responsibility, the central bank has traditionally been called the lender of last resort.
The discount facilities instituted by the passage of the Federal Reserve Act in 1913 were supposed to provide a vehicle through which the Federal Reserve could quickly inject funds precisely where needed in order to stop a panic from spreading. Banks threatened with cash drains could borrow what they needed from the Fed the lender of the last resort. Thus they could get more reserves without any other bank losing them and thereby prevent an infection from becoming a plague. In the ordinary course of events, however, bank use of the discount facility is rather routine, not at all panic-oriented, with banks borrowing here and there to make short-run adjustments in their reserves. The Fed has always stresses that ordinary borrowing of this sort should not be used too often to get banks out of reserve difficulties. Banks should run their affairs so they do not have to rely on the Fed to bail them out every few weeks. Or, as the Federal Reserve usually puts it, discounting is considered a privilege, not a right, and privileges should not be abused. Federal Reserve surveillance enforces the privilege, not a right concept by checking up on banks that borrow too much or too frequently. A bank is supposed to borrow only because of need, and not go out and make a profit on the deal. One Fed method of preventing abuse of the discounting facility is to tighten surveillance procedures: it checks up on why banks are borrowing and what they are doing with the money. Another way is simply to raise the price of borrowing which brings us to the discount rate itself. 3.1.3.3 Open Market Operations The most important way the Federal Reserve alters the actual amount of reserves the banks hold is not by discounting, but buying and selling government securities technically known as open market operations. Undertaken at the Feds own initiative, open market operations are the mainstay of the Federal Reserve policy. When the Federal Reserve buys $1,000 of government securities, much as you might buy a stock or a bond on one of the stock exchanges, it pays with a check drawn on itself. If the Fed buys the securities directly from a commercial bank, that bank sends the Feds check to its regional Federal Reserve Bank and has its deposit at the Fed its reserves increased by $1,000. The bank excess reserves rise by the full amount of the transaction,
and with more excess reserves it can make more loans and increase its demand deposits. But what the central bank gives, the central bank can take away. When the Federal Reserve sells government securities out of its portfolio, it gets paid for them, and everything is reversed. The Fed takes payment by deducting that sum from the buying banks deposit at the Federal Reserve, thus diminishing its reserves. Of course, when the Federal Reserve buys (or sells) government securities, it has no assurance that a bank will be the other party of the transaction. But it doesnt matter whether the securities someone else is selling by a bank or the Fed buys. In either case, when the Fed buys, bank reserves go up, and when the Fed sells, bank reserves go down. Commercial banks are unable to do anything to offset these measures. If the Fed wants to reduce bank reserves by open market sales, there is nothing banks can do about it. By lowering its selling price, the Fed can always unearth a buyer. Since it is not in business to make a profit, the Fed is free to alter its selling price as it wishes. And while any single commercial bank can replenish its own reserves by selling securities to other banks or to individuals who keep their accounts in other banks the reserves of the other banks will then decline. Another loses reserves replenished by one bank. Total bank reserves must fall by the value of the securities sold by the Federal Reserve. There are three types of Interest Rates, as follows: The prime rate, the discount rate, and the federal funds rate are referred to in newspapers so often that they deserve special mention, particularly since they are frequently confused with each other. The prime rate is the interest rate that commercial banks charge on loans to their most creditworthy business customers, most creditworthy meaning financially strongest and therefor most likely to repay on time. Banks charge higher rates then the prime for loans to corporations without such strong credit ratings. The prime rate is an administered rate in that banks set it and it stays there until they decide to raise or lower it; thus the prime rate typically stays the same for weeks or even months at a time.
The discount rate is the interest rate that the Federal Reserve, the governments central bank, charges on loans to commercial banks. The Federal Reserve makes short-terms loans to banks when the banks need funds for relatively brief periods of time. Thus the prime rate involves a payment commercial banks receive, while the discount rate is a cost, something they pay out. Like the prime rate, the discount rate is also an administered rate, set in this case by the Federal Reserve and often staying unchanged for months. Finally, the federal funds rate often called just the funds rate is the interest rate that banks charge each other on very short-terms loans among themselves. Usually the loans are overnight made on one day and paid back the next. Unlike the prime rate and the discount rate, the federal funds rate is not an administered rate; rather, it is a marketdetermined rate, fluctuating continuously depending on the relationship between the demand for loans (by banks who need to borrow) and the supply (from banks who want to lend).
3.1.4 Financial institutions Financial institutions such as banks, insurance companies, and pension funds are called by a special name: financial intermediaries. They dominate the financial scene at home and abroad. It is virtually impossible to spend or save or lend or invest money nowadays without getting involved with some kind of financial intermediary in one way or another. Financial Institutions in Profile Although financial institutions have a lot in common, there are also substantial differences among them. Ranked in terms of asset size, commercial banks are easily the largest. In addition to sheer size, the composition of liabilities and assets also differs significantly from one type of financial institution to another. Commercial banks are the most prominent of all financial institutions. There are about 12,000 of them, ranking from Citibank, with hundreds of billions of dollars in assets, to thousands of small banks scattered throughout the country, many of which have less that a hundred million dollars. Commercial banks are also the most widely diversified in terms of both liabilities and assets. Their major source of funds used to be demand
deposits (checking accounts), but in the past few decades savings and time deposits including certificates of deposits have become even more important than demand deposits. With these funds, commercial banks buy a wide variety of assets, ranging from short-term government securities to long-term business loans and home mortgages. Life insurance companies rank third in asset size. They insure people against the financial consequences of death, receiving their funds in the form of periodic payments (called premiums) that are based on mortality statistics. They can predict with a high degree of actuarial probability how much money they will have to pay out in benefits over the next years. They invest accordingly, aiming for the highest yield consistent with safety over the long run. Thus a high percentage of their assets are in the form of longterm corporate bonds and long-term mortgages, although the mortgages are typically on commercial rather than residential properties. Pension and retirement funds are similar to life insurance companies in that they are mainly concerned with the long rather than the short run. Their inflow of money comes from working people building a nest egg for their retirement years. They are able to predict amounts they will have to pay out in pensions (called annuities) for the next years. Since they face few shortterm uncertainties, they invest mainly in long-term corporate bonds and high-grade stocks. Mutual funds are frequently stock market related institutions but there are also mutual funds specialising in bonds of all kinds and in mortgages as well. Pooling the funds of many people of moderate means, the funds management invests the money in a wide variety of stocks or bonds, thereby obtaining diversification those individuals acting alone might not be able to achieve. Buying shares in a mutual fund is more risky than buying a savings deposit or a money market instrument such as a Treasury bill, butt it is less risky than buying stocks or bonds on your own. Money market mutual funds are like the old-fashioned kind of mutual fund. However, the funds management does not invest the money in the stock market or in corporate or municipal bonds. Instead, it purchases highly liquid short-term money market instruments, such as large-size bank negotiable CDs, Treasury bills, and high-grade commercial paper.
Savings and loan associations (S&Ls) have traditionally acquired almost all their funds through savings deposits usually called shares instead of deposits and used them to make home mortgage loans. This was their original purpose to encourage family thrift and home ownership. The Banking Act of 1980 granted them the power to issue checking accounts (NOW negotiable order of withdrawal) and also to make consumer loans. Sales and consumer finance companies specialise in leading money for people to buy cars and take vacations and for business firms to finance their inventories. Many of them are owned by a manufacturing firm and lend money mainly to help retailers and customers buy that firms products. They get their funds by selling their own short-term promissory notes (called commercial paper) to business firms with funds to invest for a short while, as well as by selling their own long-term bonds. Property and casualty insurance companies insure homeowners against burglary and fire, car owners against theft and collision, doctors against malpractice suits, and business firms against negligence lawsuits, among other things. The premiums they receive they buy high-grade municipal and corporate bonds, high-grade stock and short-term money market instruments such as Treasury bills (for liquidity). Credit unions (about 13,000) are organised as co-operatives for people with some sort of common interest, such as employees of a particular company or members of a labour union. Credit union members buy shares, which are the same as deposits, and thereby become eligible to borrow from the credit union. Mutual savings banks are practically identical with savings and loan associations except that there are only about 500 of them. They are legally structured as mutual or co-operatives, with the depositors or shareholders owning the institution. Savings banks have traditionally obtained most of their funds in the form of savings deposits and used the money mainly to make home mortgages. The Banking Act of 1980 also gave them the power to issue demand deposits (NOW accounts) and to make consumer and some business loans.
3.1.5 The regulation and structure of depository institutions 3.1.5.1 The dual banking system The American commercial banking system is known as a dual banking system because its main feature is side-by-side federal and state chartering (and supervision) of commercial banks. It has no counterpart in any other country. Indeed, it arose quite by accident in the United States, the unexpected result of legislation in the 1860s that was intended to shift the authority to charter banks from the various state governments to the federal government. Thus today the USA has a dual banking system: federally chartered banks, under the aegis of the Comptroller of the currency, and state-chartered banks, under the supervision of each of the various states. A unique feature of the system is that the regulated can choose their regulator: state banks can shift to national charters and vice versa, state member banks can shift to non-member status and vice versa. The justification for the dual banking system side-by-side federal and state bank regulation is that it is supposed to foster change and innovation by providing alternative routes through which banks can seek charters and do business. It is claimed that a dual banking system is more responsive to the evolving banking need of the economy than a single system would be. The validity of these arguments is difficult to assess, but whatever their merits no one has been marching in the streets demanding change in the status quo. The dual banking system seems to be working tolerably well, regardless of its logic. 3.1.5.2 Multiple federal authorities The dual banking system has aroused considerably less controversy than the existence of multiple and sometimes opposing supervisory authorities at the federal level. In 1960s the Federal Reserve and the Comptroller clashed frequently over the interpretation of certain laws. Relations between the FDIC and the Comptroller were also strained, although the Comptroller is one of the three members of the FDICs Board of Directors.
Different interpretations of the same statuses and intermittent dissension that has punctuated relations among the federal supervisory agencies have led many to recommend that all federal chartering, examination, and supervisory responsibilities be combined in a single agency. The proposal has always foundered, however, on lack of consensus as to which agency The Federal Reserve, the FDIC, or the Comptroller of the Currency is most appropriate. Notice that consolidation at the federal level would not affect the dual banking system, since state chartering and supervision would continue to exist. The present system is defended by some on the grounds that divided federal authority, like the dual banking system, provides an element of flexibility, fostering innovation and change that would be lacking if all federal banking powers were concentrated in one agency. On the other hand, if there is to be federal supervision of banking at all, it would appear axiomatic and operated at minimum cost which implies that one supervisory body is preferable to disagree fairly often among themselves. It has to be admitted, however, as an argument in favour of the status quo, the federal regulatory agencies, in general, have not compiled a particularly outstanding record for imaginative leadership, for stimulating innovation, or even for protecting (not to mention furthering) the public interest. While a forward-looking, able, and conscientious federal banking authority would undoubtedly be an improvement over present arrangements, lack of these qualities in a consolidated agency might only make matters worse. 3.1.5.3 Deposit insurance and the FDIC During the 1920s bank failures averaged about 600 a year, and during the years 1930-1933 over 2,000 a year! At the end of 1933 there were fewer than 15,000 commercial banks remaining out of 30,000 that had been in existence in 1920. It is not surprising, therefore, that the Congress established the Federal Deposit Insurance Corporation (FDIC) in response to this historic debacle. The Banking Act of 1993 to insure deposits at commercial and mutual savings banks created the FIDC. Companion legislation created the Federal Savings and Loan Insurance Corporation to do the same for savings and loan associations, and in 1970 the National Credit Union Administration initiated deposit insurance for federally chartered credit unions. FDIC
deposit insurance became effective on January 1, 1934, with coverage limited to $2,500 per depositor per bank. This was raised to $5,000 in mid1934, $10,000 in 1950, $15,000 in 1966, $20,000 in 1969, $40,000 in 1974, and $100,000 in 1980. According to FDIC survey data, the present coverage provides full insurance for about 99 percent of the depositors in the insured banks. With respect of the dollar volume, however, the 1 percent of the depositors not fully covered holds uninsured balances that constitute a fourth of the dollar value of total deposits. In other words, although almost all depositors are fully insured (that is, they have less than $100,000 in their accounts in any single bank), a fourth of the deposits in term of dollar value are not insured. Although nominal insurance coverage is $100,000 per depositor per bank, in fact actual coverage may be greater (never less), depending on the procedure used by the FDIC in taking over a failed bank. The FDIC may allow the bank to go into receivership, the so-called payoff method. In such cases the FDIC sends its agents to the bank verifies the deposit records, and then pays out funds directly to each depositor up to a limit of $100,000. Alternatively, the FDIC may succeed in merging the failed bank with a healthy one, the so-called assumption method. The deposits of the failed bank are assumed by another bank into which the distressed one is merged and are made available in full to the depositors. The FDIC usually assists in this procedure, either by making payments to the bank taking over and/or by relieving it of some of the weaker assets of the failed bank. The assumption method has been the one most often used in the recent years; in such cases the FDIC has in effect completely insured all depositors to the full amount of their deposits, regardless of the technical insurance coverage limit. In addition, in a few cases the FDIC has extended loans to a bank in difficulty and allowed it to continue in business. The explanation for the success of the FIDC does not involve calculations of actuarial probability, but rather rests on the premise that the very existence of federal deposit insurance eliminated the possibility large-scale bank failure. By insuring deposits under the auspices of the federal government, backed by the implied support of the United States Treasury to whatever extent necessary, the FDIC has successfully eliminated the old-fashioned run on the bank by frightened depositors that formerly heralded another
bank failure. If people hear their bank is in trouble now, they hardly pay attention. Theyre insured, so who cares? Where does the FDIC get the money it uses to pay off depositors of failed banks? It gets it from premiums it assesses on the banks it insures. Until recently these were flat premiums, unadjusted for risk, but since 1993 this has been changed: banks now pay annual premiums to the FDIC equal to 23 cents for every hundred dollars of insured deposits, with premiums rising to as much as 31 cents per $100 of insured deposits for banks considered more risky with respect to possible failure. The FDIC measures a banks risk of failure by the amount of capital the bank has and by an assessment of the quality of its loans and investments. In 1989, the FDIC was given additional powers when the government agency that insured deposits at savings and loan associations the Federal Savings and Loan Insurance Corporation (FSLIC) was abolished after it ran out of money. As a result, the FDIC now has two departments: 1. The Savings Association Insurance Fund (SAIF), which took over responsibility from the defunct FSLIC for the insurance of deposits at savings and loans, and The Bank Insurance Fund (BIF), which insures deposits at commercial banks and most savings banks, which is what the FDIC has always done.
2.
But in 1991 the Bank Insurance Fund part of the FDIC also ran out of money. The FDIC had a working balance of over $18 billion in 1987, but the flood of subsequent bank failures wiped that out in less than four years. What happens now? If banks continue to fail at the peace of the late eighties and early nineties, current insurance premiums that banks pay to the FDIC will be insufficient to pay off all the insured depositors and the FDIC will have no other choice but to borrow the remainder from the federal government. This brings us to the heart of the matter: it is the governments commitment to stand behind the FDIC that is important, not whether the FDIC has actually got enough money on hand to cover all contingencies. So long as that commitment is honoured, depositors need not worry about the safety of their money.
3.1.5.4 Bank size distribution and the McFadden Act The objectives of bank supervision, regulation, and insurance are to protect the safety of depositors funds and promote a viable and smoothly functioning banking system one that will encourage saving channels funds from savers to borrowers, enable borrowers to get funds on reasonable terms, and foster economic stability and growth. All of this means that the objectives of bank supervision, regulation, and insurance are to make sure that banks are both safe and competitive. The FDIC and bank examinations are design to ensure safety, while other aspects of supervision are intended to promote competition. In down-to-earth terms, competitive conditions mean that customers can shop around, that they have alternatives. For example, are the opportunities open to depositors sufficiently varied to give them an array of choices with respect to deposit terms and yields, so they can pick those that best suit their particular need? Similarly, do borrowers who are refused a loan at one bank have alternatives open to them other banks to which they can turn? Do banks actively seek customers, either depositors or borrowers, by offering more service or better terms than rival banks are offering? With so many commercial banks in the United States, there would appear to be, on the face of it, a high degree of robust competition in banking. However, as Table 2 indicates, a large percentage of banks are very small institutions, with less that $50 million of assets per bank. Size Distribution of Insured Commercial Banks (end of 1990)
Asset size No. of banks % of total banks % of total assets
Less that $25 million $25 50 million $50 100 million $100 500 million $500 1 billion over $1 billion
TOTALS
3,330 3,145 2,782 2,461 253 374

12,345
27 25 23 20 2 3
100
2 3 6 14 5 70
100
Indeed, almost 6,500 of the banks in the country 52 percent of them are that small (see lines 1 and 2 in the table). These 6,500 banks have only 5 percent of the aggregate assets in the banking system. Most of them are in small, one-bank towns. At the other end of the scale, about 600 large banks
(the last two line of Table 2), only 5 percent of the total have 75 percent of all bank assets. If the large number of very small were the product of natural evolution, it would indicate that the optimum (low-cost) size bank is probably a very small size institution. Their large numbers would attest to their competitive viability. In fact, the reason for so many very small banks in this country does not have much to do with their successful adaptation to changing economic needs or their innovative capabilities. It is that most of them are sheltered from competition by state anti-branching statutes, to which the federal banking authorities defer. Many very small banks would be unable to remain in business if a large bank opened up a branch next door. The fact that in many states the large bank is legally prohibited from doing so is what permits many small banks to survive. The McFadden Act of 1927 (a) prohibits banks from branching across state lines and (b) permits national banks to branch within a state only to the state extent as state-chartered banks. The result is that the McFadden Act and state anti-branching statute not economic circumstances are the principal determinants of the number of banks in the United States. However, there are many straws in the wind indicating that the prohibition against interstate branching is on its last legs: mergers between banks located in different states, acquisitions by parent holding companies, enacting of legislation permitting reciprocal interstate banking, establishing by both national and state banks of bank-related subsidiaries and affiliates. Everything considered, a number of steps toward nation-wide branch banking appear to have been taken. Most observers believe that it will be commonplace by the turn of the century. 3.1.5.5 Savings banks and savings and loan associations Savings banks were the first thrift institutions in the country. The Provident Institution for Saving in Boston and the Savings Fund Society in Philadelphia was not organised until fifteen years later. Nowadays, though, for all practical purposes savings banks and savings and loans are hard to tell apart except by their names. The 400 or so savings banks, mostly on the eastern seaboard, are almost all state chartered; federal chartering of savings banks was not begun until
1978. Because most are state chartered, they are state regulate and state supervised. Savings and loan associations may be federally or state chartered. Of the roughly 2,000 S&L in existence, slightly more than half is chartered by the states in which they operate and the rest by the federal government. Prior to 1989, virtually all of them were members of a system that was to S&Ls what that Federal Reserve System is to commercial banks: the Federal Home Loan Bank System, like the Federal Reserve System, consisted of twelve regional banks plus a supervisory board in Washington. The Federal Home Loan Bank Board (FHLBB) regulated S&Ls by chartering them, conducting examinations, and reviewing applications for branches and mergers. Under the Depository Institutions Deregulation and Monetary Control Act of 1980, otherwise known as the Banking Act of 1980, both S&Ls and savings banks must hold reserves against their checking accounts and business time deposit liabilities, as specified by the Federal Reserve; as a quid pro quo, they have full access to temporary borrowing from the Federal Reserve when needed. Most savings banks are insured by the Bank Insurance Fund of the FDIC, up to the standard $100,000 per depositor, just likes commercial banks. S&Ls, on the other hand, used to be insured by the Federal Savings and Loan Insurance Corporation (FSLIC), also up to $100,000 per depositor. While the FDIC is an independent agency, the FSLIC was a subsidiary of the Federal Home Loan Banking System, and the Federal Home Loan Bank Board determined its policies. Because of the large number of savings and loan failures, the FSLIC ran out of money in the late eighties and was abolished in 1989. Today, the Saving Association Insurance Fund (SAIF), a branch of the FDIC, insures deposits in savings and loans. 3.1.5.6 Mortgage-related financial institutions It should be noted that there are a number of government sponsored efforts to support the activities of mortgage related financial institutions. Perhaps the most popular is the Federal National Mortgage Association, also known as Fannie Mae, established by Congress in 1938. It later became part of the Department of Housing and Urban Development (HUD) and in 1968 became a privately owned corporation with certain ties to the government.
Fannie Mae buys mortgages from S&Ls and other institutions that no longer wish to hold them as investments and finances these so-called secondarymarket operations primarily by issuing bonds to the public. Fannie Maes performance in the mortgage market is complemented by the work of Ginnie Mae, more properly called the Government National Mortgage Association. A relative newcomer to the mortgage market scene, Ginnie Mae has a name in connection with the pass-through program. Instead of buying mortgages and financing these acquisitions by issuing her own securities, Ginnie Mae guarantees the timely payment of interest and principal on packages of pools of mortgages that are insured by the Federal Housing Administration (FHA) or the Veterans Administration (VA). Private mortgage originators such as savings and loan associations or mortgage bankers put these pools of mortgage together. GNMA passthrough securities are attractive to such investors as pension funds and insurance companies because of their government guarantee and liquidity. The pass-through program has made mortgages look very mush like bonds to some investors, thereby broadening the source of mortgage funds. In 1970, Congress established the Federal Home Loan Mortgage Corporation (FHLMC). Dubbed Freddie Mac by the investment community, this latest creation does just about what Ginnie Mae does, except that instead of FHA-VA mortgage-backed securities, Freddie Mac creates participation certificates in conventional mortgages and sells them to ultimate investors. As with Ginnie Mae, the objective is to attract nontraditional funds into the mortgage market by packaging individual mortgage loans into a bond like instrument. All these government and government-sponsored agencies are very active, especially during periods of tight money, in helping to finance mortgage activity. They have, in fact, let to concern in the capital market over the federalisation of the mortgage market. 3.1.5.7 Credit unions The first credit union in the country was established in Manchester, New Hampshire in 1909. Credit unions now number 14,000, making the most numerous of the thrift institutions. They have not been subject to the same problems as S&Ls and mutual savings banks, because the bulk of their lending has historically taken the form of relatively short-term consumers
loans. They may encounter similar problems if they dont watch out, though, because credit unions now engage in mortgage lending as one of their activities. Credit unions may be federally or state chartered, but the majority has federal charters. State-chartered institutions are regulated and supervised by the states in which they operate and the federally chartered ones by the National Credit Union Administration in Washington. The National Credit Union Share Insurance Fund, run by the National Credit Union Administration, provides deposit insurance (up to $100,000 per depositor) for both state and federally chartered credit unions. The Current Federal Regulatory Structure In Brief Federal Reserves (Fed). Established as an independent agency in 1913, supervises and examines state-chartered banks that are members of the FR System and regulates all bank holding companies, regardless of charter. Comptroller of the currency. Established in 1863 as an office within the US Treasury Department. Charters, regulates, examines, and supervises nationally chartered banks. Office of thrift Supervision (OTS). Established in 1989 and, like the Comptroller of the Currency, a department within the US Treasury. Charters, regulates, examines, and supervises savings and loan associations. (Until 1989 these functions were performed by the Federal Home Loan Bank Board.) Federal Deposit Insurance Corporation (FDIC). Established as an independent agency by the Banking Act of 1933. Has historically insured deposits at virtually all commercial banks and most savings banks. Examines and supervises state-chartered banks that are not members of the Federal Reserve System. Given additional Insurance powers in 1989, it now administers: (a) the Bank Insurance Fund (BIF), which insures deposits at commercial and most savings banks, and (b) the Savings Association Insurance Fund (SAIF), which insures deposits at savings and loan associations. (In 1689, the SAIF replaced the FSLIC, the Federal Savings and Loan Insurance Corporation.)
Resolution Trust Corporation (RTC). Managers the closing and/or merging of insolvent savings and loan associations. Federal Housing Finance Board (FHFB). Oversees the twelve regional Federal Home Loan Banks, a role that until 1989 was performed by the Federal Home Loan Banks Board. National Credit Unit Administration (NCUA). Established in 1970 as an independent agency to charter, regulate, examine and supervise federal credit unions. National Credit Union Share Insurance Fund (NCUSIF). Created in 1970 under management of NCUA. Insures deposits at federal credit unions and insured state-chartered credit unions. US Department of Justice. May review proposed mergers, acquisitions, and related changes in the structure of the financial industry and sue to block those believed to be anti-competitive. Securities and Exchange Commission (SEC). Established under 1933 and 1934 legislation to regulate securities brokers and dealers and securities markets. Mutual funds, including money market funds, are now also under its jurisdiction. Specifies and enforces public disclosure requirements and regulates insider trading. Involved with banks particularly with respect to bank holding companies and public disclosure regarding such matters as problem loans. 3.2 The European System of Central Banks 3.2.1 Organisation of the European System of Central Banks (ESCB) The ESCB is composed of the European Central Bank (ECB) and the EU national central banks (NCBs). The NCBs of the Member States which do not participate in the Euro area, however, are members of the ESCB with a special status: while they are allowed to conduct their respective national monetary policies, they do not take part in the decision-making regarding the single monetary policy for the Euro area and the implementation of such decisions. In accordance with the Treaty establishing the European Community and the Statute of the European System of Central Banks and of the European
Central Bank (ESCB Statute), the primary objective of the ESCB is to maintain price stability. Without prejudice to this objective, it shall support the general economic policies in the Community and act in accordance with the principles of an open market economy. The basic tasks to be carried out by the ESCB are: to define and implement the monetary policy of the Community; to conduct foreign exchange operations; to hold and manage the official foreign reserves of the Member States; and to promote the smooth operation of payment systems. In addition, the ESCB contributes to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system, while it also has an advisory role vis--vis the Community and national authorities on matters which fall within its field of competence, particularly where Community or national legislation is concerned. Finally, in order to undertake the tasks of the ESCB, the ECB, assisted by the NCBs, shall collect the necessary statistical information either from the competent national authorities or directly from economic agents. The decision-making bodies of the ECB govern the ESCB: the Governing Council, the Executive Board and the General Council. The Governing Council comprises all the members of the Executive Board and the governors of the Member States without derogation, i.e. those NCBs, which fully participate in the Monetary Union. The main responsibilities of the Governing Council are: to adopt the guidelines and make the decisions necessary to ensure the performance of the tasks entrusted to the ESCB; and to formulate the monetary policy of the Community, including, as appropriate, decisions relating to intermediate monetary objectives, key interest rates and the supply of reserves in the ESCB, and to establish the necessary guidelines for their implementation.
The Executive Board comprises the President, the Vice-President and four other members; all chosen from among persons of recognised standing and professional experience in monetary or banking matters. They are appointed by common accord of the governments of the Member States at the level of the Heads of State or Government, on a recommendation from the European Council after it has consulted the European Parliament and the Governing Council of the ECB (i.e. the Council of the European Monetary Institute for the first appointments). The main responsibilities of the Executive Board are: to implement monetary policy in accordance with the guidelines and decisions laid down by the Governing Council of the ECB and, in doing so, to give the necessary instructions to the NCBs; and to execute those powers which have been delegated to it by the Governing Council of the ECB. The General Council comprises the President and the Vice-President and the governors of all the NCBs, i.e. of both those Member States with as well as those without a derogation. The General Council performs the tasks, which the ECB took over from the European Monetary Institute (EMI) and which, owing to the derogation of one or more Member States, still have to be performed in the third stage. The General Council also contributes to: the ESCBs advisory functions (see above); the collection of statistical information; the preparation of the ECBs quarterly and annual reports and weekly consolidated financial statements; the establishment of the necessary rules for standardising the accounting and reporting of operations undertaken by the NCBs; the taking of measures relating to the establishment of the key for the ECBs capital subscription other than those already laid down in the Treaty; the laying-down of the conditions of employment of the ECBs staff; and the necessary preparations for irrevocably fixing the exchange rates of the currencies of the Member States with a derogation against the Euro.
The ESCB is an independent system. When performing ESCB-related tasks, neither the ECB, nor an NCB, nor any member of their decision-making bodies may seek or take instructions from any external body. The Community institutions and bodies and the governments of the Member States may not seek to influence the members of the decision-making bodies of the ECB or of the NCBs in the performance of their tasks. The ESCB Statute makes provision for the following measures to ensure security of tenure for NCB governors and members of the Executive Board: a minimum renewable term of office for governors of five years; a minimum non-renewable term of office for members of the Executive Board of eight years (it should be noted that a system of staggered appointments is foreseen for the first Executive Board for members other than the President in order to ensure continuity); removal from office is only possible in the event of incapacity or serious misconduct; and the European Court of Justice is competent to settle any disputes. The ECBs capital is 5,000 million. The NCBs are the sole subscribers to and holders of the capital of the ECB. The subscription of capital is based on a key established on the basis of the EU Member States respective shares in the GDP and population of the Community. The NCBs of the eleven Member States participating in the Euro area in proportion and up to their shares will pay up the capital of the ECB. In addition, the NCBs will provide the ECB with foreign reserve assets other than the Member States currencies, Euro, IMF reserve positions and SDRs, up to an amount equivalent to 50,000 million. The contributions of each NCB are fixed in proportion to its share in the ECBs subscribed capital, while in return each NCB is credited by the ECB with a claim equivalent to its contribution. The ECB has the full right to hold and manage the foreign reserves that are transferred to it and to use them for the purpose set out in the ESCB Statute. The Statute contains specific rules with regard to the calculation of those amounts, which will ultimately determine the profit distributed to the ECBs shareholders.
3.2.2 Objectives and tasks of the European System of Central Banks The primary objective of the European System of Central Banks (ESCB), as defined in Article 2 of the Statute of the European System of Central Banks and of the European Central Bank (ESCB Statute) is to maintain price stability. Without prejudice to the primary objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community. In pursuing its objectives, the ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources. The basic tasks to be carried out by the ESCB are defined in Article 3 of the ESCB Statute. These tasks include: to define and implement the monetary policy of the Community; to conduct foreign exchange operations; to hold and manage the official foreign reserves of the participating Member States; to promote the smooth operation of payment systems; and to contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system. Monetary functions and operations of the ESCB: The ESCB Statute (Articles 17 to 24) specifies the monetary functions and operations of the ESCB. On the basis of these provisions, the European Monetary Institute (EMI) prepared an operational framework for the ESCBs monetary policy. The Governing Council of the European Central Bank (ECB) will take the final decision on the operational framework. The Governing Council of the ECB may decide not to use all the available options or may change certain features of the instruments and procedures presented below. Further detailed information on these issues can be found in the EMI publications entitled The single monetary policy in Stage Three - Specification of the operational framework (January 1997) and The single monetary policy in Stage Three - General documentation on ESCB monetary policy instruments and procedures (September 1997). Monetary policy instruments
The operational framework consists of a set of instruments; the ESCB will conduct open market operations, it will offer standing facilities and it may require credit institutions to hold minimum reserves on accounts with the ESCB. Open market operations Open market operations will play an important role in the monetary policy of the ESCB for the purpose of steering interest rates, managing the liquidity situation in the market and signalling the stance of monetary policy. Five types of instruments will be available to the ESCB for the conduct of open market operations. The most important instrument will be reverse transactions (applicable on the basis of repurchase agreements or collateralised loans). The ESCB may also use outright transactions, the issuance of debt certificates, foreign exchange swaps and the collection of fixed-term deposits. Open market operations will be initiated by the ECB, which will also decide on the instrument to be used and the terms and conditions for the execution of such operations. It will be possible to execute open market operations on the basis of standard tenders, quick tenders or bilateral procedures. With regard to their aim, regularity and procedures, the ESCB open market operations can be divided into the following four categories: The main refinancing operations are regular liquidity-providing reverse transactions with a weekly frequency and maturity of two weeks. They will be executed by the national central banks on the basis of standard tenders and according to a pre-specified calendar. The main refinancing operations will play a pivotal role in pursuing the purposes of ESCB open market operations and provide the bulk of refinancing to the financial sector. The longer-term refinancing operations are liquidity providing reverse transactions with a monthly frequency and a maturity of three months. They will be executed by the national central banks on the basis of standard tenders and according to a pre-specified calendar. These operations aim to provide counterparts with additional longer-term refinancing. As a rule, the ESCB will not intend to send signals to the market by means of these operations and will therefore normally act as a rate taker.
Fine-tuning operations can be executed on an ad hoc basis with the aim both of managing the liquidity situation in the market and of steering interest rates, in particular in order to smooth the effects on interest rates caused by unexpected liquidity fluctuations. Fine-tuning operations will primarily be executed as reverse transactions, but may also take the form of outright transactions, foreign exchange swaps and the collection of fixed-term deposits. The instruments and procedures applied in the conduct of fine-tuning operations will be adapted to the types of transactions and the specific objectives pursued in performing the operations. Fine-tuning operations will normally be executed by the national central banks through quick tenders or bilateral procedures. The Governing Council of the ECB will decide whether, under exceptional circumstances, fine-tuning bilateral operations may be executed by the ECB itself. In addition, the ESCB may carry out structural operations through the issuance of debt certificates, reverse transactions and outright transactions. These operations will be executed whenever the ECB wishes to adjust the structural position of the ESCB vis--vis the financial sector (on a regular or non-regular basis). Structural operations in the form of reverse transactions and the issuance of debt instruments will be carried out by the national central banks through standard tenders. Structural operations in the form of outright transactions will be executed through bilateral procedures. Standing facilities Standing facilities aim to provide and absorb overnight liquidity, signal the general stance of monetary policy and bound overnight market interest rates. Two standing facilities, which will be administered in a decentralised manner by the national central banks, will be available to eligible counterparts on their own initiative: Counterparts will be able to use the marginal lending facility to obtain overnight liquidity from the national central banks against eligible assets. The interest rate on the marginal lending facility will normally provide a ceiling for the overnight market interest rate. Counterparts will be able to use the deposit facility to make overnight deposits with the national central banks. The interest rate on the deposit facility will normally provide a floor for the overnight market interest rate.
Minimum reserves Preparatory work has been carried out with a view of enabling the ESCB to impose minimum reserves as from the start of Stage Three. It will be up to the Governing Council of the ECB to decide whether minimum reserves will actually be applied. Any minimum reserves system would be intended to pursue the aims of stabilising money market interest rates, creating (or enlarging) a structural liquidity shortage and possibly contributing to the control of monetary expansion. The reserve requirement of each institution would be determined in relation to elements of its balance sheet. In order to pursue the aim of stabilising interest rates, the ESCBs minimum reserves system would enable institutions to make use of averaging provisions. This implies that compliance with the reserve requirement would be determined on the basis of the institutions average daily reserve holdings over a onemonth maintenance period. Counterparts The ESCB monetary policy framework is formulated with a view of ensuring the participation of a broad range of counterparts. If minimum reserves are applied, only institutions subject to minimum reserves may access the standing facilities and participate in open market operations based on standard tenders. If no minimum reserves are applied, the range of counterparts will broadly correspond to credit institutions in the Euro area. The ESCB may select a limited number of counterparts to participate in fine-tuning operations. For outright transactions, no restrictions will be placed a priori on the range of counterparts. Active players in the foreign exchange market will be used for foreign exchange swaps conducted for monetary policy purposes. Underlying assets Pursuant to Article 18.1 of the ESCB Statute, all ESCB credit operations have to be based on adequate collateral. The ESCB will allow a wide range of assets to underlie its operations. A distinction is made, essentially for purposes internal to the ESCB, between two categories of eligible assets: tier one and tier two respectively. Tier one consists of marketable debt instruments, which fulfil uniform Monetary Union-wide eligibility criteria specified by the ECB. Tier two consists of additional assets, marketable and non-marketable, which are of particular importance for national financial
markets and banking systems and for which eligibility criteria are established by the national central banks, subject to ECB approval. No distinction will be made between the two tiers with regard to the quality of the assets and their eligibility for the various types of ESCB monetary policy operations (except for the fact that tier two assets are normally not used in outright transactions). The eligibility criteria for underlying assets to ESCB monetary policy operations are the same as those applied by the ESCB for underlying assets to intra-day credit. Furthermore, ESCB counterparts may use eligible assets on a cross-border basis, i.e. they may borrow from the central bank of the Member State in which they are established by making use of assets located in another Member State. Key for the ECBs capital 1 December 1999 Following the notification issued by the Commission of the European Communities of revised GDP statistical data, it was decided to adjust the shares of the national central banks in the key for the capital of the European Central Bank (ECB) to the following percentage rates: Nationale Bank van Belgie/Banque Nationale de Belgique Danmarks Nationalbank Deutsche Bundesbank Bank of Greece Banco de Espaa Banque de France Central Bank of Ireland Banca dItalia Banque centrale du Luxembourg De Nederlandsche Bank Oesterreichische Nationalbank Banco de Portugal Suomen Pankki Sveriges Riksbank Bank of England 3.2.3 The European Central Bank (ECB) The European Central Bank was established in June 1st, 1998. Thus, this is one of the worlds youngest central banks. The legal basis for the European 2.8658% 1.6709% 24.4935% 2.0564% 8.8935% 16.8337% 0.8496% 14.8950% 0.1492% 4.2780% 2.3594% 1.9232% 1.3970% 2.6537% 14.6811%
Central Bank and the European System of Central Banks is the Treaty establishing the European-Community. In May 1998 the European Council invited the large majority of countries (11) which were able to meet the Maastricht convergence conditions to join the European Monetary Union (EMU). The four non-members were the United Kingdom, Denmark, Sweden, which all opted out, and Greece, which alone failed to meet the convergence conditions. The European Central Bankor Eurofed ensures a common monetary policy, and governments had to follow precise targets on public debt and the way in which public deficits were financed. Ceding financial power to a new central financial body was seen to be more effective and efficient than continuing weakly co-ordinated policies by existing National Central Banks. The European System of Central Banks involves the National Central Banks (NCBs) and the European Central Bank. The European Central Bank is dominant in policy-making and has exclusive authorisation and control of currency issue. Most monetary operations are decentralised to the National Central Banks. The ESCBs main instrument of control is open-market operations plus other instruments undertaken at the initiative of the European Central Bank. The European Central Bank has in its statutes the goal of price stability, whereas the US Federal Reserve Bank also has to consider output and employment as well as inflation. For inflation, no numerical target is set, whereas the European Central Bank had set a tight limit at less than 2 per cent per annum. There are also concerns about the undemocratic nature of the European Central Bank in setting the targets and implementing them. In the United Kingdom, for example, the Chancellor of the Exchequer sets the inflation targets, leaving the implementation to the Bank of England the latter is also more in publishing its minutes. The legal basis for the ECB and the European System of Central Banks (ESCB) is the Treaty establishing the European Community. According to this Treaty, the ESCB is composed of the ECB and the national central banks of all 15 EU Member States. The Statute of the European System of Central Banks and of the European Central Bank was attached to the Treaty as a protocol.
The highest decision-making body of the ECB is the Governing Council. It consists of the six members of the Executive Board and the 11 governors of the national central banks of the Euro area. The President of the ECB chairs both the Governing Council and the Executive Board. The key task of the Governing Council is to formulate the monetary policy of the Euro area. Specifically, it has the power to determine the interest rates at which commercial banks may obtain liquidity from the central bank. Thus the Governing Council indirectly influences interest rates throughout the Euro area economy, including the rates that commercial banks charged their customers for loans and those that savers earn on their deposits. The Executive Board of the ECB consists of the President, the VicePresident and four other members. All are appointed by common accord of the Heads of State or Government of the 11 countries, which form the Euro area. The Executive Board is responsible for implementing the monetary policy as formulated by the Governing Council and gives the necessary instructions to the national central banks for this purpose. The third decision-making body on the ECB is the General Council. It comprises the President and the Vice-President of the ECB and the governors of all 15 national central banks of the EU Member States. The General Council contributes to the advisory and co-ordinating functions of the ECB and to the preparation for the possible enlargement of the Euro area. The working units of the ECB are grouped in Directorates General, Directorates and Divisions, overall responsibility for which lies with individual members of the Executive Board. Independence is vital to the operational success of any central bank. Thus, the ECB has its own budget, independent of that of the European Community. This keeps the administration of the ECB separate from the financial interests of the Community. The capital of the ECB does not come from the European Community but has been subscribed and paid up by the national central banks.
At an international level, arrangements exist for the ECB to be represented at the International Monetary Fund (IMF), one of the key elements of the international monetary system, and at the Organisation for Economic Cooperation and Development (OECD). The ECB participates in meetings of these international organisations with the sole aim of exchanging information. The independence of the ECB is thus fully respected.
Progress test
1. 2. 3. 4. 5. 6. 7. 8. 9.
Describe the structure of the Federal Reserve System. What are the instruments of Central Banking? Explain how the discount rate influences the American financial market. Describe the Open market operations. Describe the activity of the FDIC. What are the savings banks? What are mortgage-related financial institutions? What are credit unions? Describe the organisation of the ESCB.
10. What are the main tasks carried out by the ESCB? 11. What are the main responsibilities of the Governing Council? 12. What are the main responsibilities of the General Council? 13. What are the main monetary policy instruments of the ESCB? 14. What is the ECB? 15. Describe the ESCBs structure and its main tasks.
ANNEX No 1
ECBS ECB Central Banks of the EU
General Council (responsible for ERM II)
Central banks: England Denmark Sweden Greece
Gouverners of the central banks in the EMU (Euro Area)
President Gouverning Council President President
ANNEX No 2 TASKS OF THE ECB: IMPLEMENT THE MONETARY POLICY Price stability Sustainable economic growth
SUPPORT THE GENERAL ECONOMIC POLICIES OF THE EU CONDUCT THE FOREX EXCHANGE OPERATIONS HOLD AND MANAGE THE OFFICIAL FOREIGN RESERVES OF THE MEMBER STATES PROMOTE SMOOTH OPERATION OF THE PAYMENT SYSTEMS (ADOPTING TARGET)
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MONEY SERVICES
Objectives After studying this chapter you should be able to understand: 4.1 Cash and cash instruments 4.2 Cheque definition, parties involved, endorsement, types of endorsement 4.3 Remittance by post: 4.3.1 Cheque 4.3.2 Bankers draft 4.3.3 International Money Order 4.3.4 International Payment Order 4.4 Remittance telegraphically / electronically 4.4.1 Telegraphic transfer 4.4.2 Girobank/post office 4.4.3 Standing orders 4.5 Electronic Banking Services 4.6 SWIFT 4.7 The process of the Romanian cheque under the Law no. 59/1934 concerning the cheque, with the subsequent amendments 4.7.1 Introduction 4.7.2 The transmission of the cheque 4.7.3 The payment of the cheque 4.7.4 Types of cheques 4.7.5 The circulation of a cheque
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4.1 Cash and cash instruments The cashiers work consists in receiving cash and cash instruments such as cheques and other instruments (documents of title to cash) in order to credit the customers accounts. Cash consists of: Banknotes; Coins; Cash instruments such as cheques. In modern banking practice, the name of the customer and his computer account number are pre-printed in the pay-in books to eliminate any error and to speed up transactions at the counter. Procedure1 used by the Romanian banks: The cashier has to make sure that the name and account number of the customer are clearly indicated; Where counter pay-in slip is used by the customer (or non-customer), the cashier should check the correctness of the name and account number of the customer whose account is credited; The cashier must count the currency notes presented and sort them into different denominations; The cashier ticks against each item on the pay-in slip with a coloured pen or pencil and places the notes in his till. Bankers drafts; Conditional orders; Dividend and interest warrants; Bearer bonds; Postal orders; Unused travellers cheques.
Cash instruments (documents of title to cash):
Internal norms of each Romanian bank
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4.2 Cheque definition, parties involved, endorsement, types of endorsement A cheque2 represents an unconditional order in writing addressed by one person to another who must be a banker, signed by the person giving the order, requiring the banker on whom it is drawn to pay on demand a certain sum in money to or to the order of a specified person or to the bearer. More clarifications: The person who draws the cheque is called the drawer; The bank through the cheque is drawn, is the drawee bank (paying bank); The person to whom the cheque is drawn payable is called the payee or beneficiary; When the drawer draws a cheque payable to himself, both the drawer and the payee are the same person. The following items need to be verified by the receiving cashier: If the Date is correct: Is the cheque post-dated or stale? Post-dated: it means the cheque has been presented before the cheque date. Stale: it means the cheque has been presented after six months of its date. In both situation the cheque should not be cashed. Payee (beneficiary): When the cheque is crossed A/C payee or crossed to a particular account, such instructions must be implemented. Content of the instruments: When there are differences between the amount written in words and the amount written in figures, the amount payable is the one mentioned in words. Anyway, the bank is entitled to return the unpaid cheque marked words and figures differ. The paying bank has the right to ask its clients that their cheques are filled in clear and unambiguous terms.
2
Kiriescu Costin - Relaii valutar-financiare internaionale, Ed. tiinific i Enciclopedic, Bucureti, 1978, p. 237
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Signature of the drawer: The signature should be verified to ensure that it is complying with the copy of the signature card which is kept in the bankers safe. The signature is a genuine one. Endorsement3: The endorsement of an instrument is the placing of a signature thereon by a person who thereby becomes a party to the instrument. There are two types of endorsement: 1. Blank endorsement: no endorsee is indicated. Such blank endorsement converts the order cheque into a bearer cheque; 2. Special endorsement: the endorser specifies the person to whom the cheque is endorsed. Usually, endorsements are written on the backside of the order cheque. Endorsement of part of the sum indicated on the cheque is irregular and invalid. An endorser can endorse the cheque payable to the order of more than one person. 4.3 Remittance by post 4.3.1 Cheque The simplest and most obvious method is merely to send a cheque to the beneficiary in the other country. This has advantages for the drawer of the cheque who only incurs the postage costs and bank charges when the cheque is debited. However, if the cheque is used in payment for goods, their delivery may be delayed while the payee of the cheque waits for it to be cleared. It is possible to issue a cheque in the relevant currency if the drawer maintains an account in that currency.
3
Palfreman David Banking: the legal environment, Pitman Publishing, London, 1994, p.242
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Now lets try to be in the position of the payee who suffers the following: The cheque will often be drawn in the drawers currency, thereby imposing an exchange risk on the payee; The payees bank may insist on collecting the proceeds of the cheque before crediting the bank account, thereby delaying the receipt of the funds by as much as a month. This delay, of course, favours the drawer; The payee will also incur some, if not all, of the expenses of the collection process; The cheque may not be paid. The process of a cheque is represented in the Annex no 1. In order to avoid some of these problems, beneficiaries can insist that: Cheques are drawn in their own currency. This transfers the exchange risk back to the drawer but does not really solve any of the other problems highlighted; Payment be made by means of Bankers draft.
4.3.2 Bankers draft This requires4 the remitter to give instructions to a bank to issue a draft, which is a type of cheque, drawn in the appropriate currency on a bank abroad. So, a bank draft is in effect a cheque drawn by one bank on another. This may be one of its own subsidiaries or associates or a correspondent bank. For the payee this method solves the exchange risk problem, guarantees payment as the draft is drawn on a bank, and removes the delay in the collection process. Consider the following example that illustrates the process of a draft: Mrs. Roberts wishes to send FF 100,000 to a property developer in the Dordogne as a deposit on a holiday cottage she wishes to purchase. She
4
Davies Audrey & Kearns Martin Banking Operations, Pitman Publishing, London 1994, p. 35
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banks with the North Bank, whose correspondent bank is the Left Bank in Paris. The developer banks with the Perpignan branch of the Bastille Bank. 1. Mrs. Roberts gives instructions to the North Bank and requests the issue of a draft. 2. North Bank draws a draft for FF 100,000 on the Left Bank in Paris. 3. North Bank debits Mrs. Roberts account with the sterling equivalent of FF 100,000 plus charges, accounts to Left Bank for FF 100,000, and hands the draft to Mrs. Roberts. 4. Mrs. Roberts sends the draft to the developers who pay it into their account with the Bastille Bank. 5. Bastille Bank collects the proceeds by remitting the draft to the Left Bank for payment. This process is represented in the Annex no. 2. Despite the obvious benefits, drafts are relatively expensive and can be delayed or lost in the post, causing considerable inconveniences and additional costs to all concerned, particularly as the customer will be required to give an indemnity to the bank. It is because of such problems that quicker, more efficient and less costly ways of transferring funds internationally have been developed. Analysing the process of the bank drafts, we consider that there are major disadvantages in using the drafts for large transfers, such as the following: The remitter is debited at the time the draft is issued, but there is a delay before the beneficiary can pay the draft into his bank account and obtain cleared funds. If the beneficiary does not bank at the bank on which the draft is drawn, the funds will be treated as unclear. The draft could be lost or stolen, and banks are reluctant to stop a bank draft because it amounts to dishonour of the banks own paper.
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4.3.3 International Money Order One of the most popular alternatives to the cheque or bankers draft is the International Money Order (IMO). It has the advantage of being immediately available once the customer has completed the application form and is often the cheapest method of sending money abroad. The bank draws the International Money Order on itself and the payment is, therefore, guaranteed. In the United Kingdom, International money orders are usually issued either in sterling pounds or US dollar and are used for relatively small amounts e.g. GBP 1,000 or USD 2,500, but can be used for as much as GBP 5,000/USD 7,500. As they can be encased throughout the world they represent a simple and effective way of remitting funds abroad, particularly as the beneficiaries can obtain the funds immediately on presentation to their own bankers. You can see in the Annex no. 3, the process for an International Money Order. If the remitter wishes to meet a commitment for an amount greater than the limit imposed by the bank for an International Money Order, then more than one International Money Order can be purchased, although it is likely to become impractical to use more than two. For the larger amounts it may be better to use an alternative method and particularly an international payment order. 4.3.4 International Payment Order An International Payment Order (IPO)5, also known as an Airmail Transfer, is simply an authority by a customer or non-customer to a bank to remit funds abroad in any available currency, by airmail. Banks recommend its use for non-urgent transfers where the amount that requires remitting is above the limit of I International Payment Orders or the currency required is one other than sterling pounds or US dollars. For example, if a customer wishes to send to Spain the equivalent of GBP
5
Davies Audrey & Kearns Martin Banking Operations, Pitman Publishing, London 1994, p.25
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10,000 as a stage payment in respect of the building of a villa, and there is no urgency, then an International Payment Order is the best method. The relevant instructions on a pre-printed form will be given to the bank in the United Kingdom. These instructions will be then sent to the bank in Spain nominated by the remitter or, failing this, chosen by the remitting bank. The Spanish bank will ensure that the beneficiary receives the funds as instructed and in the nominated currency. The way the funds are transferred between the banks will depend upon which currency the payment is in. You can see in the Annex no.4, the process of an International Payment Order. An International Payment Order is a relatively cheap method of sending funds abroad but generally should be used for non-urgent payments. It is possible that some payments will be received if the SWIFT system is used, but a more normal period would be three to four weeks, instructions being sent by airmail. There are several ways in which the beneficiary can receive payment. Instructions can be given as follows: (a) Notify and pay used if the beneficiarys bankers are not known. The beneficiary, once advised, will have to call the bank to collect the money. (b) Advise and credit the beneficiarys account. (c) Pay the beneficiary upon application used when the beneficiary wishes to collect the funds personally from a specified branch of a bank abroad. (d) Place to the credit of a new account to be opened in the beneficiarys name used when the beneficiary wishes to have a new account opened. In this case references and a specimen signature may be required by the bank abroad. Whether the remitter or the beneficiary pays the costs involved will depend on the agreement between them. If the beneficiary pays some or all of the costs, then they will be normally deducted from the amount received.
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4.4 Remittance telegraphically / electronically 4.4.1 Telegraphic Transfer A Telegraphic Transfer (TT) is the quickest way of sending money abroad and as such will often be used where the payment is urgent. As with International Money Orders and International Payment Orders, an order form is completed with the remitters instructions, enabling the bank to authorise the bank abroad to make the funds available to the beneficiary. The beneficiary can receive the funds in most of the ways described for International Payment Orders, i.e. Notify and pay Advise and credit the account Pay on application
The exception is the opening of an account, which is unlikely to be urgent. Furthermore, because instructions are sent by cable or telex it is not possible to send references or specimen signatures. It normally takes two working days for the processing of TTs from receipt of instructions to payment to the beneficiary, unless payment is being sent to a remote part of the world, in which case it may take a little longer. The speed of payment is achieved by using cable or telex to transmit the payment instructions rather than sending them by airmail as with International Payment Orders. The disadvantage is that this method makes the TT more expensive. Payment can be made in sterling pounds or most foreign currencies, and TTs are particularly appropriate where large sums need to be transferred quickly to reduce interest charges or improve interest income. 4.4.2 Girobank / post office Girobank offers several ways of sending money abroad, some of which are similar to those, described already. Not all the services are available to all countries, but if you wish to send money to a country not on the Girobank
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list, payment will be made by means of a bank cheque in US dollars, sterling, or an appropriate alternative currency at Girobanks discretion. The three main methods are: 1) Payment by cheque; 2) Payment in cash; 3) Payment direct to a Giro account overseas; There is a fixed charge for each method, but if the remitter has a Girobank account and the beneficiary overseas has a Giro account, then a transfer can be made between the two, free of charge. Finally, it is also possible to remit funds overseas by means of a postal order but there is a limited number of countries to which the system is applicable. 4.4.3 Standing orders There are certain payments, which have to be made regularly. Missing a payment for an essential item or service could cause problems. A Standing Order service provided by the banks is a way of ensuring that specific payments are made to certain people or organisations on the date that are due (The payments can be once a year, quarterly, monthly whenever required). This means that the customer only has to arrange essential regular payment once. The customer has to inform the bank the necessary details concerning who the payment is to, the amount of money to be paid out when and how often the payment is to be made. After that, the bank will take on the responsibility of ensuring that the payments are made: Out of the customers account; Into the account of the person/organisation named. Because standing order payments are made automatically through the banking system, the customer is saved the bother and potential cost of writing and sending off cheques.
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The customer can make as many payments as he likes through standing orders. Details of each standing order payment will appear in the customers bank statement. In order to make a standing order arrangement the customer just fills in a form which in England can be obtained by asking the Enquiries counter of any bank. The main information that the customer has to fill in is: Details of the customers account; Details of bank account of the person/organisation the customer is paying; Name of the person/organisation the customer is paying; Amount of each regular payment, etc Table 1 summarises the advantages and disadvantages of the methods we have covered so far. Advantages and disadvantages of different forms of payment:
METHOD Cash ADVANTAGES DISADVANTAGES
Small amounts can be sent in note form very easily. Remittance is quick and simple. Can be inexpensive for the remitter where recipient covers collection costs. Attachments are possible. Issue process is straightforward. Remittance is quick and simple. Available in most major currencies exchange risks for recipient can be avoided. No limit on amount. Payment is guaranteed and quick if drawn on a bank in beneficiarys country. Attachments are possible.
Cheque
Impractical and expensive if in large amounts. Can be lost or stolen. Exchange risks unless issued on appropriate currency account. Delay in receipt of proceeds by beneficiary where bank insists on collection. Collection costs. Cheque may not be paid. Relatively expensive to purchase. Can be lost or stolen involves lengthy formalities including giving an indemnity to the bank. Encasement overseas may be costly.
Bankers draft
Money Services METHOD ADVANTAGES DISADVANTAGES
International Money Order
Cheapest method, widely available and accepted. Issue process is quick and straightforward. Refunds/replacements available with little formality. Instructions can be given in most currencies exchange risk for recipient can be avoided. No limit on amount. Documents can be attached, e.g. specimen signatures. Several payment instructions available. Payment is inter-bank, therefore secure. Quickest method of transfer. Interest income on large sums can be saved interest charges reduced. No limit on amount. Instructions can be given in most currencies exchange risk for recipient can be avoided. Relatively inexpensive. Issue process is straightforward. Remittance is quick and simple. Simple and quick. Free if from one Giro account to another. Purchase is simple and inexpensive. Attachments are possible.
Only appropriate for smaller amounts up to GBP 1,000 or USD 2,500, say, but possible up to GBP 5,000/USD 7,500. Only available in sterling or USD.
International Payment Order
Not appropriate for urgent transfers. Relatively expensive.
Telegraphic Transfer
Most expensive method.
Giro cheque
Possible collection costs. Can be lost or stolen.
Giro transfer
Recipient has to have a Giro account. Number of countries limited. Exchange risk for the recipient. Can be lost or stolen. Number of countries limited.
Postal order
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4.5 Electronic Banking Services Electronic banking (see Chapters 6 and 7 for more information) essentially automated payment by computer will increase in importance and volume. The main forms of electronic banking services are: Telephone Banking Such a service represents a competitive area and it may be either voiceactivated (i.e. the computer is expected to react to customer's voice and comply with his or her instructions accordingly), or electronically activated (i.e. the client speaks over the microphone of their telephone and dials certain numbers meaning a certain transaction). The telephone banking can offer transfers of funds, payments of regular bills, applications for loans and overdrafts etc. Bankers Automated Clearing System This system is especially used for funds transfers between the participating members and essentially operates standing orders, direct debits, payment of wages, salaries, rentals, trade debts, etc. Bankers Automated Clearing System is supplied with a magnetic tape containing the details of the accounts to be debited or credited. It sorts them into bank orders and, then, it provides each paying bank with the relevant details, a printout being also available. Electronic and Internet -Based Payments Internet banking is a banking product, which follows the older solutions like e banking. E-banking represents a solutions which is technologically obsolete, supposing at the client level of that service a phone line and a computer dedicated for such an operation, able to fulfil technical needs requested by the bank and to run (execute) a software program necessary for the optimal communication with the clients bank. In that way, the person which will handle the e-banking application have to work only from that computer which it is not very good for someone with a dynamical job and with many physical places of work even in different localities or countries. Despite e banking, the I-banking (Internet-banking) supposes the usage of a computer from wide world on which is installed a browser and an Internet
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connection. The performances of such a solution are far away better also for the bank and for the end user (the client). The costs are calculated to a number of 100 banks from the United States of America which are using all the channels, but the costs are represented at a world wide level because they are common to all the banks that promote the electronic payments. World tendencies 63 % from the great banks6 are offering Internet banking services and 59 % are offering electronic banking services. Not all Internet banking institutions are charging the services, but most of those, which do, are starting to use a monthly subscription for the base services an supplementary charges for some services. 61 % from the firsts 150-th banks from the United States of America are offering on-line banking services, 15 % dont have included in their strategies for the future the offer of on-line banking service and 19 % already announced their intention to provide such services until the end of 2001. In May 2000, Forrester Research estimated that by the end of the year 2003 will exist over 20 million of home users in the United States of America which will use the I-banking services, that means around 30 % from the profits obtained from retail. At the end of 2000, the specialists from Data monitor estimated that at the end of the year 2005, around 20% from the world population would be connected at the Internet. Regarding Europe, since March 19, 2001 the British group Vodafone has announced that the first transaction pilot project that will use the digital signature using the mobile phone will start in April 2001 together with the Radio Communications Agency. That announcement was made at a short period of time after the British Government announced that it intended to allow all physical persons to pay their taxes throw an electronic environment, using digital signatures. On July 19, 2001, expired the cut-off time until which all the member states of the European Union had to implement the Directive regarding digital signature. The ending of that period will lead inevitably to a new beginning
6
Booz Allen & Hamilton April 2001
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in the development of electronic transactions field and in the e-business area. As a consequence of that, the banks renounced at their territorially development instead they are concentrating on the new products which are based on new technologies and the Internet development. So, the banks are reorienting their investment politics to new technologies. That supposes the reconsideration of the concept of territorial network of a bank, which is about to become an informational network. At the end, the new technologies allow the banks to be closer to their clients and in the same time to provide them more comfort and a depersonalisation of the services due to the elimination of the classical physical direct relation between the account officer and the banks customer. 4.6 SWIFT These initials stand for the Society for Worldwide Interbank Financial Telecommunication, which is an international organisation whose members consist of several hundred of the largest international banks. The society, which was created under Belgian Law and located in Brussels, was formed to accelerate the transfer of funds and other messages between the member banks. The system works by means of a telecommunication link between the computer systems of the banks, which allows the rapid transmission of messages. The system is used to execute telegraphic transfers previously sent by cable or telegraph and may also be used for international payment orders/airmail transfers at the discretion of the bank, making for a much faster execution of a customers instructions. When instructions are transmitted in this way the bank is said to be sending a SWIFT message and for telegraphic transfers the phrase used is urgent SWIFT message. SWIFT7 processes information (i.e. data, text, or commands) in the form of messages. From the users point of view, messages are sent either: From one user to another (e.g. Normal banking messages such as a customer transfer); or From a user to the system (e.g. Requests for information such as a retrieval request); or
7
Watson A. Finance of international trade, 4th edition. Chartered Institute of Bankers, London 1992
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From the system to a user (e.g. Responses to requests, such as a retrieved message). A message can consist of one or more headers, which contain reference information for the message, a body which contains the text of the message, and one or more trailers, which are added for control purposes. Messages are seen from the point of view of the SWIFT system. All messages introduced into the system by a user are referred to as input messages; all messages, which the system delivers, to a user are referred to as output messages. A three-digit number, e.g. MT 100 represents messages, where the first digit defines the message category, indicating the general usage of the message. There are nine categories of user-to-user messages, identified as categories 1-9, and a separate category for messages exchanged between a user and the system, identified as category 0. Security at SWIFT meets four objectives: Confidentiality information is only disclosed to authorised persons at authorised locations; Integrity information can be relied upon to be complete, accurate and valid; Availability information and associated services are accessible and usable when needed; Accountability every individual authorised to use the system is accountable. Confidentiality and integrity are ensured by means of security of transmission, delivery and message storage; by validation of messages; and by user-to-user authentication. The various system functions of SWIFT are separated into a well-defined hierarchy, with each level of the hierarchy controlled by a particular computer. A global communications network links all of Swifts computers so that they are in constant communication with each other. All processors have at least one standby processor. An unique ISO Bank Identifier Code (BIC) identifies financial institutions. BICs are published in the SWIFT BIC Directory. The first 8 characters of
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the BIC, when used for addressing purposes, are called the destination; it is made up as follows: Bank (Financial Institution) Code Country Code Location Code 4 characters 2 characters 2 characters
The bank code, country code and location code are mandatory components of a BIC. In addition, an optional branch code of 3 characters can be used to identify any branch of a user institution. If no branch code is defined, the default of XXX is used for addressing purposes. There are three main types of SWIFT message8: System Messages (MT category 0) which may relate to either the sending and receiving of messages (e.g. User-to-SWIFT message, Delivery Notification, Retrievals), or to some aspect of an users logical terminal (LT) or destination; User-to-User Messages (MT categories 1-9) which enable users to perform financial transactions; Service Messages (or Control Messages) ,,which relate either to system commands or to acknowledgements.
The SWIFT system normally processes user-to-user messages on a First-InFirst-Out basis. User-to-user messages fall into distinct categories to be used for different types of financial transactions. A 3-digit number identifies individual types of messages (MTs). The first digit identifies the category of the message. There are 9 categories9 of financial messages. Each category referring to a different general usage: Category 1 Category 2 Category 3 Customer transfers Cheques Financial institution transfers Treasury markets & Derivatives Foreign exchange, Forward rate agreement etc
8 9
SWIFT User Handbook Network Acces Guide, August 1998 SWIFT User Handbook Network Acces Guide, August 1998
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Category 4 Category 5 Category 6 Category 7 Category 8 Category 9
Collections Cash letters Securities Precious metals & Syndications Documentary credits Guarantees Travellers cheques Statements, Reports etc.
All SWIFT messages conform to a defined block structure. Each block of messages contains data of a particular type and is used for a particular purpose. A typical SWIFT user-to user message may consist of: {1: BASIC HEADER BLOCK} {2: APPLICATION HEADER BLOCK} {3: USER HEADER BLOCK} {4: TEXT BLOCK} {5: TRAILER BLOCK} Block 1, 2 and 3 relate to header information, block 4 contains the text of the message, and block 5 contains trailer information. Only block 1 is mandatory for all messages. Block 2-5 are optional and depend upon the nature of the message and on the application in which the message is being sent or received. All user-to-user messages contain blocks 2, 4, and 5. SWIFT offers round the world, round the clock expert support to its customers, covering administrative, operational and technical matters. Support is available 24 hours a day, seven days a week and in many languages.
Money Services
4.7 The process of the Romanian cheque under the Law no. 59/1934 concerning the cheque, with the subsequent amendments 4.7.1 Introduction The cheque is an instrument of payment used by the banking accounts holder with available funds into these accounts. The available funds are a result of a bank deposit, collecting proceeds or a credit. The cheque is an instrument of payment, which connects three persons: the drawer; It is the person who makes out the instrument, being the holder of the banking account. the drawee; It is always the bank where the drawer has an account opened with. It will pay the presented cheque only if the drawer has enough availability in his account. the beneficiary (payee). It is the person who will receive the money. This person can be a third person or the drawer himself.
The instrument is made out by the drawer, who by virtue of a deposit in a bank, gives an unconditionally order to that bank (the drawee) to pay a determined sum of money to a third party (or to the drawer himself), who is the beneficiary. In the process of the cheque the drawer issues the cheque, the legal owner cashes it and the drawee pays the cheque. In order for the drawer to issue cheques, the bank must deliver to its client a blank passbook. The owner of the cheques fills in the blank cheque, signs and delivers it to the beneficiary, who will present it to his bank for cashing it. In order to be valid, the cheque has to contain the following compulsory mentions10 (see Annex No 5): the name Cheque written in the text of the instrument; the unconditional order to pay a certain amount of money; the name of the drawee, respectively the bank where the drawer has an account opened with;
10
Cheque Act, 1934, with the subsequent amendments
Money Services
the place of the payment, respectively the locality and the address of the bank where the payment is made; the date and the place of the issue of the instrument, respectively the day, month, year, as well as the name of the locality; the signature of the drawer. 4.7.2 The transmission of the cheque The transmission of a cheque can be: a) by simple remittance; it is the case of the cheque payable to the bearer, which in the moment of issue doesnt show exactly the beneficiary and bears the mention cheque payable to bearer. This kind of cheque is payable to the beneficiary, or to the bearer of the cheque. b) by ordinary transfer of debts; it is the case when the cheque is issued for a specified person and it has the mention not to order; only the authorised person can enact the cheque. c) by endorsement - it is the operation by which all the rights of the cheque are sent with the remittance. It has a special mention on the backside of the cheque in the favour of somebody, including the drawer. The new beneficiary can, on his turn, endorse the cheque. 4.7.3 The payment of the cheque The cheque is payable only at sight/at presentation. In Romania, the cheques are issued and payable at the following terms: 8 days, for the cheque payable in the same place it was issued; 15 days, in any other cases.
These terms are calculated from de subsequent day of the issuing date of the cheque. The presentation of the cheque after the expiring of the legal term will cause the loss of the right for a legal action against the previous endorsers if the cheque wouldnt be paid.
Money Services
All the persons who obliged themselves in any way by the cheque (drawer, endorsers) are jointly and severally responsible for paying that cheque, although the obligations had been assumed at different moments. 4.7.4 Types of cheques The main types of cheques used in Romania are: a) the cheque payable to bearer. It is the instrument, which has in the text the special mention to bearer or payable to bearer or is has no mentions. b) the crossed cheque - the drawer or the owner of a cheque can make a cross by drawing two horizontal or crossed parallel lines on the side of the cheque; meaning that the beneficiary has to ask for a banks services in order to cash the sum written on the cheque. The cross can be: general - there is no special mention between the two lines; special - between the two lines is specified the name of the bank.
The general cross can be transformed into a special cross. c) certificate cheque - by this kind of cheque the bank (the drawee) confirms on the cheque the existence of the necessary fund for payment and the person who issued the cheque (the drawer) can not withdraw funds from his account until the end of the submitting period.
d) Travellers cheque in this case, the drawer can condition the payment of this cheque upon the identity between the signature of the person who got the cheque (the possessor) and the signature of the person who cashes it at submitting. In fact, the possessor puts his first signature on the cheque in the moment he buys it; the second time, he signs it in the moment of cashing the cheque, in the presence of the banking clerk, or in the moment of the payment in the presence of the beneficiary. This kind of cheque is an easy and safe mean of payment.
Money Services
In Annex No 6 you can see different types of cheques. 4.7.5 The circulation of a cheque The Company Atlas Inc. purchases from the store of The Company Star Inc. electronics, amounting to ROL 5,000,000. The Company Atlas Inc. has a current account opened with The Bank X, and The Company Star Inc. has a current account opened with the Bank Y. Under the available funds in the current account, The Bank X gives a passbook to the Company Atlas Inc. When the representative of the Company Atlas Inc. purchases the goods, he fills in a file of the pass book with the necessary dates and the sum which represents the equivalent value of the electronics bought, he signs that file and hands it to the representative of the store. Since that moment, the Company Atlas Inc. has become the drawer, the Bank X the drawee, and the Company Star Inc. the beneficiary. The Company Star Inc. submits the cheque to the Bank Y, and sends it to The Bank X in order to cash it. The Bank X pats the cheque to the Bank Y. In this way, the obligation of the Company Atlas Inc. towards the Company Star Inc. is cleared, as you can see in the Annex no 7. The role of the banks When the clients of a bank (drawers) issue cheques, these have to be presented to the bank (the payee bank) to be paid. The bank has the obligation to pay the cheques in favour of its clients in the following conditions: the client has enough money in his account; the cheque was drawn correctly and signed by the client (the drawer); there is no any other legal reason for the bank not to pay. The beneficiary bank has the obligation to collect the cheques from its own clients for encasement. The bank will remit the cheques to payment.
Money Services
Progress test
1. Enumerate some cash instruments. 2. What is a cheque? 3. What are the items verified by the receiving cashier? 4. Describe the process of a cheque. 5. Define the bankers draft and its process. 6. List some disadvantages of using Bankers draft. 7. Explain the process for an International Money Order. 8. Define the International Payment Order and its process. 9. List a few ways in which the beneficiary can receive payment. 10. What is a Telegraphic Transfer? 11. What is a Standing Order service? 12. List the main electronic banking services. 13. In what consists a SWIFT message? 14. List the three types of SWIFT messages. 15. List at least five categories of financial messages. 16. What does SWIFT represent? 17. Describe the transmission of the cheque under the Romanian law of the
cheque.
18. List and define the main types of cheques under the Romanian law of
the cheque.
19. A customer wishes to send a birthday present of 50 pounds to her
daughter in Canada. Her birthday is not for two months. Which payment method would you suggest?
20. A retiring customer has decided to spend 6 months of the year in Spain
and wishes to open an account there prior to departure. What method of transferring the funds would be the most appropriate?
ANNEX No 1 THE PROCESS OF A CHEQUE
Drawer
Sends personal cheque (1)
Beneficiary
Debits Account (4)
Takes the cheque to the bank (2)
Pays Credit in Account (6)
Drawee Bank
Sends cheque (3) Collects proceeds (5)
Collecting Bank
ANNEX No 2 THE PROCESS OF THE BANKERS DRAFT
Mrs. Roberts
Account Debited (3) Orders Draft (1)
Sends draft (4)
Property Developer
Issues Draft (2) Remits draft and collects proceeds(7)
Account credited (6)
North Bank
Credits (5)
Left Bank
Bastille Bank
ANNEX No 3 THE PROCESS OF AN INTERNATIONAL MONEY ORDER

Sends IMO (3)
Customer
Beneficiary
Orders IMO (1)
Issues IMO (2)
Pays in Account credited (4)
Issuing Bank
Remits IMO (5) Collects proceeds (6)
Collecting Bank
ANNEX No 4 THE PROCESS OF AN INTERNATIONAL PAYMENT ORDER
Customer
Beneficiary
Issues Instructions (1)
Debits Customer (2)
(4) Notifies and pays or advises and credits or pays on application or opens new account
Remitting Bank
Sends Instructions (3)
Overseas Bank
ANNEX No 5 THE COMPULSORY MENTIONS OF THE CHEQUES
Money Services
Money Services
Money Services
Money Services
Money Services
Money Services
ANNEX No 6
TYPES OF CHEQUES Romanian crossed cheque:
Money Services
International types of cheques:
Money Services
ANNEX No 7
THE CIRCULATION OF A CHEQUE
The Trading Company Atlas Inc - drawer -
2 4 8
The Trading Company Star Inc - beneficiary -
The X Bank -drawee-
6 7
The Y Bank -beneficiarys bank-
Explanation: 1. The issuance of the cheque book; 2. The sales contract is concluded; 3. The Atlas Inc. draws a cheque against the X Bank; 4. It remits the cheque drawn against the X Bank; 5. It submits the cheque to the Y Bank; 6. It submits the cheque for paying; 7. The debt is liquidated; 8. It pays the cheque.
Electronic Banking Services
ELECTRONIC BANKING SERVICES
Objectives After studying this chapter you should be able to understand: 5.1 Introduction into e banking services 5.2 Concepts definition regarding e-banking 5.2.1 Development of electronic money in the Euro area; electronic money oversight, supervision and the Community regulatory framework 5.2.2 Services of e banking in Romania 5.3 The legal framework in the e-services field 5.3.1 The EU s on-line Financial Services legal framework 5.3.2 The E regulating provisions in Romania 5.4 The risk management for e-banking activities and e-money 5.4.1 Risk identification and risks analysis 5.5 Advantages and disadvantages of Internet banking
5.1 Introduction into e banking services The evolution into the Internet and electronic banking era is set to be the most fundamental transformation that the industry would have ever had to undergo. Yet, when we arrive on the other side we should not envisage being greeted by an era dictated by geeks and impersonal switches, but by the level of human interaction and use of information that kept eluding us all through the industrial revolution. Starting the 80s, analysts1 of financial transactions stated that Electronic Banking services for physical persons will become a common way of effecting from home the banking transactions. In the same period, banks from all over the world invested in developing software solutions, equipment like servers, modems and the development of information departments. Electronic Banking is a service provided by many of the largest banks to enable the ordinary customer to transfer funds from one person to another and to remit funds to a named beneficiary. This kind of service was firstly accepted by the small savings bank in the United States of America, where in a small town the customers are well known and the relationships between the banking clerks and the customers are close and stable. In this environment, the operations solicited by phone have appeared. The sphere of asked services was also restricted and the bank initially agreed to pay only some usual phone bills, with small values. The bank by phone was called like this due to the fact that the operations were solicited based on human voice, by telephone.
Source: Piaa Financiar magazine, November, 2000
The communication in both ways raised some problems regarding: - The presentation and identification of the account holder that solicits access to the banking services and the possibilities of fraud; - The ways of communicating the information, especially the receiving by the computer and the coherent answer to be given. The identification possibilities were varied, but it should be mentioned a few: - The phone tone, with the help of an emitting pill included in the customer s phone; - The password; - The personal identification number (PIN). For an increased safety, some banks have installed a small card reader at the customer location. A computer having the communication possibilities: following characteristics facilitated the
- It asks and answers to the customer, partially based on pre-recorded messages; - It recognises the human voice (the words yes and no, the figures, some key words, etc.). So, based on some precise orders and some key words, the computer may receive the customers orders and may give some significant answers to him.
The diversity of the solutions adopted by bank to solve these problems and facilitate the communications is shown in the following table: Nationwide England BS Royal Bank of Scotland Automatic answer (human voice) through the phone and using a recognition tone Password Special PIN
The offer
Lloyds
Bank of Scotland
TSB
The type
Automatic answer (human voice) through a phone and a special terminal
Automatic teletext through the phone (keypad, home computer)
Automatic answer (human voice) through the phone and using a recognition tone
The access to the system
PIN using a special card
Password and account Special PIN number and account Password and number special PIN Fixed monthly and additional tariffs according to its use Quarterly subscription of L2.50 for each account
Costs (besides the phone circuit)
Fixed tariffs are established monthly according to its use
Free
Source: Basno C., Dardac N.- Moneda. Credit. Banci, Ed. Didactic i Pedagogica RA, Bucureti. 1999 The table shows that many banks use video equipment in order to give the customer access to a larger range of services.
Technological characteristics The Videotext system is based on video, a telecommunication procedure that enables the visualisation of alphanumerical images on a screen. The Videotext system is a video system with telephone transmission, hence it is a videography where the transmission is done through a telecommunication network (the phone line). There are three entities that take part in this system: the user, the transmission network and the service performer (that is a database and a processor of information in the same time). The user will be equipped with a terminal and a phone line. He will be connected to the network through a phone call, after he was identified and recognised (through the above-mentioned procedures). The transmission network initially implies the phone contact through the telephone and after the identification it enables the connection with the performer through the video access point (WAP). The functional characteristics of the Videotext System The system has several functional characteristics that reveal its superior qualities: - It ensures the fast transmission of information; - It allows a continuous updating of data; - It has an unlimited stocking capacity, so all the specific elements may be included in the database; - It has a permanent availability. Hence, it may be accessed from different places and without any time restrictions; - The system presents a specific accessibility through: - The use of a communication mean, a simplified language; - The easy orientation in the system, within a tree structure; - The multi-criteria access, that enables the information to be selected based on more criteria and hence the use of the same information on more objectives (a simple example is that the operations recorded in an account may be structured as credit operations, debit operations, balances at different dates, etc.) - The system implies the interaction between two parts.
The Techniques of the Banking Operations Performed through the Videotext System The payment from distance The payment from distance is possible only when the bank gives the holder of the payment card a purchase power. In this case, the memory of the card records this ability that may be interpreted as a credit limit. Under the above-mentioned circumstances, the holder of the payment card connects through the Videotext system with the seller. The operations are performed in the following order: 1. The order regarding the goods or services solicited is given; 2. The decision to pay is expressed; 3. The PIN is typed (this operation is juridical equivalent to signing a cheque); 4. The amount is typed (this operation is equivalent to filling this mention on the cheque). Consequently, the operation is recorded simultaneously in the memory of the payment card and in the performer. In order to finalise the operation in the seller account; the performer periodically asks the bank for payment. The bank validates the operation and covers the amount by debiting the holder s account. On the other hand, the payment card keeps in its memory all data regarding the payments made (the day, the amount, and the beneficiary). So, we may say that this memory acts as an archive. The credit limit may be renewed monthly. The Teletransfer The holder of the payment card may use this system to make payments on behalf of some natural or legal persons. These operations are recorded in the card memory, but do not affect the purchasing power. Consequently, this operation does not have the same execution guarantee, meaning that it may be performed only if the holder has enough money in his account.
If not, the bank notifies the holder that the operation is not possible. Usually, this operation is used for the treasury management of the holder. He operates for the transfer of funds to special accounts: savings accounts, term deposits, etc. Payments regarding electronic bills The user of the Videotext System establishes with the bank a regime of automatic payments for the bills that have specific payment terms (usually the monthly bills). Based on these agreements, the payments are automatically made at the established dates. The user has the right to cheque if the payments to be made are right. When he thinks he is entitled he may cancel the payment by addressing a special order to the bank, also by using the Videotext system. The teleconsultancy This denomination refers to the dialogue between the holder of the payment card and the bank. It concerns the situation of the holder s account and is done through the system. The most frequent questions refer to: - the balance of the account at the bank or the balance of the purchasing power (the credit); - the last operations recorded in the account; - the interest amounts to be received or paid. The request of a cheque card The cheques are used on a large scale, sometimes in parallel with the credit card. Th request for a new cheque card usually requires the holder to go to the bank. But the user of the Videotext system has the advantage to request this by means of a Videotext message. The operation is quite simple. The bank will honour the customer request and will mail him a new cheque card. The local consultancy The local consultancy is a very natural and sometimes useful service. It consists of reading of the credit card memory.
The expenses ordered according to their succession, the suppliers etc. will appear on the screen and they may be retained. This ensures the clarifications asked by the holder. The offer of e-banking services of the well known types- m-banking, ITV and PC based on Internet - will permit the bank, in the first place to attract sophisticated clients, that are using many platforms for effecting transactions, managing, in the same time to access a larger base of potential customers. ITV-Banking represents a channel that implies small costs; in the same time, data confidentiality during transactions effected using the infrastructure of cable TV is reduced. M-Banking offers the clients the possibility to effect transactions everywhere in the world and at any time; the size of the phone terminal, as well as the fact that the mobile phone is a personal object gives maximum confidentiality assurance to this e-banking service. M-banking services2 will attract an increasing number of active users on the near future and the volume of the transactions for m-banking users will be bigger than the volume of transactions through ITV and even through PCbased e-banking. Nowadays, the PC-based Internet Banking users represent the most important category of e-banking users, the situation will change; a bank should develop strategies for new banking services offered on a different platform, by adding a new presentation form in a shorter period of time and at small costs. 5.2 Conceptsdefinition regarding e-banking The Banking Supervision Committee from Basle defines the e-banking activity as the retail banking services and products distribution of different values through electronic channels.
Source: E-Finance, supplement of Piaa Financiar magazine, December, 2000
These banking products and services can include: attracting banking deposits, granting loans, the accounting management, as well as providing other products and services for electronic payment as e-money. Usually, the more accessible procedures by which it is possible to distribute to the consumers e-banking products and services are: POs (point of sale terminal), ATMs (automatic teller machine), mobile phones, personal computers, distance terminal, Video Kiosk, Internet, and others. Through the Internet, a person can have access 24 hours a day/ 7 days per week to her/his accounts and can make transactions, for this operation needing only a PC connected to the Internet and a browser. The Internet banking services can be accessed also through the mobile telephone and with the help of WAP. This way, because of its rapid extension, the Internet brings new opportunities to the banking industry. The Internet Banking number of users3 is increasing. In Europe, from 2.8 million users in 1999, Forester Research estimates that the number will reach the value of 10 million by the year 2002. In the United States of America, the Internet home country, from 7 million Internet Banking users in 1999, it is estimated that in 2002, there will be 24.2 million. From the banks point of view, clients segments to which these services address are: individual clients market (it is estimated that till the end of the year 2003, there will exist in the United States of America about 18.5 million home users); institutional clients market (corporate clients). It is estimated that by the end of 2003, there will be over 18.5 million Internet banking home users, in the USA. These clients segment will probably represent 30% of banks retail activity profits. It is estimated that Internet banking will be the leader of the Home Banking American market. Electronic money is a payment instrument whereby monetary value is electronically stored on a technical device in the possession of a customer. The amount of stored monetary value is decreased or increased, as appropriate, whenever the owner of the device uses it to make a purchase, sale, loading or unloading transaction.
According to E-Finance, supplement of Piaa Financiar magazine, March, 2001
A distinguishing feature of transactions carried out with electronic money is that they do not necessarily involve a bank account. This is a fundamental difference between electronic money and access products. With access products, such as debit cards, payments are settled by means of transfers between bank accounts. Electronic money represent deposited money through electronic means with the scope of making payments via POs terminal, direct transfers, or through computers network, like the Internet. The product of stored value includes hardware or mechanisms based on card (the so called electronic wallets) and software or mechanisms based on the network (named digital cash). The stored value cards can have only one destination (single purpose), like the phone card, and can be used for buying one single type of merchandise or service from one single vendor; cards with more destinations (multi-purpose) which can be used for more buying from more vendors. The banks can participate in the electronic money circuit in the quality of issuer, but can fulfil also other functions like: distribution of electronic money issued by other entities, processing and transaction discount made with the help of electronic money, as well as the registration in accounting of the corresponding transactions. According to the Report on electronic money published by ECB in August 1998, Electronic money is broadly defined as an electronic store of monetary value on a technical device that may be widely used for making payments to undertakings other than the issuer without necessarily involving bank accounts in the transaction, but acting as a prepaid bearer instrument4. A legal definition of electronic money has recently been provided in Article 1 of the European Parliament and Council Directive 2000/46/EC on the taking-up, pursuit and prudential supervision of the business of electronic money institutions. According to this definition, electronic money shall mean monetary value as represented by a claim on the issuer which is: (i) (ii)
4
stored on an electronic device; issued on receipt of funds of an amount not less in value than the monetary value issued;
ECB Monthly Bulletin November 2000.
(iii) accepted as mean of payment by undertakings other than the issuer. The legal definition set out in Directive 2000/46/EC introduces the concept of a claim on the electronic money issuer. This clarifies the concept of the issuer, i.e. the undertaking that has ultimate financial responsibility towards the holders of electronic money. This distinction is necessary because in some electronic schemes the tasks of issuing and administering electronic money are the responsibility of different entities. Technological features On a technological level, electronic money products can be further divided into hardware-based and software-based products, depending upon the storage device. In the case of hardware-based product, purchasing power resides in a device containing hardware-based security features (generally a chip, which is usually embedded in a plastic card). By contrast, softwarebased products employ specialised software on a personal computer, typically allowing electronic value to be transferred via telecommunications networks, such as the Internet. Hardware-based products have the potential to be used not only for face-toface payments, but also for payments via telecommunications networks, for example by means of a card-reading machine and a personal computer connected to the Internet. Whenever electronic money is transferred via telecommunications networks, the term network money is used, regardless of whether the electronic money is hardware-based or softwarebased. In addition, the following characteristics of electronic money should be emphasised. First, at the present juncture, electronic money received by the beneficiary cannot, in most cases, be used again, but has to be forwarded to the issuer for redemption (closed circulation of electronic money). With open circulation, electronic money functions in much the same way as banknotes and coins, which allow for a number of transactions to be carried out without the involvement of the issuer. Second, electronic money can provide varying degrees of anonymity, from total anonymity to full disclosure of the identity of the user, depending on the technical features of the individual scheme. By contrast, with access products such as debit cards, the processing of payments requires the
identification of both parties to the transaction, since their bank accounts need to be debited and credited. The Electronic money are represented by many forms5, such as: 1. Debit cards by using these, the consumer is empowered to buy merchandise through effecting an electronic transfer of funds from their personal accounts from the bank in the merchants account. 2. Stored-value card they are cards similar to the debit and credit cards, but they distinguish by the fact that they contain a fix amount of digital cash. A sophisticated stored-value card is represented by the smart card. 3. Electronic cash represents an example from the real world of the electronic systems of payment, using e-mail or Web. E-cash is used on the Internet for buying products and services. A consumer can obtain ecash by opening a bank account at a bank connected to the Internet. Then, e-cash is transferred to his computer. When a client wishes to buy a merchandise with e-cash, then he navigates on the net, looks for a shop and selects the option of buying a named article, after which e-cash is transferred automatically from the clients computer into merchants computer. 4. Electronic cheque these permit the users of the Internet to pay the bills directly through Internet without transmitting the check paper. The user of the computer writes the equivalent value of the check, after which he transmits the electronic check to the other party, which, in its turn, transmits it to his bank.
Advantages6 of Internet Banking Services -analysed from banks and also from clients perspective are:
5 6
Source: Net Report magazine, February, 2001 According to Piaa Financiar, September, 2000
BANK
good image on the market; reduced costs of transactions; rapid answer to the market demands; increase of revenues; increase in the clients number. reduced costs for the access and use of different products; ease; rapidity; funds administration; reduced costs for accessing and use of products; liquidity administration.
INDIVIDUAL CLIENT
INSTITUTIONA L CLIENT
5.2.1 Development of electronic money in the Euro area; electronic money oversight, supervision and the community regulatory framework The role of electronic money in the economy derives from its function as a retail payment instrument. In this regard, electronic money is analogous to banknotes and coins, cheques, bank transfers or credit and debit cards. Each of the existing retail payment instruments offers certain specific services which make that payment instrument particularly attractive to certain customers or for certain types of transactions. Nonetheless, there is scope for competition between them. For example, following their introduction, credit and debit cards competed with cheques. Apart from the range of services offered by retail payment systems, the key factor in determining competitive outcomes is the cost associated with the use of each retail payment instrument. For banknotes and coins, as well as for cheques, handling costs are sizeable. For credit and debit cards, the main costs arise from the bookkeeping in relation to bank accounts, including the verification of accounts and transfers between accounts. With electronic money, transaction costs can be lower than with banknotes and coins. For example, when payments at vending machines are made with electronic money, there is no need for the merchant to handle banknotes and coins stored in the machine and to spend resources on the physical safety of the vending machine. Furthermore, with electronic money, transaction costs may also be lower than with debit cards, because the settlement process
generally requires fewer data exchanges and there is usually no need for any online authorisation of electronic money transactions. The development of electronic money will depend on the decisions made by customers and merchants as to whether or not to use electronic money as a payment instrument. From the point of view of the merchant, it is useful to distinguish between the fixed costs and the marginal costs of using payment instruments at a particular point of sale. In the case of electronic money, fixed costs include the costs associated with the purchase and maintenance of electronic money cards and software or dedicated merchant terminals. By contrast, the marginal costs are those relating to the processing of a single transaction, including in particular the costs incurred for telecommunications. To the extent that electronic money systems need to rely on new technologies or new standards, which may remain relatively expensive in the early stages of their development, fixed costs are likely to be relatively high, at least during an initial phase. However, the marginal costs of using electronic money may be lower than those of using alternative payment instruments. Electronic money and monetary policy The impact of electronic money on the monetary policy has been a widely debated issue since the developments in technology made the widespread use of electronic money a feasible scenario. The primary objective of the monetary policy is to maintain price stability. With regard to this objective, the development of electronic money raises three different issues: First, there is need to safeguard the role of money as the unit of account for economic transactions. Society reaps substantial benefits from using a single well-defined and stable unit of account, for conducting transactions, irrespective of the issuer or the form in which money is issued. Second, the effectiveness of monetary policy instruments might be affected by a widespread adoption of electronic money. This relates mainly to effects on central bank balance sheets and the ability of central banks to steer short-term interest rates.
Third, the emergence of electronic money might have repercussions on the information content of monetary indicator variables with regard to the primary objective of price stability. The Eurosystems policy on electronic money The Eurosystems policy on electronic money is explained in the ECBs7 Report on electronic money (August 1998) and further elaborated in the official opinion of the ECB on draft Community legislation on electronic money8. On the basis of monetary policy, payment systems policy and supervisory concerns, the report sets out seven minimum requirements for electronic money schemes to fulfil, as well as two desirable objectives. The requirements are as follows: (i) (ii) issuers of electronic money must be subject to prudential supervision; electronic money schemes must have solid and transparent legal arrangements;
(iii) electronic money schemes must maintain adequate technical, organisational and procedural safeguard to prevent, contain and detect threats to the security of the scheme, particularly the threat of counterfeits; (iv) protection against criminal abuse must be taken into account when designing and implementing electronic money schemes; (v) electronic money schemes must supply the central bank with whatever information may be required for the purpose of monetary policy;
(vi) issuers of electronic money must be legally obliged to redeem it at par value; (vii) the possibility must exist for the ECB to impose reserve requirements on all issuers of electronic money. The desirable objectives, which relate mainly to the smooth functioning of payment system, the prudential supervision of credit institutions and the stability of the financial system, are: i)
7 8
the interaction of electronic money schemes;
European Central Bank ECB Monthly Bulletin November 2000
ii)
the adoption of adequate guarantee, insurance or loss-sharing schemes.
Hence a framework is needed to ensure that electronic money schemes are safe and efficient and that electronic money issuers are sound. The new regulatory framework for electronic money institutions (ELMIs) is defined in two recently adopted Directives: European Parliament and Council Directive 2000/46/EC on the taking-up, pursuit of and prudential supervision of the business of electronic money institutions and European Parliament and Council Directive 2000/28/EC amending Directive 2000/12/EC relating to the taking-up and pursuit of the business of credit institutions. According to European Parliament and Council Directive 2000/46/EC on the taking-up, pursuit of and prudential supervision of the business of electronic money institutions, the main elements of the new regulatory framework for ELMIs include the following: i) the limitation of activities article 1 limits the business activities of ELMIs to the issuance of electronic money, the provision of closely related financial and non-financial services and the issuance and administration of other means of payment, but excluding the granting of any form of credit. the scope of application of banking Directives Article 2 stipulates that only two EU Directives, if not otherwise expressly provided for, will apply to ELMIs, namely a number of provisions of Directive 2000/12/EC and Directive 91/308/EEC on money laundering. Redeemability- Article 3 stipulates that the bearer of electronic money may, during the period of validity, ask the issuer to redeem it at par value in coins and banknotes or by a transfer to an account free of charges other than those strictly necessary to carry out that operation. Initial capital and ongoing own funds requirements - the initial capital and minimum ongoing capital requirements for ELMIs is Euro 1,000,000, while capital requirements are also set on an ongoing basis. The limitation of investments Article 5 requires that ELMIs invest an amount not less than their outstanding financial liabilities related to electronic money in highly liquid assets which attract a 0% or, subject
ii)
iii)
iv)
v)
to quantitative limitations, a 20% credit risk weighting. Limitations also apply to ELMIs activities in derivatives etc. The legal and regulatory regime for electronic money in place in the countries of the European Union (EU) has, until recently been characterised by a low degree of harmonisation. The recently adopted Community legislation on electronic money provides a comprehensive and harmonised regulatory framework for electronic money schemes. The framework limits the issuance of electronic money to traditional credit institutions and to a new type of credit institution known as an electronic money institution (ELMI). ELMIs are institutions, which specialise in the electronic money business. The particular nature of their activity and of the risks that they incur has led to the definition of a specific supervisory framework. In addition, the application of provisions of the Directive relating to the taking-up and pursuit of the business of credit institutions will allow ELMIs to benefit from an European passport, which will enable them to carry out their activities throughout the EU. As a conclusion, it should be mentioned that electronic money has the potential to become an important element of the Euro area financial system. The development of electronic money in the Euro area will be determined by market forces and reflect competition between electronic money and existing retail payment instruments, as well as among the various issuers of electronic money. As a result, it is difficult to predict whether electronic money will develop in the future, and what form its development will take. 5.2.2 Services of E-Banking in Romania Bank Austria Credit Anstalt launched on-line banking in March 2001. Bank Austria Creditanstalt Romania (BA/CA Romania) recently launched Internet Banking, named ON-LINE BANKING, through which the customer saves time and money, and does not have to support the costs corresponding to this system. Offering some modern and secure solutions, of high quality coming and receiving the client, will be the success of BA/CA Romania.
The Commercial Bank Ion Tiriac introduced Office2Office electronic banking Sine March 1st, 2001, electronic banking service Office2Ofice has been introduced. It addresses to physical persons mainly and permits a direct link with the bank through a computer. The new electronic payment system works under Windows and permits the client to manage directly from his office the bank accounts. Data can be viewed and printed or imported to his bookkeeping system. Using his own computer the client can make payments in Romania and abroad and has access to current account information related to effected transactions, initial sold, final sold, and Treasury information. The system is working off-line, this allowing the client to make a verification of data before the transmission to the bank. The access can be done based on a user name and unique password, having the possibility of defining on profiles of different types of users. The system also permits choosing a set of authorised signatures corresponding to internal policy of the company and also the approval of different schemes, depending on the payment nature. Citibank Announced the Launching of an Internet-Only Banking Operation Demirbank Romania is offering Mobile and Internet Banking Services. DemirBank Romania has been offering since March 2001 M-banking. Introducing Mobile Banking service (based on WAP technology) represents a new stage in the development of the bank s offer of products and services on the market. A year ago, the bank launched Electronic Banking services on the market and after that Internet Banking. Mobile banking represents the users possibility to access his account from where ever he is, with the help of his own mobile phone. The computer is no longer necessary. The bank does not have additional fees and commissions for the Mobile-Banking services, permitting its customers to access their own accounts through the mobile phone system. Alpha Bank Alpha Web Banking was introduced in 1998; it permits clients to effect online elementary banking transactions. In October 2000, share transaction was introduced. Alpha Bank was one of the first banks that introduced mobile banking through WAP technology. Alpha Bank was in Romania the first bank that implemented on-line connection, and executed operations in real time, it also implemented a multibranch/ multicurrency accounting type.
Alphaline is a very modern, accessible and secure home-banking service, one of the firsts in its product type. The bank intends to introduce in the near future the Internet banking. The Romanian Commercial Bank is Launching Home-Banking The Romanian Commercial Bank is offering to its clients new facilities of e-type. The bank is offering on the market two products: multicast-BCR, addressed to big customers of corporation type and e_BCR, addressed to small and medium size customers. This new system will function by creating an interface with the customer. The connection with the bank will be done through the bank s Internet site, with the help of a local browser. Piraeus Bank In March 2001, Piraeus Bank launched EXPRESSBank services package. This comprises four remote banking services: TeleBank, MobilBank, InfoBank, and DirectBank. The Commercial Bank of Greece Starting December 2000, the Commercial Bank of Greece offers Internet banking services, which permit the clients the access to banks products and services without being necessary the physical presence in the offices. 5.3 The legal framework in the e-services field 5.3.1 The EU s on-line Financial Services legal framework The European Commission launched a new plan of on-line financial services development, having at its basis the so-called origin country principle9, a principle that governs cross border commercial relationships, applicable to buying and selling financial services. According to an Internal Market Department official, the plan should become operative till 2005. On the other hand, another department of the Commission, the one that is focussing on the legal field and internal affairs is working at a new law whose provisions are in contradiction with the unique market requirements. This is stating that the law of the client or consumer s country should apply in other words the destination country principle. The Commissions representatives in the legal field already adopted a law named Bruxelles1; recognising the destination country principle. Rome
9
Source: Piaa Financiar magazine, September, 2000
Document2, which will be soon proposed to Commission members political approval takes, also, into account the same principle. The lack in the consumers trust is the main thing that stops e-commerce development, a juridical problem spokesperson from the commission, declared. The economists in charge of the unique market regulation elaboration are strongly affirming that consumers interests are better served if encouraged competition exists. The existing statutes based on the destination country principal include Broadcasting Directive, Electronic Signature Directive, technical standards Directive and Copyright for Satellite and Cable Transmission Directive. The E-Commerce Directive adopted at the EU level must be transposed into national legislation by the 15 Member States and revised according to Brussels and Rome. The EU, in order to regulate and uniform the controversial field of the electronic signature, recently published a series of directives to be implemented, for the Member States. Two important objectives are outlined: firstly, it is provided the fact that from the time of the directive entering into force, in the EU states; the electronic signature10, has the same value as the written signature, starting from the premise that the electronic signature, will be able to be certified by a institution specialised in this field. Secondly, there is the archivation of those documents problem. The question: for how long the signatures must remain in the computer s memory? represents an important aspect of the problem. The legal provisions will be uniformly submitted to obeisance and this aspect constitutes an important phase in the dematerialization of the payment system. About on-line, off-line non-discrimination principle, applicable to commercial operations, the solution was to keep the existing implemented legislation regarding the operation system using printed documents, and to extend it to on-line operations, to the biggest possible extent, exceptions
10
Source: www.europa.eu.int.
being constituted by the particular regulations applicable to specified situations. Another important aspect is the jurisdiction problem. In the present, there is no jurisprudence unanimously accepted, and there are situations in which the two systems are in contradiction. In such cases, beyond the risks assumed by the providers, there also intervene a series of complicated and time- consuming procedures. The advice that can be given in these conditions is to be attentive, and prudent in the operations performed and assume for that moment, due to the existent situation, a minimum possible risk. 5.3.2 The E regulating provisions in Romania In Romania, the trust in e sector activities could come only from law. It is necessary that laws regarding e world be concluded and adopted by the Romanian Parliament. The Law Regarding the Electronic Authentication The main actors of e market can be, for the moment, public institutions and physical persons. The law of electronic authentication is necessary, and it should oblige the public institutions to enter the game. A good legislation in this field should focus on the participants to the economic game protection, and non-intervention as long as the participants have nothing to reproach one to the other. The Law Regarding the Electronic Signature11 The electronic signature12 represents an information attached to an electronic document which: - uniquely identifies the signer, being realised with means placed at users disposal; - it identifies the document, - and signals any afterward modification brought to it.
11
12
The author of the project of law regarding the electronic signature is Varujan V. Pambuccian, the president of the IT Commission from the Romanian Parliament. Source: www.pambuccian.ro/RlegSign.htm
It is much stronger than the hand written form one (and given this reason it can have its juridical regime). It is clear that the law on the electronic signature is at the basis of any regulation referring to an electronic data needing juridical regime. The regulating institution should be a recently created one, namely, the Information and Communication National Agency, having the role of regulating the certification and e-commerce service providers. The Agency is under the control of the Romanian Government. The project of regarding e-commerce The project of law13 regarding the e-commerce states the juridical aspects related to business to business operations (with the typical application: virtual factory) and to those of business to customer type. The law form proposed by the Romanian Information Communication National Agency collects all the common regulations from the existent legislation. The challenged questions are those related to taxes that could be perceived on e-commerce. The only way in which these activities can be taxed is the one proposed by the law project, would be the establishment of an Internet Police Department having the duty of monitoring every transaction in the network. For the on-line documents transacted the aspects related to the hour and the place of the signing of the document and the ways of proving that the addressed really got the document, these, together with the electronic signature. The law defines the electronic exchange of data as a data electronic transfer from one system to another using a stated standard for information structure. In the sense of the same law, the informational system is a system used for generating, transmitting, receiving, stocking or any other similar processing. The information used under the form of an electronic message, is considered valid of producing juridical effects, regarding the conditions provided by law.
13
Source: www.pambuccian.ro/ R-LegEcom.htm
The agency must elaborate regulations regarding electronic data exchange security in order to protect electronic commerce operations it also realises reports on multilateral recognition with organism from other states. The law of non-cash digital payments systems14 An economys state of health depends also on the speed at which economic cycles close up, and, in Romania it appears that the fluidity of the economic cycles is one of the major problems of the economic decline. So, the noncash digital operations must be initialised on a large scale, together with the legislative framework. 5.4 The risk management for e-banking activities and e-money When speaking about e banking we refer to on-line delivery of banking services. The Internet is the main medium of distribution for the on-line services, therefore the services offered are mainly subject to the risks related to the Internet, without forgetting the traditional risks related to the banking activity. On-line security must be a fundamental component for any E-Banking strategy. During the time when managers create networks opened to new applications and to many users, the network is exposed to bigger risks. The complex networks nowadays are frequently vulnerable to different types of attacks like information steal, denial-of-service attacks, and unauthorised breakthroughs. Risk establishment is a continuous process, which supposes the realisation of the following three stages: - the bank engages in a process of risk identification and where it is possible, of measurement. When risks can not be measured, the management establishes the potential risks that might appear, the steps to be taken and establishes the impact that these can have on the bank. - Risk establishment means for a bank determining the bank s risk tolerance, thing that implies losses establishment that bank permits in the case of some unforeseen events.
14
According to Piaa Financiar, July,2000
- The management can compare risk tolerance with the magnitude established for a certain risk, for establishing if the respective risk enters in the tolerance limits. Risk Control and Administration After establishing the risks and tolerances, the management must administer and control them. This stage of risk administration includes such activities as: internal communication co-ordination, supplementing protection measurements against external risks, clients instruction as to services use, a.s.o. Banks increase the ability in the inherent risk control and administration in any activity when all these are established through procedures and they are accessible to the whole staff. The risk management and control process include: - Security measures and policies. Security represents a combination of systems; practical applications and internal control used for putting in a safe place the integrity, authentication, data confidentiality and operating proceeds. The security policy states the intentions of the firms management of sustaining the information security regarding the bank security planning. The policy shapes the responsibilities for modelling, implementing and strengthening information security measures strengthen: it can also establish the procedures for the banks results evaluation, for the of disciplinary measures and for security violation reporting. The security measures include encrypt, password protection, viruses scan. - Internal communication. The supreme management must inform the key personnel the way in which e-banking and e-money system provisions intend to sustain the general objectives of the bank. In the same time, the technical personnel must clearly inform the management about the way in which the systems are projected to function, which are the fort and weak points of the system. For assuring an adequate internal communication, all the procedures must be previewed in writing. In the scope of operational risk limitation, the management must adopt a common policy of continuing teaching the personnel the new technologies. - Products and services evaluation before they are introduced on a large scale can limit the operational and reputation risks. Testing validates the fact that equipment and systems function and produce the desired results.
Pilot programs or prototypes can be also of help to the development of new informational applications. Having as objective the enumerated risks reduction, the regulation of all e activities, the establishment of an adequate infrastructure are necessary things to be done, as well as providing those entitled to authorise and supervise these activities. As any other commercial operation, electronic commerce needs a specific infrastructure. In this case, this comprises three elements: technical infrastructure, the interface with the classical commercial components and the specific juridical regime. The technical infrastructure is constituted of hardware systems, the corresponding software and communication network. This constitutes in fact, the component, which determined the apparition and development of electronic commerce. It is necessary, also, a major interface with the classical systems of commerce. The bank represents the key element, because any commercial operation is possible with the use of money. A bank s insertion in the electronic banking system supposes a securitized connection between the bank and the user through which to be able to effect operations in real time. 5.4.1 Risk identification and risks analysis Thanks to the rapid changes interfered in the information technology; banks confront risks specific to e-banking activities and e-money, risks presented in the annexes. At this level, it appears that the operational risk, the reputation risk, and the juridical risk represent the most important categories of risks, especially for the international banks. Operational risk appears from a potential loss due to some significant deficiencies in the integrity and viability of the system. Security issues are supreme, if banks are subjects to external or internal attack against their products and systems. Operational risk can appear as a consequence of the incorrect use of e money or e-banking systems, as well as of the inadequate realisation and implementation of those systems. Security risk. The access control to the banks systems became more and more complex because of the developed capacities of the computer, geographic dispersion of access points and use of various
communication ways including public networks like the Internet. The unauthorised access to the network could lead to direct losses, adding some duties to clients, a.s.o. here could, also, appear a variety of authentication problems and specific access. For example, the inadequate controls could lead to successful attacks of hackers operating on the Internet, which could access, save and use confidential information about clients. If an adequate control lacks, a pier could have access to the information system of the bank and could virus it. Close to the external attacks against the electronic banking and money systems, banks are exposed to the operational risk concerning the employees fraud. The employees could get, in a clandestine way; data related to the authentication with a view to access the clients accounts or steal the stored value cards. The errors due to employees could also, compromise banks systems. Of an increased importance for the supervising authorities is the risk of e-money counterfeits, activity, which, according to the Criminal Code represents an offence. This risk can be increased if banks fail to incorporate adequate measures for discovery and prevention of counterfeits. A bank confronting operational risk from forgeries and becoming liable for the sum of the forged e-money account. There can also appear costs due to repairmen of a compromised system. Risks related to the projection, implementation and maintenance of systems. Thus, a bank is exposed to the risk of an interruption or slowness of its systems functioning if the e-bank or e-money chosen by the bank is not compatible to the user s requirements. Risk which appear due to unproper use by clients of banking products and services. The risk is increased when a bank does not instruct in a corresponding manner its clients in what it concerns the security precautions. More than that, the lack of proper transactions verification, clients could reject transactions already authorised, this way creating numerous financial losses. Clients that use personal information (authentication information, number of credit cards, a.s.o.) in an unsecured electronic transmission can permit evil intentioned persons to obtain access to clients accounts. Following this, the bank can suffer financial losses caused by unauthorised transactions. Money laundry can be another source of worry. Reputation risk is the risk caused by significant negative public opinion, which consists of a critical loss of funds or bank s clients. Reputation risk can appear when bank s actions produce a major loss of
people s trust in the bank s ability to fulfil its critical functions in order to continue its activity. Reputation risk is important not only for a single bank, but also for the entire banking system. Legal risk appears by violation or non-observance of laws, rules, regulations or prescribed practices, or when the legal rights and obligations of the participating parties to a transaction are not correctly established. Banks engaged in e banking and e-money activities can confront juridical risks referring to the release of information regarding clients and protection of banking secrecy. Other risks. Traditional banking risks like credit risk, liquidity risk, interest rate risk and market risk are risks that can appear also in the electronic banking activity. Credit risk represents the risk that appears due to a partial payment of a credit obligation, at the established term or in any other established moment after that. Banks that perform e-banking activities can extend credit by untraditional channels and extend their market beyond traditional geographical boundaries. Inadequate procedures, by which debtors credibility asking credit through electronic channels is determined, can influence credit risks for the respective banks. Liquidity risk represents the risk that appears due to banks incapacity to fulfil its obligations at maturity term. Interest rates risk refers to the bank financial situation exposure to undesired movements of interest rates. Market risk is the risk of registered losses in the positions from inside the balance sheet, as well as in those from outside, losses that appear due to price movements on the market, including the exchange rates. Examples of risks: Credit Risk Lack of payment of the debtors that have solicited credits through electronic channels. Lack of payment from e-money issuers. Liquidity Risk Payment incapacity of an e-money issuer Interest Rate Risk Sudden changes of the interest rates of the instruments in which an e-money issuer invests
Market Risk Foreign Exchange risks coming from the acceptance of foreign coins as a payment for e-money. Country Risk Transfer risk coming from a Foreign Service provider or foreign participants to an electronic banking project. Management risk. A process of risks administration that includes the three basic elements of risk: evaluation, exposure control risk and monitoring the risks will help banks and supervisors to fulfil these objectives. It is essential that banks have a transparent risk administration. And when there are identified new risks in these activities, the Board of Administration and the executive management must be informed.
As a conclusion, it should be stipulated the following: Traditional financial service providers must exploit the business solutions based on the Internet, otherwise running the risk of being taken out of the market. In the financial sector rapid changes are happening, and institutions do not have the opportunity to offer the best services in each category. Pioneers have the potential to invent and bring on the market new products that the customers find attractive. For this reason, the banks, being unable to rapidly adapt the changes, will have to become product distributors or producers of some of them. In both cases, Internet will be delegated to perform unimportant functions for the financial institution. Virtual distribution (on the Internet) has the advantage of lower costs, on the decreasing costs of electronic data processing and communication expenses. Banks, insurance societies, and real estate societies will have to work with the specialised producers of a certain service type and effect cross selling. Furthermore, there are new opportunities of establishing closer relationships with the clients, beyond the traditional boundaries.
For successfully maximising, the bank of the future will have to develop the essential competencies related to distribution or product specialisation. An institution can not be successful in both directions. A core competence is essential when directly affecting the competitive advantage of that particular institution in a market field. Core competitive advantages goal is to create a bigger differentiation and assign the best resources for it. E-Business and, in the first place e-commerce became a well-known and generally accepted phenomenon. The evolution from a few innovative firms (especially from B2C type of commerce) to commerce on a large scale (of B2B type) was rapid. The motivation would be the accelerated transactions, reduced costs and an interaction with the client through personalised solutions. E-business is no longer a tendency, it is an important changes generator in the value added. Vital to this field is the field of electronic banking, which is vital for on-line transactions. Ian Greenspan, president of Federal Reserve Board, a key decision maker in the economic policies establishment, states15 that the prolonged economic increase and recession stop in the United States of America have at their basis the increase in productivity due to information technology and ebusiness. The phenomenon became global and had implications in the entire world. It is said that the necessary step for entering the 3rd millennium should be on-line banking16for all the transactions effected in Romania. The new payment way could revitalise the existent payment mechanism. The financial services will be on-line or will not be at all. This is the opinion of the most important players in the financial service field. In Romania, the Internet represents one of the solutions for making the financial services field more competitive. The traditional solutions will not be able to satisfy the modern clients demands. No matter how many working points will be opened, the client will always be at a certain distance from that; no matter for how many hours the offices will be opened, the client will always work later than the closing
15 16
Source: E-Finance supplement of Piaa Financiar, February, 2001 Source: Piaa Financiar, December, 2000
hour. It is sure that a service to which a client can have access 24 hours out of 24 a day, will be closer to the clients wishes. From the banks point of view many branches opened represent high costs with the buildings, employees salaries. On the other hand, E-Banking implies investing in technology, applications that will provide the support for the development of such activities, assuring the security of transactions, well functioning. A short overview of the requirements and advantages will include: In Romania, the analysis of the financial-banking market lead to the following statements: the technological endowment is old and isolated; the economic climate needs a serious investment; the legislative context continues to be rigid, but steps have been made the projects of law regarding the e domain are waiting for the approval of the Romanian Parliament; major banks offering e-banking services proved to be successfully in Romania. For the establishment of electronic banking service platforms, the basic requests are: the rapid access, a simple connection to a variety of channels, respecting the security business rules; assure secure and rapid transactions; the programming of the electronic applications must be simple; to contain efficient administration utility programs; Clients Benefits: mobility; comfort and cost savings; 24 hours per day, every day accessibility; security that meets the very highest European standards; people can focus their attention on achieving their every day objectives; time saved; account management. In Romania, the electronic payments could be a factor of revitalisation of the monetary field. But there are still many things to be done.
Although the electronic payments are more efficient and cheaper than a paper- based payment system, there are certain facts related to the environment that are not favourable to the passing to the digital economy: It appears that, even if steps have been made in order to gradually adopt the electronic system, even if e-business continues to develop in Romania and the IT market is increasing, Romania in not entirely ready to accept the new era of digital economy; this is due to the fiscal evasion manifested on the market, to the economic agents that are not acting disciplinary, to the existence of a financial blockage, on one hand. On the other hand, our monetary unit is not convertible and the legislation is restrictive in the sense that it imposes a partial foreign exchange control of the capital transactions, with implications over the Romanian balance of payments. In Romania, the infrastructure is not corresponding for the development of e-business; the legislative framework has many gaps. Recently, the Law of electronic signature was promulgated and this represents a clear step toward e era of digital transactions; other projects of law with the aim of regulating the electronic domain are in a project phase: the law of e-commerce, the law regarding the payment effecting through Internet, the law on the software parks, the laws regarding e-banking and e-finance, the regulations regarding the encryption. The electronic payments are still in an incipient phase; in order for an efficient electronic payment to be made, institutions like the National Bank of Romania and other public institutions adopt electronic systems, offer in-time and modern services. The clearing system should be automatically be designed and effected. The Romanian system, as a whole, is reticent to changes. The electronic system does not benefit of trust. In Romania there is no encouragement from authorities to use the electronic system, there is no project sustaining the electronic system. Romanians mentality, the conservatory regime is present also in the field of electronic transactions. 5.5 Advantages and disadvantages of Internet banking Cynics would say banking is being driven towards the Internet by fear and greed: fear because everyone is afraid of being left behind and greed
because there is such potential to save money. While there is an element of truth in this view, it is too glib an explanation of the real drivers and potential of using the Internet in banking. If used to its full potential, investment banking across the Internet in conjunction with the related technologies of intranets and GroupWare could radically change the way business is conducted to everyone's benefit and could do much to democratise the finance sector. Banking could be more easily available to individuals and smaller companies as well as making information accessible in countries whose infrastructure is yet underdeveloped. A survey published by management consultancy Booz-Allen & Hamilton in August 1996[1] supports these arguments. It found that Internet personal banking costs run at 15-20 per cent of income compared with the average cost-to-income ratio of 60 per cent. Furthermore, starting an Internet-based bank could cost as little as US$ one million because all the necessary software is already available. When compared with the US$ 1.5-2 million required to set up a single traditional branch and the US$ 350,000-500,000 per year to operate it, Internet banking clearly represents an extremely costeffective alternative to traditional branch banking networks. Needless to say, Internet-based financial organisations could well afford to charge their customers much less for the services they offer. Investment banks are also investigating the opportunities offered by the Internet. More than 70 of the world's top 100 banks already have a presence on the Web, with the overall number of sites increasing at 90 per cent a year. By March 1997, there were over 1400 financial servers delivering information on the Web. Although the majority of such sites are currently little more than electronic brochures about the banks' services, the race is on to offer real services from Websites. "There is no doubt that the Internet will become a fully fledged delivery channel in a very short period of time," said Michael Berger, a member of the Booz-Allen & Hamilton financial services team. "Ultimately, all banks will have a Web presence and most would have advanced Web sites capable of conducting most traditional banking transactions within three years." Internet banking: What is it? Online systems allow customers to plug into a host of banking services from a personal computer by connecting with the bank's computers over telephone wires. The convenience can be compelling. Not only is travel time reduced, but also ATM machines; telephones banking or banking by mail is often unnecessary. And, technology continues to make online
banking, once attempted only by computer enthusiasts, easier for the average consumer. Even that may not be easy enough, though. Many systems that offer greater financial control also require more work. Online bill payment is an example of an effort that requires setting up which leads to ultimate convenience. Banks use a variety of names for online banking services, such as PC banking, home banking, electronic banking or Internet banking. Internet Banking: Many advantages Regardless of the name, these systems offer certain advantages over traditional banking methods. Consumers can use their computers and a telephone modem to dial in from home or any site where they have access to a computer. The services are available seven days a week, 24 hours a day. Transactions are executed and confirmed quickly, although not instantaneously. Processing time is comparable to that of an ATM transaction. And the range of transactions available is fairly broad. Customers can do everything from simply checking on an account balance to applying for a mortgage. Internet Banking: There are disadvantages There are also disadvantages. The most obvious: Technophobes need not apply. You must be comfortable using a computer. Investment of time upfront can be formidable. The data entry is necessary before the numbers can be massaged and money managed successfully. Online bill payment is an example of an effort that requires setting up which leads to ultimate convenience. Other advantages of Internet banking are: Easy 24-hour access to account information and transactions; Automatic chequebook balancing;
Current and accurate account balance; No monthly fee for bill paying or account access; Electronic transfer of funds between accounts; Free bank wires; Immediate accesses to statements and cleared checks. Future Many experts agree that Internet Banking will revolutionise the World Wide Web and completely change our perceptions and attitudes of an increasingly digital society. Others suggest that Internet Banking and electronic commerce will usher in a new and sinister digital era in which the US Government will have access to all our PCs. We must, however, remember our ancestors experience with the introduction of televisions. Many believed that "Big Brother", otherwise known as the US government, would be watching us through the television we purchased for our homes. Perhaps a more realistic concern is the current state of security. With advances in secure transmission technology, these concerns will be relieved. Financial institutions will continue to offer PC-based home banking services to their customers. Estimates of the number of PC home-banking customers in 2000 range from the single- to double-digit millions. Microsoft now has 58 announced banking partners distributing its Money home-banking software to customers, while Intuit has racked up 37 bank partners. Dozens of other financial institutions are turning to bank-brandable software available from a slew of more traditional banking vendors, such as CFI ProServices, Online Resources & Communications and CheckFree (Servants), as well as developing proprietary packages. One thing is guaranteed the growth in US household PC penetration rates and constant marketing references to the Internet and the World Wide Web have increased the awareness of the PCs capability to communicate with the world. As a result, interest in Internet Banking has accelerated. After losing ground to non-banks in credit cards, mutual funds, and mortgages, bankers hold more effective relationship management among Internet Backings objectives. Financial institutions are hoping that Internet Banking will assist in retention of their most profitable customers when those customers relocate.
An important factor in the growth of Internet Banking is the number of households that own personal computers. The number of households that own personal computers grew by 16% last year, according to a new survey by Computer Intelligence Infocorp, which interviewed 11,500 PC users. That puts the total percentage at 38.5% of U.S. homes that have one or more PCs. According to a recent Wall Street Journal article, recent buyers tended to be older and less-affluent Americans. The growth in PC ownership among households making $10,000 to $30,000 was up nearly 25%, to a range between 10% and 30% of the total, and about 20% of households headed by people over 60 now contain a PC. Advantages The advantages of Internet Banking are numerous for both financial institutions and users. For the Financial institutions, the most obvious advantage is cost. The following table shows the relative costs to the bank per transaction for the various channels: Channel - Cost/Transaction 1. Branch Full Service: $ 1.07 2. Telephone Average: $ 0.54 3. ATM-full service: $ 0.27 4. PC banking (3rd party): $ 0.015 5. Internet Banking: $ 0.010 Although other surveys have come up with different figures, there is consistency in one important sentiment; they all agree there are tremendous potential cost savings if financial institutions manage to carry out a higher percentage of their transactions over the Internet. Another incentive for financial institutions is image. Having been famously described by Bill Gates as "Dinosaurs", they are now eager to promote themselves as innovators in order to attract customers and, more importantly, to retain existing customers. Mr. Gates also commented "give me a slice of the transaction industry and the banks are history". While he has since made his peace with the banks, claiming that the Dinosaur comment was aimed at their systems rather than at financial institutions themselves, he has managed to incite them into action. They need to
remember that they have no divine right to rule the financial transactions industry and can no longer afford to be complacent. Luckily, the U.S. government denied Microsoft the opportunity to acquire Intuit due to antitrust and monopoly restrictions; however, financial institutions should still continue to take notice, as the spectre of Bill Gates still looms ominously over the financial services industry. Internet banking isnt just restricted to the countrys largest financial institutions. Some of the more regional players, such as credit unions, are also making their mark. The smaller size of these institutions has allowed them to out-manoeuvre some of their larger competitors. One effect of the trend towards Internet banking is to level the playing field so that even smaller financial institutions can offer the type of sophisticated service customers would normally expect only from a large bank. The increased competition can benefit both the financial institution and the consumer. The financial institutions will benefit from the drive to utilise the best technology available (increased efficiencies, lower incremental transaction costs). The consumer benefits from greater choices and lower costs. In addition, Internet banking can be especially appealing to financial institutions whose "members" are not located near branches (again benefiting both the institution and consumer). In addition to providing existing customers with access to banking services, Web sites operated by financial institutions may also be used to solicit new customers. For the user, the advantages are more obvious. The ability to pay bills electronically, check balances, transfer money and do other banking tasks from the office or a home P.C, saves time and increases efficiency. It also simplifies account tracking and record-keeping. Disadvantages Security issues have always plagued the Internet. Although the Internet will never be completely secure, the fact is that current fears are in many ways irrational, fuelled by horror stories rather than fact. Recent advances in security technology have lead to "more" secure systems. An example is the development of SET by Microsoft and Visa. Another example is the development of CSEPS and CSETS by Clay Pigeon Technologies. Perhaps it is an indication of the power of the message provided by the media that we worry about internet security but continue to use other insecure
transmission media such as the telephone to transfer confidential information. Socialists also suggest that Internet Banking "dehumanises" banking by taking away social, human contacts. This argument raises two important points: 1. Those of us think the idea of a great social event is to stand in line waiting for a teller need not worry. Internet banking is not, at least for the moment, intended as a replacement to the traditional brick-andmortar financial institution, but merely as an additional channel to provide customer service and efficiency, much like telephone banking, PC banking, and 'real' banks. 2. Internet banking is up and coming. Although it is important to be aware of the security issues, there is nothing to prevent it from dramatically changing the future of financial transactions. Financial institutions proposing to provide services through the Internet have to confront a number of legal issues. These include the problems of authentication, electronic formation of contracts, and issues related to the creation and protection of content provided on a financial institutions Web site. Regulators are also taking an interest, as foreign financial institutions are increasingly able to solicit domestic residents. As well, the potential that electronic cash will be increasingly adopted as a medium of exchange for transactions conducted across the Internet is raising concerns that existing forms of regulation may not be adequate. Pros and cons about Internet banking Intent banking can provide advantages and disadvantages. The positive factors are: Convenience. The services are open 24 hours a day, seven day a week. Bills can be paid with a few keystrokes, so you do not have to write the check, address and stamp envelopes. Financial planning capability. Internet banking can give you fingertip access to all areas of personal money management such as budgeting and forecasting.
Low cost. Internet banking operate at an expense much lower than a branch. Banks can be able to provide services at lower prices. The possible negative factors may include: Lack of person-to -person interaction. Since all transactions are executed via computers, Internet banking is impersonal. Computer overload. If the system goes down at the same time when you want to do banking, you may have to fall back on traditional banking methods. Growing pains. Some Internet banking services are coming to market before they are ready. Stories have surfaced about not working PIN numbers or incompatible modems. Service limits. You can not deposit online and you can not withdraw cash from a PC. ("The ABCs of Banking Online", Black Enterprise. 26(8): 45-46. 1996 March). Disadvantages of Internet banking compared to other systems What are Internet Backings weaknesses compared to other alternative delivery systems? A discussion of the weaknesses follows: New developing technology - Internet Banking is the latest form of technology for banks. Internet Banking is a developing technology supporting self-service delivery channel. It is extremely customer driven and responsive to the customers needs. Developing technologies such as Internet Banking, though, run the risk of getting too far of ahead of the banks; therefore, the banking industry will not be able to sell to the customer. In reverse, the banking industry can get too far ahead of technology, and banks will be able to deliver to the customer. Unknown strategy- the dilemma of the "nervous banker" refers to the banking industrys wait and sees approach. Banks are now struggling to play catch-up. Banks have missed chances to strengthen customer relationships by not taking full advantage of the Internets interactive capabilities. They have viewed the Internet as a means of providing static
information promoting their products and services. The banking industrys biggest challenge is in establishing an electronic banking strategy and fully understanding its options and implications. The Internet is a new alternative delivery channel, which requires new thinking and marketing efforts. Investment cost - The initial cost investment of Internet Banking technology is higher than the other forms of alternative delivery systems. Due to inexperience, banks that attempted to establish Web home pages run up against major problems. They need to invest in their own server, a highly sophisticated and costly computer to create their Internet presence. The cost estimated for a Web site ranges up to $60,000. Unlike the other systems, a Web site costs an additional several thousand dollars per month in maintenance costs. The complexity and the cost of creating and maintaining a Web site on the Internet can quickly overwhelm Banks. Security - Security is perceived as the biggest weakness of the Internet. The Internet is a security nightmare because of its characteristics: public, open, network of peer to peer networks, flat and mesh topology, connectionless datagram routing, no central authority, protocols based on mutual trust, and nave users. The banks rely on the secrecy or authenticity of information and transactions on the Internet. Banks need to establish an infrastructure that incorporates both security policies and management staff to support information security. CONCLUSION Because the world directions in any field are drowned by the most developed nation into the world we will report our conclusions to their statistics. So, first will examine the Internet services situation generally and after that we will conclude and about the Internet Banking situation. All that, because this segment of market is already prepared to use the Internet Banking solutions. First: the Electronic Commerce (business-to-consumer) is one of engines that are working for the Internet Banking cause. Forrester Research estimated in 1997 that residents of five million U.S. households had shopped for some product using the Internet. The number for 1998 was 10 million and the forecast for 1999 is that 13 million U.S. households will shop on the Internet. Also IDC estimates the dollar volume of business-to-
consumer sales at $14.9 billion for 1998. The IDC forecast for 1999 is $31 billion. Other IDC predictions are $50.7 billion for 2000, $78 billion for 2001, $116.5 billion for 2002, and $177.7 billion for 2003. (See figure below).
Source: Forrester Research, Inc. Second: Electronic Commerce: business-to-business17. International Data Corp. (IDC) estimates that the dollar volume of business-to-business electronic commerce in 1998 was $27.4 billion. The projected volume for 1999 is $64.8 billion. IDC forecasts $138.8 billion for 2000, $270.9 billion for 2001, $526.4 billion for 2002, and $978.4 billion for 2003. (See next figure)
17
- Internet - http://www.usic.org/papers/stateoftheinternet99.htm
Source: IDC, Inc. (1999) In Romania the Internet Industry has a great potential and it is continuously growing. In the year 2001 after a general agreement among all the Internet Providers, there was implemented a Romanian Backbone that will improve considerably the quality of the Internet Banking services. The Electronic Signature Law was adopted by the Romanian Parliament. That low is very important, because it helps the movement of electronic payments of confidential data into the Internet with confidentiality and authentication of sender and receiver (electronic signatures instead of ololgraphic ones). There are a lot of banks in Romania that are already providing such a services, such as: the Commercial Bank of Greece Romania, Demir Bank (also and with a mobile banking using mobile phones), Bank Austria Creditanstalt, City Bank Romania, Libra Bank, Banca Unirea, etc. So, we estimate that soon that kind of banking service will have a great future in Romania and all over the world.
Progress test
1. 2. 3. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. What is an e-bank activity? What are the techniques of the banking operations performed through the Videotext System? List the three entities that take part in the Videotext system. What are the functional characteristics of the Videotext system? List some procedures by which it is possible to distribute electronic banking products and services. What are the main forms of Electronic Money? List the main definitions. List the main technological features of electronic money. Define the legal framework in the e-services field. Explain the impact of electronic money on monetary policy. List the seven minimum requirements for electronic money schemes. Show the main types of risk for e-banking activities and e-money. What is the Romanian environment and development of e-banking services List the main elements of the new regulatory framework for ELMIs. List the main elements of the new regulatory framework for Electronic Money Institutions. What are the advantages of Internet banking services from the bank point of view? What are the advantages of Internet banking services from the individual client point of view? What are the advantages of Internet banking services from the institutional client point of view? List some electronic banking services realised by the Romanian banks. What is the electronic signature under the provisions of the Romanian legislation? List the main advantages and disadvantages of Internet banking.
ANNEX No 1 Extract from the European Parliament and European Council Directive 2000/31, concerning data confidentiality Directive 2000/31/EC of the European Parliament and of the Council of June 2000 on concern legal aspects of information society services, in particular electronic commerce, in the Internal Market. (Directive on electronic commerce)/ quotation regarding the confidentiality of data and the definition of the information societies as stated by the Community Law. (15) The confidentiality of communications is guaranteed by Article 5 Directive 97/66/EC; in accordance with that Directive, Member States must prohibit any kind of interception or surveillance of such communications by others than the senders and receivers, except when legally authorised. (17) The definition of information society services already exists in Community law in Directive 98/34/EC of the European Parliament and of the Council of 22 June 1998 laying down a procedure for the provision of information in the field of technical standards and regulations and of rules on information society services (21) and in Directive 98/84/EC of the European Parliament and of the Council of 20 November 1998 on the legal protection of services based on, or consisting of, conditional access(22); this definition covers any service normally provided for remuneration, at a distance, by means of electronic equipment for the processing (including digital compression) and storage of data, and at the individual request of a recipient of a service; those services referred to in the indicative list in Annex V to Directive 98/34/EC which do not imply data processing and storage are not covered by this definition. (18) Information society services span a wide range of economic activities which take place on-line; these activities can, in particular, consist of selling goods on-line; activities such as the delivery of goods as such or the provision of services off-line are not covered; information society services are not solely restricted to services giving rise to on-line contracting but also, in so far as they represent an economic activity, extend to services which are not remunerated by those who receive them, such as those offering on-line information or commercial communications, or those providing tools allowing for search, access and retrieval of data;
information society services also include services consisting of the transmission of information via a communication network, in providing access to a communication network or in hosting information provided by a recipient of the service; television broadcasting within the meaning of Directive EEC/89/552 and radio broadcasting are not information society services because they are not provided at individual request; by contrast, services which are transmitted point to point, such as video-on-demand or the provision of commercial communications by electronic mail are information society services; the use of electronic mail or equivalent individual communications for instance by natural persons acting outside their trade, business or profession including their use for the conclusion of contracts between such persons is not an information society service; the contractual relationship between an employee and his employer is not an information society service; activities which by their very nature cannot be carried out at a distance and by electronic means, such as the statutory auditing of company accounts or medical advice requiring the physical examination of a patient are not information society services.
ANNEX No 2 Extract from the European Directive concerning electronic signature Directory 1999/93/EC of the European Parliament and of the European Council of 13 December on Community for electronic signatures gives the definitions for the notions operating with when speaking about this subject as follows: Article 2 Definitions For the purpose of this Directive: 1. "electronic signature" means data in electronic form which are attached to or logically associated with other electronic data and which serve as a method of authentication; 2. "advanced electronic signature" means an electronic signature, which meets the following requirements: (a) it is uniquely linked to the signatory; (b) it is capable of identifying the signatory; (c) it is created using means that the signatory can maintain under his sole control; and (d) it is linked to the data to which it relates in such a manner that any subsequent change of the data is detectable; 3. "signatory" means a person who holds a signature-creation device and acts either on his own behalf or on behalf of the natural or legal person or entity he represents; 4. "signature-creation data" means unique data, such as codes or private cryptographic keys, which are used by the signatory to create an electronic signature; 5. "signature-creation device" means configured software or hardware used to implement the signature-creation data;
6. "secure-signature-creation device" means a signature-creation device which meets the requirements laid down in Annex III; 7. "signature-verification-data" means data, such as codes or public cryptographic keys, which are used for the purpose of verifying an electronic signature; 8. "signature-verification device" means configured software or hardware used to implement the signature-verification-data; 9. "certificate" means an electronic attestation, which links signatureverification data to a person and confirms the identity of that person; 10. "qualified certificate" means a certificate which meets the requirements laid down in Annex I and is provided by a certification-service-provider who fulfils the requirements laid down in Annex II; 11. "certification-service-provider" means an entity or a legal or natural person who issues certificates or provides other services related to electronic signatures; 12. "electronic-signature product" means hardware or software, or relevant components thereof, which are intended to be used by a certificationservice-provider for the provision of electronic-signature services or are intended to be used for the creation or verification of electronic signatures; 13. "voluntary accreditation" means any permission, setting out rights and obligations specific to the provision of certification services, to be granted upon request by the certification-service-provider concerned, by the public or private body charged with the elaboration of, and supervision of compliance with, such rights and obligations, where the certification-service-provider is not entitled to exercise the rights stemming from the permission until it has received the decision by the body.
ANNEX No 3
Extract from the Commission Recommendation 97/489/EC, of July, 1997 concerning transactions by electronic payment instruments and the relationship between issuer and holder Text: COMMISSION RECOMMENDATION of 30 July 1997 concerning transactions by electronic payment instruments and in particular the relationship between issuer and holder (Text with EEA relevance) (97/489/EC) SECTION I SCOPE AND DEFINITIONS Article 1 Scope 1. This Recommendation applies to the following transactions: (a) transfers of funds, other than those ordered and executed by financial institutions, effected by means of an electronic payment instrument; (b) cash withdrawals by means of an electronic payment instrument and the loading (and unloading) of an electronic money instrument, at devices such as cash dispensing machines and automated teller machines and at the premises of the issuer or an institution who is under contract to accept the payment instrument. 2. By way of derogation from paragraph 1, Article 4 (1), the second and third indents of Article 5 (b), Article 6, Article 7 (2) (c), (d) and the first indent of (e), Article 8 (1), (2) and (3) and Article 9 (2) do not apply to transactions effected by means of an electronic money instrument. However, where the electronic money instrument is used to load (and unload) value through remote access to the holders account, this Recommendation is applicable in its entirety. 3. This recommendation does not apply to (a) payments by cheques; (b) the guarantee function of certain cards in relation to payments by cheques.
Article 2 Definitions For the purpose of this recommendation, the following definitions apply: (a)electronic payment instrument` means an instrument enabling its holder to effect transactions of the kind specified in Article 1 (1). This covers both remote access payment instruments and electronic money instruments; (b) remote access payment instrument` means an instrument enabling a holder to access funds held on his/her account at an institution, whereby payment is allowed to be made to a payee and usually requiring a personal identification code and/or any other similar proof of identity. This includes in particular payment cards (whether credit, debit, deferred debit or charge cards) and phone- and home-banking applications; (c)electronic money instrument` means a reloadable payment instrument other than a remote access payment instrument, whether a stored-value card or a computer memory, on which value units are stored electronically, enabling its holder to effect transactions of the kind specified in Article 1 (1); (d) financial institution` means an institution as defined in Article 4(1) of Council Regulation (EC) No 3604/93 (5); (e) issuer` means a person who, in the course of his business, makes available to another person a payment instrument pursuant to a contract concluded with him/her; (f)holder` means a person who, pursuant to a contract concluded between him/her and an issuer, holds a payment instrument. SECTION II TRANSPARENCY OF CONDITIONS FOR TRANSACTIONS Article 3 Minimum information contained in the terms and conditions governing the issuing and use of an electronic payment instrument 1. Upon signature of the contract or in any event in good time prior to delivering an electronic payment instrument, the issuer communicates to the holder the contractual terms and conditions (hereinafter referred to as the terms`) governing the issue and use of that electronic payment instrument. The terms indicate the law applicable to the contract. 2. The terms are set out in writing, including where appropriate by electronic means, in easily understandable words and in a readily comprehensive form, and are available at least in the official language or languages of the Member State in which the electronic payment instrument is offered.
3. The terms include at least: (a) a description of the electronic payment instrument, including where appropriate the technical requirements with respect to the holders communication equipment authorised for use, and the way in which it can be used, including the financial limits applied, if any; (b) a description of the holders and issuers respective obligations and liabilities; they include a description of the reasonable steps that the holder must take to keep safe the electronic payment instrument and the means (such as a personal identification number or other code) which enable it to be used; (c) where applicable, the normal period within which the holders account will be debited or credited, including the value date, or, where the holder has no account with the issuer, the normal period within which he/she will be invoiced; (d)the types of any charges payable by the holder. In particular, this includes where applicable details of the following charges: -the amount of any initial and annual fees, -any commission fees and charges payable by the holder to the issuer for particular types of transactions, -any interest rate, including the manner of its calculation, which may be applied; (e) the period of time during which a given transaction can be contested by the holder and an indication of the redress and complaints procedures available to the holder and the method of gaining access to them. 4. If the electronic payment instrument is usable for transactions abroad (outside the country of issuing/affiliation), the following information is also communicated to the holder: (a) an indication of the amount of any fees and charges levied for foreign currency transactions, including where appropriate the rates; (b) the reference exchange rate used for converting foreign currency transactions, including the relevant date for determining such a rate. Article 4 Information subsequent to a transaction 1. The issuer supplies the holder with information relating to the transactions effected by means of an electronic payment instrument. This information, set out in writing, including where appropriate by electronic means, and in a readily comprehensible form, includes at least: (a) a reference enabling the holder to identify the transaction, including, where appropriate, the information relating to the acceptor at/with which the transaction took place; (b) the amount of the transaction debited to the holder in billing currency and, where applicable, the amount in foreign currency; (c) the amount of any fees and charges applied for particular types of transactions. The issuer also
provides the holder with the exchange rate used for converting foreign currency transactions. 2. The issuer of an electronic money instrument provides the holder with the possibility of verifying the last five transactions executed with the instrument and the outstanding value stored thereon. SECTION III OBLIGATIONS AND LIABILITIES OF THE PARTIES TO A CONTRACT Article 5 Obligations of the holder The holder: (a) uses the electronic payment instrument in accordance with the terms governing the issuing and use of a payment instrument; in particular, the holder takes all reasonable steps to keep safe the electronic payment instrument and the means (such as a personal identification number or other code) which enable it to be used; (b) notifies the issuer (or the entity specified by the latter) without delay after becoming aware of: -the loss or theft of the electronic payment instrument or of the means which enable it to be used, -the recording on his/her account of any unauthorised transaction, -any error or other irregularity in the maintaining of that account by the issuer; (c)does not record his personal identification number or other code in any easily recognisable form, in particular on the electronic payment instrument or on any item which he/she keeps or carries with the electronic payment instrument; (d)does not countermand an order which he/she has given by means of his/her electronic payment instrument, except if the amount was not determined when the order was given. Article 6 Liabilities of the holder 1. Up to the time of notification, the holder bears the loss sustained in consequence of the loss or theft of the electronic payment instrument up to a limit, which may not exceed ECU 150, except where he/she acted with extreme negligence, in contravention of relevant provisions under Article 5 (a), (b) or (c), or fraudulently, in which case such a limit does not apply. 2. As soon as the holder has notified the issuer (or the entity specified by the latter) as required by Article 5 (b), except where he/she acted fraudulently, he/she is not thereafter liable for the loss arising in consequence of the loss or theft of his/her electronic payment instrument.3. By derogation from paragraphs 1 and 2, the holder is not liable if the payment instrument has been used, without physical
presentation or electronic identification (of the instrument itself). The use of a confidential code or any other similar proof of identity is not, by itself, sufficient to entail the holder's liability. Article 7 Obligations of the issuer 1. The issuer may alter the terms, provided that sufficient notice of the change is given individually to the holder to enable him/her to withdraw if he/she so chooses. A period of not less than one month is specified after which time the holder is deemed to have accepted the terms if he/she has not withdrawn. However, any significant change to the actual interest rate is not subject to the provisions of the first subparagraph and comes into effect upon the date specified in the publication of such a change. In this event, and without prejudice to the right of the holder to withdraw from the contract, the issuer informs the holder individually thereof as soon as possible. 2. The issuer: (a) does not disclose the holder's personal identification number or other code, except to the holder; (b) does not dispatch an unsolicited electronic payment instrument, except where it is a replacement for an electronic payment instrument already held by the holder; (c) keeps for a sufficient period of time, internal records to enable the transactions referred to in Article 1 (1) to be traced and errors to be rectified; (d) ensures that appropriate means are available to enable the holder to make the notification required under Article 5 (b). Where notification is made by telephone, the issuer (or the entity specified by the latter) provides the holder with the means of proof that he/she has made such a notification; (e) proves, in any dispute with the holder concerning a transaction referred to in Article 1 (1), and without prejudice to any proof to the contrary that may be produced by the holder, that the transaction: -was accurately recorded and entered into accounts, -was not affected by technical breakdown or other deficiency. Article 8 Liabilities of the issuer 1. The issuer is liable, subject to Article 5, Article 6 and Article 7 (2) (a) and (e): (a) for the non-execution or defective execution of the holder's transactions referred to in Article 1 (1), even if a transaction is initiated at devices/terminals or through equipment which are not under the issuer's direct or exclusive control, provided that the transaction is not initiated at devices/terminals or through equipment unauthorised for use by the
issuer; (b) for transactions not authorised by the holder, as well as for any error or irregularity attributable to the issuer in the maintaining of the holder's account. 2. Without prejudice to paragraph 3, the amount of the liability indicated in paragraph 1 consists of: (a) the amount of the unexcited or defectively executed transaction and, if any, interest thereon; (b) the sum required to restore the holder to the position he/she was in before the unauthorised transaction took place. 3. Any further financial consequences, and, in particular, those concerning the extent of the damage for which compensation is to be paid, are borne by the issuer in accordance with the law applicable to the contract concluded between the issuer and the holder. 4. The issuer is liable to the holder of an electronic money instrument for the lost amount of value stored on the instrument and for the defective execution of the holder's transactions, where the loss or defective execution is attributable to a malfunction of the instrument, of the device/terminal or any other equipment authorised for use, provided that the malfunction was not caused by the holder knowingly or in breach of Article 3 (3) (a).
Other Electronic Banking Services
OTHER ELECTRONIC BANKING SERVICES
Objectives After studying this chapter you should be able to understand: 6.1 6.2 Introduction in the Electronic Funds Transfer - EFT The banking cards 8.2.1 8.2.2 8.2.3 6.3 6.4 General aspects The typology of bankcards The fraud
Card market infrastructure Bank Clearing System in the United Kingdom
6.1. Introduction in the Electronic Funds Transfer - EFT The Electronic Funds Transfer is a very simple electronic method by which it is realised one of the oldest banking functions i.e. the money transfer. We shall describe a lot of methods EFT, such as: EFT-POS the Electronic Funds Transfer to the Selling Points Terminals; Cards; ATM - Automated Teller Machines; Electronic Data Interchange EDI; Internet. EFT-POS the Electronic Funds Transfer at the Point of Sale represents a system, which allows the customer to pay for goods and services electronically without any paper vouchers at the time and place where the customer makes the purchase. Thus, the funds are transferred electronically from the customers account via computer in the sellers account. The methods of payment are: - Electronic; - Instant; - Paper-free. The key to operating any EFT-POS transaction is a plastic card, such as: - Credit cards; - Store cards; - Debit cards; - Charge cards. The main benefits of using EFT-POS for the consumer are: Convenience o An alternative method of payment; o Less need to carry cash; o EFT-POS is a system which is easy to use; o All benefits of non-cash payments. Speed Using EFT-POS to make payments quicker than any other non-cash method of payment.
Lower Bank Charges For consumers who are liable to pay bank charges, there may be a lower rate of charge for electronic transactions as compared to paper-based transactions. In the United Kingdom, the EFT-POS is a national system, which was founded by 13 banks and building societies under the auspices of the Bank of England. The system has been designed to be flexible and provide Online and Off-line transactions authorisation to suit all retailer needs. The EST-POS objective is to operate a national transaction network, which is both secure and uses standard equipment. The key links in the EFT-POS chain are: 1. Customers plastic cards. The information about the customer, his or her account and other details, are contained in electronic form within the magnetic strip on the back of the card. 2. The retailer (via the terminal); 3. The retailers bank; 4. The customers bank; 5. The EFT-POS central control (Controls the flow of electronic messages within the system and provides centralised settlement of all transactions). 6. An automated network carrying the messages and linking the whole system together. EFT-POS is a new method of payment the basis of a national electronic shopping system. As such it is a move towards the cashless society when all payment transactions can take place without the need for any paper. But, for the moment EFT-POS is intended as an alternative to existing methods of payment (cash, cheque, credit card, etc.) The payment procedure is a simple one, following steps1, such as: Cardholder asks to pay for goods by plastic card. Card is swiped through the terminal. The following data is captured from the magnetic stripe on the plastic card: - bank sort code; - cardholders account number; - expiry date on the card; - card issue number.
1
Davies Audrey&Kearns Martin Banking Operations, Pitman Publishing, London, 1994
The amount of the purchase or refunds is keyed; The above data, together with the retailers special identification number and terminal identification, is coded and then transmitted to the EFT-POS UK Central Computer Switch. From the bank details, EFT-POS UK recognises the destination bank and sends the electronic message to the cardholders bank computer system for authorisation. The bank decodes the message, checks the card against its own files, checks the account balance and returns in coded form, an approval to the retailers terminal via EFT-POS UK; When the EFT-POS UK Central Computer Switch receives the approval, it forwards the message to the retailer terminal so that the transaction can be completed. At the same time, it sends a message to the retailers bank computer system, advising the bank to credit the retailer. At the retailer terminal, the cardholder and cashier are advised of the approval and the cardholder is asked to sign the advice slip. If the Personal Identification Number or signature is OK, the cashier can complete the transaction. If there is a problem, the cashier can telephone a help desk for guidance. At the end of the day, all cardholder transactions are collated, as are retailer payments, and the banks must pay each other the amounts due. This is done via accounts held by each bank at the Bank of England. As a conclusion, it should be mentioned that the term EFT-POS brings together two separate terms: EFT: Electronic Funds Transfer An information technology system by which payments from person A to person B take place by the use of electronic messages-without the need of the traditional paper vouchers. Paper vouchers covers items such as bank notes, cheques, credit card sales vouchers, bank giro credit forms, etc. POs: Point of Sale In other words the place where the goods and services can be purchased.
Automated Teller Machine ATM represents a Service till or Auto bank seen in the walls of the high street banks. Each has its own version of the ATM, and a large network to which these and the central computer system are linked. The ATM is a mean of providing various services to the customer; which can include: o Cash dispensing (the amount requested is checked against the limit for that day or week); o Balance enquiry (the enquiry is transmitted through the banks communication network to the central computer; disk holding the account information is accessed; the answer is routed back through the system to the ATM); o Statement request o Cheque book request. Requests for statement and chequebook are noted and the response produced and posted to the customer. The customer has a card on which there is a magnetic stripe, which holds the details of their account: Account number Bank/branch number Cash limit (weekly/daily) this is decided by the bank manager Security Any other relevant information. The PIN (Personal Identification Number) which the customer uses is held on the stripe in coded form rather than in the same form as that known to the customer for security reasons. The use of cards through Automated Teller Machine ATM has the following steps: Customer inserts the card into the ATM; ATM reads the stripe and confirms that the card is genuine and accepted by the bank; Customer punches in their PIN and this is verified as compatible with the one stored on the card; Customer chooses the service he/she requires;
ATM provides all the information on transactions to the central computer several times a day. Information is processed and any cash withdrawn debited from the customers account at the next update; Customer using the wrong PIN is asked to try again, or card is retained by the ATM, or a stop is made on any further cash withdrawals until customer and bank have clarified the situation.
6.2 The banking cards 6.2.1 General aspects The origins of the bankcard have been attributed to John C. Biggins, a consumer credit specialist at the Flatbush National Bank of Brooklyn, New York. In 1946, Biggins launched a credit plan called Charge-it. The program featured a form of scrip2 that was accepted by local merchants for small purchases. After the sale was completed, the merchant deposited the scrip in a bank account, and the bank billed the customer for the total scrip issued. Not long after, in 1951, the Franklin National Bank in New York issued the first modern card. The major reasons behind rapid growth must be considered from the perspective of the consumer, the merchant and the bank. For the consumer, the bankcard made purchases of products and services more convenient, especially when credit was desired to fund these purchases. Bank customers could obtain credit for a variety of purchases without repeatedly going to the bank for a loan. The amount owed could be paid in full each month or extended through monthly instalments. The merchant found the bankcard attractive because sales transactions could be validated easily and payment guaranteed. Heavy promotion of the card by banks and the national associations increased the sales opportunities for merchants who accepted the cards. The associations likewise relieved the merchants of the risk and cost of in-house credit plans.
2
Paper money substitute redeemable at face value at participating merchant outlets for merchandise purchased.
Banks found an attractive way to extend credits to consumers through the revolving line of credit attached to the bankcard. Geographic market areas were expanded because banks could issue cards to customers who did not reside near the bank. With these new customers came additional opportunities to sell other banking products. Income from cardholders was complemented with new income sources from merchant discounts and new deposits from sales drafts. Rapid growth in credit brought new level of credit losses. In many cases, approval criteria were inadequate for numerous lines of unsecured revolving credit. Early authorisation systems were slow and use of the card was difficult to curtail. Nevertheless, these programs survived. 6.2.2 The typology of bankcards The card represents a payment instrument based on electronics. A. From the point of view of the technological characteristics, the bankcards may be classified in: Magnetic bankcards; Bankcards with microprocessor. The magnetic bankcards are manufactured from plastic and have the same size standardised by ISO3. On the front side they have the issuer symbol and denomination and a tri-dimensional hologram, while on the backside they have a magnetic band and a signature panel. The bankcards with microprocessor are also known as Smart Cards. These cards contain a computer chip with memory and interactive capability, so that the data can be updated each time the card is used in an ATM or point-of-sale (POs) terminal. B. From the point of view of the specific functions they have, the bankcards may be classified in: credit card; debit card; cheque guarantee card; ATM card;
3
International Standards Organization
multifunctional card; point-of-sale card. The purpose of a credit card is to enable the cardholder to purchase goods or services at a shop, petrol station, restaurant or other establishment, which operates the scheme, without paying immediately. The holder presents his card and signs the bill, which is sent by the supplier to the bank or credit company, concerned for settlement. The credit cardholder receives a monthly statement listing all the transactions for that period and he settles for all of them with one payment, or he is possibly allowed to run an overdraft up to a set limit with agreed terms for repayment and the charges he will incur. The main steps of the process are: - The customer hands over his credit card to the supplier of the goods or services; - The supplier then enters details of the sale on the sales voucher (e.g. date, description of goods or services, total cost, etc); - The customer checks if the above details are correct and that the total has been filled in and if so signs the sales voucher. - The supplier checks that the customers signature matches the specimen on the customers credit card, and also the expiry date of the card. - The supplier hands one copy of the sales voucher to the customer (together with a receipt for the sale) and returns to the customer the credit card. - The supplier keeps a copy of the sales voucher; this is paid into the suppliers own bank account. The credit card company pays the suppliers bank the amount due for the purchase. After all these steps: - the suppliers bank sends the third copy to the credit card company. It is then recorded as a transaction in the customers computer file. - at a date fixed for each of its customers credit card companies send out to that customer a monthly statement of what is owed. A bank or other financial institution issues the debit card and it permits access to a customers checking or savings account. The debit cards can be used in place of a paper check and the transaction will be automatically guaranteed because funds transfer immediately from the purchasers account to the sellers.
Debit is, of course, a financial term. Its use in connection with the card implies access to a deposit account, as opposed to the line of credit accessed by the bank credit card. As noted before, the term debit refers to accessing a deposit account typically a personal checking account, although the card can access a savings or money market account. When used to make a purchase at a store, the debit card takes the place of a personal cheque. The record of the transaction appears on the customers checking account statement. To validate the sale, the merchant follows authorisation procedures much like those followed for credit card purchases. In spite of immense attention paid to debit cards in the 1970s and early 1980s, widespread use in the market place was just the beginning. The growth of proprietary debit cards4 is accelerating because many supermarkets and other high-volume-cheque-cashing merchants are beginning to accept them. Properly banks participating in regional point-ofsale networks frequently issue debit cards. Transactions are handled outside the national networks, and the cost of interchange, as applied to bank credit cards transactions, is avoided. One factor that limits the appeal of the debit card involves the consumers choice to use either personal or bank funds to pay for a purchase. Not only does a debit card access personal funds it also effects immediate transfer of funds from the account, and so the period of processing and collection known as float is eliminated. Merchants that accept bank credit cards should also be willing to accept debit cards. A merchant that follows routine authorisation procedures for the card validates the sale and guarantees its payment. In addition, the forms and procedures used for handling debit cards are similar to those used for credit cards. Therefore, merchants are already familiar with the routine. However, not all things are equal. First, some merchants view the cost of interchange as more expensive than the cost of handling a personal cheque. Research studies have indicated that handling personal cheques is more expensive than the cost of interchange, but this research typically comes from banks.
This card identifies a specific bank or group of banks in a regionally shared point-of-sale network.
A second issue is that of paper transactions versus electronic transactions. Merchants generally view the latter as less expensive because cheques have to be handled from the store to the bank. In addition, the merchants must pursue collection of the returned cheques. In the case of an electronic transaction, the paper stays on site (the customer gets a receipt and the merchant retains a copy of the transaction). A third issue, especially for high-volume merchants, involves the speed of checkout. Electronic debit card transactions are usually faster than transactions made with personal cheques. From the banks point of view, the debit cards offer convenience to customers and provide a less expensive way to process deposit-related transactions. A banks identity is also enhanced when cards are presented to merchants. However, most customers enjoy the delayed payment schedule credit cards have to offer. As a result, bankers will have to improve their sales techniques if they want to persuade customers to access personal deposits for their purchases. Individual banks to permit customers to access transaction and savings accounts 24 hours a day, every day of the year, through automated teller machines issue the ATM cards. ATM is an acronym for automated teller machine. Most ATM cards enable the authorised holder to perform the following functions: - withdraw cash from checking and savings account; - deposit to checking and savings account; - obtain a cash advance from a MasterCard or Visa account; - make a loan payment, such as to a bankcard, automobile loan, or real estate loan account; - get balance information on checking and savings accounts or the available credit on a bankcard or other credit account, such as a line of credit attached to a checking account; - transfer funds from one account to another, such as from savings account to a checking account. The ATM card extends banking convenience to the customer. because ATM machines are typically on the exterior of the bank or in some cases, at a location away from the bank, they usually operate around the clock, seven days a week. Therefore, the customer can access accounts without having to
go into the bank. Consequently, the ATM card is called sometimes Access card. This means, for example, that a customer can use the ATM to get money without searching for somewhere to cash a cheque. Deposits and loan payments can be made at night or on weekends, and the customer can get his or her account balanced even when the bank is closed. The cheque guarantee card enables merchants to accept personal cheques, without the risk of recourse, provided the merchant follows accepted authorisation and documentation procedures. Because the cheque guarantee card is frequently attached to a line of credit associated with a personal checking account, it is sometimes not considered a bankcard. However, the cheque guarantee card is plastic, issued by a bank, and presented to a merchant to validate a purchase. To the consumer, this type of card offers another form of banking convenience. Cheques can be cashed at merchants stores more easily. These cards offer the merchants some guarantee that the cheque being presented is valid. The distinctive features of a true cheque guarantee card is that it does guarantee the cheque. If a bad cheque is returned, the merchant may collect the amount of the cheque from the bank that issued the card. However, most cheque guarantee cards may only be used to guarantee fist-party personal cheques and not pay roll cheques or cheques made payable to the person holding the card. The terms of guarantee are generally simple: - the cheque must be a personal cheque, presented by the cheque guarantee card holder; - the amount of the cheque cannot exceed a specified amount; - the expiration date on the card must not have passed; - the signature on the card must be reasonably similar to the one on the cheque. Banks typically do not charge a fee for the card or cheque guarantee service. If credit is used, the customer pays interest and fees associated with the personal line of credit. The most customers view the cheque guarantee card as a free service that makes cheque cashing easier.
The point-of-sale card (POs) refers to any card presented at the point of sale, the merchants store or other location away from the bank. The POs system uses communication lines and is designed to authorise, record, and forward electronically each sale that occurs. The POs debit card is really a combination of the cheque guarantee card and an ATM card. If a checking account transaction can be performed at an ATM, why not have the same functions performed at a merchant location (provided the merchant has the necessary equipment to accommodate the card)? The multifunctional card has mix functions and facilities that derive from the above mentioned types of cards. From the issuers point of view, the cards may be divided in: cards issued by banks (bankcards); cards issued by merchants (private cards); cards issued by other institutions or organisations (the letter of credit international cards, the cards issued by credit institutions). 1. The bankcards After the 1980s the holders of bankcards as well as the number of the transactions performed through bankcards have strongly increased. In the developed countries, efforts have been made to unify the offer and eliminate banking competition (we must take into account the fact that some banks issue bankcards for free). The inter-banking5 phenomenon appeared as a consequence. This offers to each cardholder the possibility to use it at all cash dispensers and with all the merchants, no matter the issuer. A classification of the bankcard according to their possibilities of utilisation may be: Cards for cash withdrawal; National cards; International cards; Prestigious international cards.
In France, six networks have regrouped in 1983 in two economic groups: GIE Carte Blue and GIE Carte Vert, that have merged on 1 November 1985 and constituted GIE Carte Bancaires.
The cards for cash withdrawal usually have two levels of utilisation: - Level zero that allows the card to be used only for the services offered by the issuer. They are issued for free. - Level one that gives the possibility to use these cards at the interbanking network of cash dispensers. They are issued for a fee. The national cards, called level two cards have the same characteristics as the level one cards. Supplementary, they allow the payment regulation when the purchase is made at affiliated merchants. The card may be personal or professional and offers two options: rapid debit and ulterior debit6. The international cards are defined through the third level of the interbanking agreements and have a similar importance to those of level two (national cards), but their utilisation is extended to international payments. They are grouped in two networks: VISA and EUROCARDMASTERCARD7. Both networks offer common services and guarantees, being more advantageous than the national ones: insurance against loss or theft, insurance in case of travels accidents, invalidity and death. The prestigious international cards are defined through the fourth level of the inter-banking agreement and offer various services: cash withdrawal from the country or abroad, the automated insurance of travels, reservation services assured, car renting without guarantees, juridical protection, a wide range of guarantees and insurance accompanied by higher amounts. Each of the two networks offers its prestigious card: PREMIER for VISA and GOLD for MasterCard. 2. The private cards Their issuers are usually large distribution networks (supermarkets, the leaders of correspondence sales) that are well known by the customers and have a large market share. Some cards are used only for some specific markets of products or services, while others are multi-usable.
6
For an ulterior debit, the holders account is debited monthly, with fixed date, with a term that may be up to 4-5 weeks. 7 Besides, MasterCard offers medical assistance and a reservation guarantee in the larges hotel chains based on a simple phone call.
3. The cards issued by other institutions or organisations The cards may be issued not only by banks or merchants, but also by other partners: credit institutions, transport and telecommunications companies, car renting companies, oil companies, insurance companies, tourism agencies, clubs, professional services performers. 6.2.3 The fraud Bankcard fraud has been described as a two-man war game between the good guy and the bad guy. The good guys are the issuing and acquiring institutions, the national associations and law enforcement agencies. The bad guys are dishonest individuals or groups who are always on the lookout for ways to beat the system8. The amounts of dollars lost to fraud in the bankcard industry across the world have drawn significantly since the beginning of 1980s. The American Bankers Association (ABA), MasterCard International and Visa International, and other interested parties in the bankcard business have undertaken many efforts to help financial institutions find more effective ways to prevent bank credit card fraud. These parties work to stop fraud in instances where preventive measures fail. New technologies help in the effort and procedures are continuously being refined. However, fraudulent transactions actually occur between people. Sometimes a dishonest person fools an honest person in the transaction, such as unsuspecting retail clerk or a bank teller. Other times, the transaction occurs between two dishonest people, such as a person working for the bank in collusion with a merchant. People are involved in every fraudulent bank credit card transaction. A great deal of time and money are devoted to deterring criminals from altering or counterfeiting cards in an attempt to stop the dishonest user before he or she uses the card. The fraud losses come directly out of the bank earnings, a concern that reaches the highest level of bank management. Approximately 60% of fraud losses occur before the bank personnel know that customers card is
8
Michael J Auriemma, Robert S Coley Bankcard Business, American Bankers Association, 1998.
missing. In fact banks post around 40% of the fraudulent transactions to their customers accounts before the cardholders report their cards missing. Thus, the bank must work harder to reduce the amounts lost to fraud each year. Criminals employ several methods to obtain and use cards fraudulently. These methods include the use of: Fraudulent applications that result in accounts being set up and cards issued to criminals; Lost and stolen cards used for unauthorised purchases; Counterfeit cards; Lost and stolen cards altered for fraudulent use; Collusive merchants engaged in fraudulent transactions using counterfeit and altered cards, white plastic fraud, and laundered drafts9; Employee fraud in which employees steal cards from inside the card centre (bank or third-party processor), give out valid account number to criminals, or set up bogus cardholder or merchant accounts. Security experts in the bankcard industry continue to evaluate existing and potential security features for the cards to improve the deterrence of credit card fraud. Banks and card manufacturers may use any combination of the following security features in their cards to help deter fraudulent use: Embedded ink, visible only under ultraviolet light, helps detect counterfeit cards for use selectively with merchants that have a high exposure to fraud; Fineline printing, like that which appears on currency, makes counterfeit more difficult because of the precision of printing; Micro printing of bank identification codes on the cards makes counterfeiting more difficult; Trademarks visible only under ultraviolet light reveal counterfeit cards; Embossed security symbols facilitate the identification of the bank issuing the card (often another banks customer account number will appear on an altered card) and make the tracking of drafts possible through easier identification.
9
Fraudulent transactions that are mixed with legitimate transactions for bank deposits in an effort to hide the fraudulent activity.
A printed back identification number (BIN) above the embossed number makes alteration of the BIN on the card readily identifiable; Signature panels on the front of the cards make an erased signature more obvious. It is not uncommon for sales personnel to fail to check the signature on the back of the card with the signature on the sales draft even though merchants agreements require them to do so; Matched indelible account number on the back and front of cards make counterfeiting more difficult and alterations easier to detect. The banks have adopted their own security measures in order to reduce the fraudulently use of bankcards. These include: Limits for the value and number of cash withdrawals; Limits for the trials allowed to the users that wrong introduce the PIN; Observance of the use of the TEF systems in order to detect the fraud; 24 hours phone line that may be used by the customers to announce the loss or theft of the bankcard. As the profitability of bankcard programs has increased, so too have the incidences of fraud. The parties are taken a much stronger stance in both prevention and prosecution of card abuses. 6.3 Card market infrastructure This infrastructure include the following: 1) Cash Dispenser (CD); 2) ATM; 3) Selling Points Terminals (off-line, on-line); 4) Imprinter. The Cash Dispenser (CD) is a device that allows the authorised user to withdraw cash-coins or banknotes. The visible part contains: A keyboard that allows the user to communicate his demands; A small screen where the instructions and answers can be seen;
A hole where the cards can be introduced in order to contact the necessary information to and from the computer; A special hole where, by the mechanical move of a trap, the banknotes fall. The operations of the cash dispenser have the following steps: The owner introduces his card in the special hole of the machine; Than, the user must type on the keyboard his personal identification number (PIN). The correct PIN allows him to access the information stored in the card. The user types the amount of money wanted, but the amount must not exceed the maximum amount negotiated with the bank. The dispenser provides the money in coins and banknotes. After the transaction, the device gives back the card. Selling Points Terminals represent working stations at the staples selling points. They are used to take in and transmit information concerning the payments made through them. The terminal consists of a special device- a complete structure terminal, or made by screen, a keyboard and the compatible electronics that can maintain the connection with the banks computer- where the user has his account. The Imprinter. A less rapid way to pay using a card involves the telephone connection with the authorisation centre and the use of an imprinter. In this case, the merchandiser formally checks the card; the cashier calls the authorisation centre and sends the identification elements of the card, and the value of the transaction. The processing centre, using the satellite telecommunication system, allows the performing of the transaction. When the authorisation comes, the cashier makes the bill in three copies using the imprinter. The buyer must sign the bill. After comparing the signatures, the seller gives the shoppings and the receipt to the client. At the end of the day, the seller gathers all the bills, he registers them, and he gives one copy to the bank. The bank has to pay the bills within a period of time established by the contract.
6.4 Bank Clearing System in the United Kingdom Every single working day all banks receive cheques payable to their customers either across the counter or by post for the credit of their various accounts. The banks as agents for collection have the duty of presenting all of these cheques for payment and having credited the customers account, then receiving reimbursement themselves. The clearing system began over 200 years ago, when the clerks of the various banks in London used to take the cheques paid in by their customers, sort them into bank order then walk round each bank, presenting these cheques for payment and taking back to their own bank sums of money given in settlement. Like any other commercial activity, the business of banking increased, not only with the number of cheques in circulation but also the number of banks that opened in the City of London and the West End. Thus, the clerks decided to short-circuit the system and unofficially agreed to meet at some convenient place to exchange the cheques drawn on their own banks: any differences in the amounts due could then quickly and easily be settled. The banks, anxious to improve the system, hired a room for the purpose of exchanging cheques. The system expanded and in 1833, in 10 Lombard Street, the first clearing house was established. This system continued10, but until 1854 the membership of the clearing house was restricted to the private banks only. a) Debit Clearing. The Bankers Clearing House in London was established in 1833 to facilitate the daily exchange of cheques between banks and a daily settlement. At the beginning, the Clearing House was concerned only with the work of the private bankers but its activities rapidly increased in the second half of the nineteenth century as the joint-stock banks established their networks of branches. The presentday ownership and administration of the London Clearing House is vested in the Committee of London Clearing Bankers, i.e. Barclays, Coutts, Lloyds, Midland, National Westminster and Williams and Glyns. The Bank of England is also a member of the Clearing House, but takes no part in its administration. On each working day, the Bankers Clearing House handles more than three million cheques worth on average about 7,000 million sterling pounds.
10
Whiting D.P. Elements of banking, Macdonald & Evans Ltd., London, 1985
b) The Town Clearing. The work of the Clearing House is divided into two parts, the Town Clearing and the General Clearing. The Town Clearing handles cheques of 5,000 sterling pounds or more drawn on offices within the City of London, i.e. within walking distance of the Clearing House which is located in Lombard Street. All other cheques have to go through the General Clearing. The Town Clearing is meant to serve the needs of the institutions with the London Money Market, and large companies such as those concerned with insurance and shipping. These institutions deal in very large amounts and must have a speedy system for clearance. There is an understanding that any cheque dealt with through the Town Clearing is cleared the same day. The total value of the Town Clearing usually exceeds 90 % of the total daily clearing but the number of items involved is quite small in comparison with the volume of work handled by the General Clearing. c) The General Clearing. Branch banks sort into bank order all the cheques drawn on other banks that are paid in by their customers and sent them up to their own Clearing Department in London. Each bundle is accompanied by a list giving the total as well as the value of each individual cheque. A Clearing Department of one of the Clearing Banks will receive from each of its branches a bundle of cheques drawn on each of the Clearing Banks. The Clearing Department having checked the totals of the bundles will amalgamate them so as to produce a large parcel of cheques on each of the banks. The listing slips will accompany each of these large parcels for all of the bundles and a summary of them. The Clearing Department then delivers the parcels of cheques to the representatives of the other banks at the Clearing House. These are then taken from the Clearing House to the respective Clearing Departments of the banks where the totals are agreed with the listings. After this the cheques are sorted into branch order and dispatched to the branches on which the cheques are drawn. Settlement between the banks for the General Clearing takes place the day after the cheques has actually been exchanged. This is because the cheques do not reach the branches on which they are drawn until that day and they are then either paid or returned unpaid. Unpaid cheques are returned direct to the bank branch where cheques were paid in. d) Credit Clearing. Since 1960 the Bankers Clearing House has operated a credit clearing system which works in a rather similar fashion to the General Clearing but the vouchers that are used represent payments due to, and not payments received from other banks. They are the credit
transfers under the Bank Giro system. Each day branches remit bundles of credit transfers to their Clearing Departments in London and these are handed over to the representatives of the other banks to be dealt with in a similar fashion to cheques. e) Computer Clearing. The Clearing and Scottish banks recently established the Bankers Automated Clearing Services Ltd., which is a company that operates a clearing system based on the use of computers. Instead of preparing transfer vouchers in order to debit the account of one person and credit the account of another, such as the standing orders, direct debits and salary payments, the items are put on the magnetic tapes. They then pass through Bankers Automated Clearing Services and in effect pass from the paying banks computer to the receiving banks computer. Now that the banks have computerised their customers accounts it is possible for transfers to be made in this fashion and there is obvious room for rapid developments in the use of the technique. An ultimate possibility is for the larger shopkeepers to be able to debit a customers bank account directly by a computer link. f) Daily Settlement. At the end of each working day it is necessary for each of the banks to summarise all of the transactions with each of the other banks that have resulted from the Town Clearing, the General Clearing and the Credit Clearing and the Bankers Automated Clearing Services. On the daily statement all the balances due from the other banks are listed on the debit side and on the credit side all payments due to other banks are listed. These statements are totalled and the difference between the two sides represents the net balance due from or to all the other banks collectively. All that is then necessary is for the banks account at the Bank of England to be debited or credited with this sum. Obviously the overall position must be that the total of the debits to clearing bank accounts at the Bank of England must be equal to the credits, and at the end of the day after these transactions have been dealt with nothing is owed by one bank to another in respect of the days clearing transactions. g) Local Clearings. In addition to the Town Clearing, the General Clearing, the Credit Clearing and the B.A.C.S. Clearing, there are local clearing arrangements and a banks own settlements between branches. Banks located within a short distance of each other, in the same High Street maybe, will clear cheques drawn upon one another. A batch of cheques will be handed over in exchange for a single claim form, which
can be passed through the General Clearing. A banks Clearing Department will receive a batch of cheques each day from every branch that has been drawn by customers of other branches. Likewise, a batch of credit items will be received that are to be paid over to customers at other branches. The accompanying lists are checked and the vouchers sorted out and sent to their respective branches. Each branch is debited or credited accordingly in the Branch Accounts at Head Office. The Clearing Department will also receive a batch of miscellaneous cheques and payments warrants, which are cleared by direct presentation by messengers from the Clearing Department.
Progress test
1. What is the Electronic Funds Transfer? 2. What is the Automated Teller Machine? 3. What are the magnetic bankcards? 4. What are the bankcards with microprocessor? 5. List the steps of the credit card process. 6. What are the cheque guarantee cards? 7. What are the ATM cards. 8. What is the fraud in the cards field? Explain and describe. 9. Describe the infrastructure of cards 10. Who owns the Bankers Clearing House? 11. Describe the Town Clearing. 12. How does the General Clearing differ from the Town Clearing? 13. Describe the Credit Clearing. What is the fundamental difference between the Credit Clearing and the Debit Clearing? 14. What was the purpose of the establishment of the Bankers Automated Clearing Services Ltd.? How might its services be developed? 15. How do the London Clearing Bankers settle their daily transactions? 16. Describe the local clearing, and the inter-branch clearing arrangements.
Business of Banking
BANKER - CUSTOMER RELATIONSHIP
Objectives: After studying this chapter you should be able to understand: 7.1 Introduction 7.2 Deposits and bank accounts general overview 7.3 Banks duties and rights in the United Kingdom 7.4 Customers obligations to his bank in the United Kingdom 7.5 Banking procedures of opening an account in the United Kingdom and Romania 7.6 Procedures for the opening of adults as individual customers in a Romanian bank 7.7 Customer due diligence for banks
Business of Banking
7.1 Introduction Banking deals with people and their money. The people who use banks are called customers, a term which is different from client, the noun used by accountants and solicitors to describe persons who employ them. The term customer emphasises the need for services. Who is a customer? A person becomes a customer of a bank when he/she goes to the bank with money or cheques and asks to have an account opened in his/her name and the bank accepts the money or cheque and is prepared to open an account in the name of that person, after which he/she is entitled to be called a customer of the bank. So, a customer is clearly someone who uses the services of a bank. The Banker There is no clear descriptive definition of a bank in either the statute or case law, although the use of the word bank or banker in various pieces of legislation is of some help. For example, the Bill of Exchange Act 18821 says that a banker is: any person whether corporate or not who carries on the business of banking The Agricultural Credits Act 1928 states: A bank can be any firm, incorporated company caring forward banking business which is approved by the Ministry of Finance Under the Banking Act 1979, the supervision of the deposit taking institutions is exercised by the Bank of England, and there are three classes of such institutions2: recognised banks, licensed deposit taking institutions and exempt bodies. In this later category come the Bank of England itself, the National Savings Bank, the Trustee Savings Bank, the building societies, the insurance companies etc. Recognised Banks To be granted recognition, a bank must satisfy the Bank of England as to its standing and reputation in the financial community, with special reference to the ability and competence of its management. It must also have capital issued and reserves of at least 5 million and adequate level of solvency for
1 2
In the United Kingdom. Jacob Brian An introduction to banking, Mackays of Chatham, Kent, London, 1990, p. 185
Business of Banking
the extent of its operations. The Bank of England will also take into account the extent of the banking service offered and the degree of specialisation. Among the basic services required are the acceptance of deposits, lending, foreign exchange transactions, and bill finance, investment management and corporate financial services, although the Bank of England has discretion of not insisting upon the provision of all of the last named. The first two, however, are essential. Such a body is authorised to use the words bank, banker in describing itself. Licensed deposit taking institutions There are smaller undertakings and in order to obtain a license, a deposit taking institution must satisfy the Bank of England that its business is being conducted in a manner that the directors and management are fit to and proper persons. Such a body must have an issued capital and reserves of at least 250,000 coupled with a good trading record. In deciding whether to grant a license or not, the Bank of England will take account of balance sheet ratios, liquidity, and the matching of liabilities and assets. Upon obtaining its license, the institution may trade and accept deposits from the public for whose protection this legislation was enacted, following the secondary-banking crisis in the United Kingdom in mid 1970s. As a conclusion What is a banker? A banker is someone who works in a bank. What is the banking business? The banking business means the business of receiving money, on current savings deposit or other similar account, money which is repayable on demand by order, cheque, or draft, and money which will be invested by way of advances to customers or otherwise. Banker Customer Relationships The relationship of a bank with its customers gives rise to important legal rights and duties quite apart from any commercial considerations.
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The basic and perhaps most common relationship between a banker and his customer is that of debtor and creditor. The bank has duties and rights3 and the customer has, at the same time, obligations to his bank. 7.2 Deposits and bank accounts general overview The basic functions of banks are to accept deposits, transfer funds and facilitate transactions between different parties. Therefore, banks may offer a large variety of services including deposit accounts, credit card, lending facilities, funds transfer, foreign currency sales, travelers cheque, payments and government project funding, taxes and fines collection, executor of wills, safe custody, investment transactions, discounting of bills, trust, advice on investments and business, clearing systems, indemnities, opinions and replies to status enquiries etc. Sale Custodian Sale custody or bailment is the oldest service the banks can offer. It means that a property is preserved and returned upon demand in the same condition as it was deposited, the customer being the bailor and the banker the bailee. Moreover, all clearing banks can offer night safe facilities through selected branches for the safe keeping of money overnight. Indemnities There are instances when even a clearing bank may give guarantees or indemnities to third parties in respect of its customer's liabilities, especially for good customers having sound financial positions. Status Enquiries Banks are obliged to keep their customers' affairs secret and disclosures are possible only with customer's consent. As a rule, opinions are not given directly to an individual but to other bankers or certain recognized trade protection organizations. As banks strongly tend to increase their business they are highly interested in drawing in more and more deposits so as to be able to fund lending and investment activities. For the purpose of attracting funds from individuals and companies, banks offer a large variety of personal and business
3
Palfreman David Banking: The legal environment, Pitman Publishing, London, 1994, p.102
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accounts and give their customers statements of account showing the account balance, at regular intervals or on demand. Current Accounts The current accounts are also known as cheque accounts and offer a low interest rate or no interest at all. As a result, they represent a low-cost fund for banks. Both individuals and corporations open them. Budget Accounts These accounts are separate nominated cheque ones and are specifically used for paying bills such as for household expenses, telephone, gas, electricity, taxes, insurance etc., by monthly transfers or cheque drawing. Credit cards They are convenient for both banks and customers as they are easy to bear and use. Banks receive interest on the amounts advanced to customers as well as commission from the shopkeepers accepting credit cards in the payment for goods and services. Savings Accounts They are sight accounts similar to the current ones but as they represent medium or long-term deposits the rate of return is higher. In the corporate banking, this type of accounts can be also used for night deposits or payroll payments. Term Accounts This category of deposits has the advantage of a higher interest rate for customers and can be used as a guarantee for loans as well. As the term accounts are not payable at any time, they offer higher return for depositors and represent an adequate medium or long-term financing source for banks. Certificates of Deposit Specifically, they require a small amount of money, can be changed into cash at any moment and their ownership can be transferred by consequently losing part of interest. Restricted-Close Accounts Within such an arrangement, the depositor is not allowed to raise the money until a certain term elapses.
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Student and Youth Deposits They represent an incentive for promoting savings among young people, on one hand, and, on the other hand, provide necessary money for progress in their professional careers; they have a higher interest rate. Foreign Exchange Accounts These accounts are specific to the commercial customers of the banks as the transactions in foreign currency are expanding due to the globalization of economies and deregulation in funds transfers between countries. Sweep Accounts They are particular types of accounts where balances exceeding a certain level can be transferred into money-market funds; they are mainly offered to major customers. Cash Management Accounts This type of accounts specifically combines a brokerage account with a bank one. These accounts offer customers a number of facilities such as daily interest on account balance, Visa debit card, cheque facilities or instant loans at brokerage interest rates. Revolving Credit Accounts They are special accounts where customers can pay in fixed amounts of money monthly and give depositors the option of withdrawing several payments by cheque every month. Office Accounts Banks usually open such accounts for professionals such as solicitors, accountants, architects, doctors etc. who need them for their daily accounting practice. Similarly, special accounts may be opened for administrators, executors, trustees and supervisors on the condition that they are personally liable for any borrowing approved by creditors and beneficiaries. Estate Agents Accounts In Great Britain, estate agents can open a separate trust account in pursuance of law where they keep the money from their clients in order to use it as pre- contract or contract deposits.
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Insurance Broker Accounts Except for the ones who are members of Lloyds, the insurance brokers are required to open separate current or deposit accounts for the money used in insurance transactions. Such insurance broker accounts may be also used for receipt of premiums on policies as well as for payments in respect of claims. Joint Accounts They represent accounts opened by two or more parties and the most common ones are run by husbands and their wives; withdrawals can be made upon a clear authority given to the person intending to take out the money. Company Accounts Public limited or private limited companies constitute the most important customers of banks as they need banking services for their trade activities and business operations such as payments to suppliers, guarantees to international partners, safe custody of excess cash as well as funds for performance in accordance with the company objects. In this respect, they run various deposit accounts available to corporations, namely current and savings accounts, certificates of deposit, repurchase agreements, credit accounts, foreign exchange accounts as well as all new types of deposit accounts such as sweep and cash management accounts. In order to open an account, companies are obliged to lodge with the bank a resolution passed by directors, a company mandate, the Certificate of Incorporation, the Memorandum and the Articles of Association. Business accounts can be also opened by sole traders and partnerships requiring working capital for trading, finance for repairs, refurbishment or purchase of new fixed assets or capital items like computers and cars. Single signature of the proprietor or joint signatures of the partners is needed for opening such accounts. Accounts for Unincorporated Entities The unincorporated entities are associations, clubs or societies having separate identity in law which can open accounts by mandate as they are usually conducted by members or a committee and use them for shorter or longer periods.
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Nostro and Loro Accounts When currency is transferred all over the world through correspondent banks the cash becomes titles of ownership. The accounts of the correspondent banks are known as nostro and loro accounts; the bank maintaining the nostro account is the one where the debit and credit entries are performed, while the foreign bank refers to such an account as loro meaning your account with us. When such inter-bank accounts are used, the clearance is carried out by cable, telex, and fax requests or by SWIFT messages. 7.3 Banks duties and rights in the United Kingdom These may be summarised as follows: - provided that the customers cheques are properly drawn, the bank must honour the cheques to the amount of the balance or if the account is overdrawn, to the agreed limit; - the bank is entitled to charge its customers reasonable commission for services rendered to them, and to charge interest on loans made to them, except where special arrangements have been made; - to be indemnified by its customers for expenses and liabilities incurred while acting for them; - to exercise a lien4 over any of its customers securities that are in its possession, other than those deposited for safe custody, for any money owing to it; - a bank must maintain strict secrecy about its customers affairs, both while the account is open and even after it had been closed; - the bank must give reasonable notice to its customer, before closing an account, which is maintained in credit; - to render statements of account to its customer periodically or upon request;
4
In the United Kingdom, it is a right to retain possession of the property of another in lieu of payment due from that person.
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- a bank has no obligations to third parties, arising out of the duty to pay its customers cheques; - to collect cheques and other normal banking instruments for its customer and to credit the amounts collected to his account; - To exercise proper care and skill in carrying out any business it has agreed to transact for its customer. 7.4 Customers obligations to his bank in the United Kingdom The main customers obligations to his bank are: - the customer is under the duty to exercise reasonable care when drawing his cheques, to help prevent fraud or forgery; - the customer must go to his bank when he requires payment; it is not the incumbent on the banker to seek out the customer; - before drawing the cheques, the customer must ensure his account is put in funds to meet it; - A customer must pay reasonable interest and commission and other charges for banking services and this is implied when he/she opens an account. 7.5 Banking procedures of opening an account in the United Kingdom and Romania a) Before opening either a current or a deposit account in the United Kingdom, a bank must be satisfied as to the character and standing of the applicant and know his employers name and nature of his employment. This information can be obtained either by a personal introduction from an existing customer or another branch or bank; or by taking references, usually two, one of which should be from the applicants employer. In the latter case, if the referee is unknown to the banker, the authenticity of the reference should be checked, for example, through the referees own banker. Accounts are frequently opened on production of satisfactory identification, e.g. driving license or passport.
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Banks differ as to the exact procedures and formalities involved in opening an account. The following are the standard opening formalities: 1. Specimen signatures of all parties to the account must be obtained. 2. A mandate covering all operations on the account must be obtained if it is other than a sole amount. 3. A chequebook should only be issued when a satisfactory introduction or references have been obtained and checked and any cheque opening the account cleared. 4. A cheque guarantee card should only be issued after the bank has established that the account will be run in a regular and responsible manner, or where there is no doubt about the persons integrity and responsibility as an account holder. 5. If possible, commission and interest charges should be agreed when the account is opened in order to avoid having to rely on a bankers implied right to recover reasonable charges and commission. While all banks are anxious to increase their business and draw in deposits, it is necessary to exercise a degree of caution before opening an account and affording full banking facilities. No prudent banker would open an account5 immediately on the mere request of a stranger, as there would be many risks in conducting an account for a rogue. For common sense reasons therefore, the most important requirement upon opening an account is that the banker should have a satisfactory introduction to his new customer, and this is commonly called a reference. Recently, however, some banks have surprisingly decided to dispense with the taking of references and are prepared to open accounts for new customers provided that the stranger proves satisfactorily the identity and provided that upon carrying out a credit reference bureau search an negative reply is not received. Presumably, those banks which have reduced their standard of care this way, have been prepared to do so on reasoning that the new procedures will
5
Palfreman David Banking: The legal environment, Pitman Publishing, London, 1994, p.102
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reduce the costs of opening a new account and will be less inhibiting to prospective customers. Except for regulated agreements under the Customer Credit Act 1974 (in United Kingdom), where the duty is a statutory one, it is part of the implied contract between the banker and his customer that the banker will provide a statement of the account from time to time, or when asked to do so, by his customer. The modern practice is to issue computerised statements and past books are seldom used. When a customer wishes to authorise another person to sign on his account without becoming a party into it, it will be necessary a special written authorisation of the customer to the bank. The authorisation becomes void upon death, bankruptcy or mental incapacity of the customer, and any cheques drawn by any third party should then be returned unpaid by the bank with the answer Account holder deceased or refer to drawer as appropriate. A customer can close his account when he wants to, by withdrawing the funds and paying his bank charges to date. b) In Romania, there is usually a contract (see Annexes No. 1, and 2) between the bank and its customer. It appears upon consideration to include the following provisions: the bank undertakes to receive money and to collect bills for its customers account; the proceeds so received are not to be held in trust for the customer, but the bank borrows the proceeds and undertakes to repay them; the promise to repay is to repay at the branch of the bank where the account is kept, and during the banking hours; It is a term of the contract that the bank will not cease to do business with the customer except upon reasonable notice. The customer, on his part, undertakes to exercise reasonable care in executing his written orders so as not to mislead the bank or to facilitate forgery.
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Categories of customers: A - Natural Persons/Physical Persons (individuals) B - Legal Persons/Legal Entities (companies) In Romania, the commercial banks have the following procedures, in order to open an account. 7.6 Procedures for the opening of adults as individual customers in a Romanian bank When a member of the public applies (in Annex No. 3 you can seen models of application for opening different types of accounts with a bank, Romanain legal entity) to a bank to open an account, the bank has a primary duty to satisfy itself on the following points: 1. Verification check the prospective customers identity : Is he the person he claims to be? Is he legally capable of opening an account in his own name? (Is he a minor, or under legal disability?) Is he self-employed or the employee of a company or other statutory body or organisation? Is he a proper person the bank would like to do maintain a bank account for? (A bank is not under any legal obligation to enter a banker/ customer relationship).
In practice, there are several steps to follow: Step one: 1. Customer verification ( identity card, recommendation letter reference) 2. Verification of the legal capacity of prospective customer (minor adult signature)
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3. Integrity (Is he a fir and proper person to be entrusted with a cheque book?) Step Two: 1. As soon as satisfactory references have been obtained, the account may be opened. 2. The new customer should be invited to complete a signature card. This card contains specimen of the customers signature. Also, the customer should be asked to complete a detailed application form providing the bank with full details regarding his personal and business life. 3. The bank signs its acceptance when it is satisfied with the references given and when it notifies the customer that the account had been opened in his name. Statements and General Requirements Many branch customers inquire about the status of the account under the following circumstances: a. Before they draw a cheque on their account; b. They may wish to certify the credit/debit balance on their account for reconciliation purposes; c. They may wish to confirm that a particular payment has been made into their account (or that a certain withdrawal has been effected) before presenting a cheque for payment. d. They may ask for a statement of their account with the branch for personal reasons.
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Customer inquiring at counter The procedure is as follows: 1. The customer should be supplied with a copy of the banks Account inquiring form and asked to sign it specifying the type of information he requires. 2. The signature should be checked against the branchs records (i.e. the signature card.) Once satisfied about the correctness of the signature, the required information should be furnished, preferably, in a sealed envelope and passed on the customer. It is established practice in most banks that all inquiries or information about customers statement to be furnished only after the customer had signed the above request form and his signature had been verified as a means of certifying his identity. Rules and Regulations The Banker-Customer relationship once established it is often a long term one. (It may even continue after the customers death, when the bank acts in the capacity of executor or trustee of the deceased customers wealth); It should always be remembered that the bank is not under legal obligation to accept every applicant as a customer. The banker must be satisfied with the responses to all inquiries before agreeing to open an account for a prospective customer. Banks will satisfy themselves about the identity of a person seeking to open an account, in order to protect themselves, their customers and general public. All banks should institute effective procedures for obtaining identification from new customers. 7.7 Customer due diligence for banks Supervisors around the world are recognising the importance of ensuring that their banks have adequate controls and procedures in place so that they know the customers with whom they are dealing. Adequate due diligence on new and existing customers is a key part of these controls. Without this due
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diligence, banks can become subject to reputational, operational, legal and concentration risks, which can result in significant financial cost. In reviewing the findings of an internal survey of cross-border banking in 1999, the Basel Committee identified deficiencies in a large number of countries know-your-customer (KYC) policies for banks. Thus, the Basel Committee asked the Working Group on Cross-border Banking to examine the know-your-customer procedures currently in place and to draw up recommended standards applicable to banks in all countries. Sound know-your-customer procedures must be seen as a critical element in the effective management of banking risks. The know-your-customer safeguards go beyond simple account opening and record-keeping and require banks to formulate a customer acceptance policy and a tiered customer identification pogramme. These procedures constitute an essential part of sound risk management (e.g. by providing the basis for identifying, limiting and controlling risk exposures in assets and liabilities, including assets under management). Certain key elements should be included by banks in the know-your-customer procedures. Such essential elements should start from the banksrisk management and control procedures and should include: 1. customer acceptance policy; 2. customer identification; 3. on-going monitoring of high risk accounts, and 4. risk management. Banks should not only establish the identity of their customers, but should also monitor account activity to determine those transactions that do not conform with the normal or expected transactions for that customer or type of account. Banking supervisors must determine if banks have adequate policies, practices and procedures in place, including strict know-your-customer rules, that promote high ethical and professional standards in the financial sector and prevent the banking from being used, intentionally or unintentionally, by criminal elements. Financial institutions should develop programs against money laundering. These programs should include, as a minimum:
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(i)
the development of internal policies, procedures and controls, including the designation of compliance officers at management level, and adequate screening procedures to ensure high standards when hiring employees; an ongoing employee training programme;
(ii)
(iii) an audit function to test the system.
Progress Test
1. Who is a bank customer? 2. What is a banking business? 3. What are the banks duties and rights? 4. List the customers obligations to his bank. 5. Describe the banking procedures of opening an account in the United Kingdom. 6. Describe the banking procedures in Romania. 7. What are the procedures for the opening of adults as individual customers? 8. What are the key elements included in the know-your-customer procedures? 9. Describe the contain of a contract concluded between the bank and its customer.
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ANNEX No 1
AGREEMENT FOR A BANK DEPOSIT Completed today,................., 200.... Between the contracting parties: The Bank X SA, which has the headquarters at .. Street represented by Manager .. and the Chief Accountant .., named trustee in this agreement, as a party, and: ____________________________________________________________ (The first and the last name of the natural person, the name of the artificial person) living in_____, district_____, sector__, released on___, by____, which has the residence in___, district____, sector____, incorporated in the Trade Register under no., represented by____, named depositor in this agreement, as another party. By virtue of the provisions of the art. 1591 and of the Civil Code, this bank deposit agreement was completed under following conditions: Art. 1: The object of the agreement: 1.1. The object of this agreement is the depositor to form a bank deposit for the trustee in amount of lei________, with an interest rate of ____% annual. Art. 2 The period 2.1. The deposit is made for a period of_____ days, starting with the date of____. Art.3.The legal obligations of the parties: A. The trustee committed himself to: 3.1. Open for the depositor a separate account for every deposit that he makes.
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3.2. Receive the money as a deposit and to hand the proving acts of the deposit. 3.3. Keep the secret about the deposit and not to provide proving information about this only if the depositor agrees with that and only in special cases provided by law. 3.4. Release the deposit if the depositor asks for that and to guarantee the deposit. 3.5. Pay the interest specified at Art. 1 to the depositor. B. The depositor commits himself to: 3.1. Respect the level and the period of the deposit, provided at Art. 1 and Art. 2 3.2. Ask for the extend or the liquidation of the deposit at the expiring date of the deposit, or else the deposit is considered a new deposit, on the same period and under the same conditions provided in this agreement. Art. 4 Special Clauses 4.1. The interest of the deposit is calculated monthly (a month being considered as 30 days). 4.2. If the depositor asks for reimbursement of sums from the deposit before the expiry of the period for which it was made, the trustee is authorised to recalculate the interest at the level of the sight interest. 4.3. The depositor vests Mr./Ms._________, the son/daughter of Mr._________ and Ms. ___________, born on the ____________, in _______________, to withdraw the hole amount, or a partial amount from this deposit, including the relevant interest. Art. 5 Final provisions 5.1. This contract can be modified only if both parties agree.
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5.2. The contract may be terminated by any partys wish, if that party communicates this in writing to the other party, without any other formality. The present agreement was completed in two original patterns, every party having one of it.
TRUSTEE, DEPOSITOR, MANAGER,
CHIEF ACCOUNTANT,
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ANNEX No 2
MISR ROMANIAN BANK On...............................200.. Egyptian Joint Stock Company Account No........................ Bucharest Branch APPLICATION TO OPEN AN ACCOUNT Manager of Misr Romanian Bank Dear Sir, Please open a .................. account in the name of .... with you and I accept to deal with you according to the general conditions of the account mentioned hereunder which are considered a complementary part of our dealings with the Bank. They are as follows: 1. The correspondences of the Bank are considered to have reached the client as soon as they are sent to him by mail at the latest address given by him to the Bank. 2. The debtor statements of accounts are sent monthly to the client and the creditor once every six months till the end of June and the end of December every year. 3. The debtor interests are charged and passed monthly to the account considering the year as having 360 days and the creditor interests every six months till the end of the year considering it as having 365 days besides the commission and expenses such as mail, cables, telephones, stamp duty etc. 4. The Bank has the right to close the clients account at any time without giving any reasons. In this case, the client should either withdraw his money from the Bank during the fixed time or the Bank will have the right to deposit what the client owns at the safe of the court. If the
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account is closed, the client should return the remaining cheques without using them. 5. All the different account opened at the Bank (Head Office and Branches) in the clients name are considered as indivisible units. Also all the property of the client at the Bank such as cash, bills, securities, goods etc. are considered as mortgaged in favour or Misr Romanian Bank and a guarantee for the disbursement of all his liabilities. 6. The client has to authenticate the statement of his account sent him by the bank within fifteen days from the date of sending the statement (with the exception of the normal period of travel) or send a complaint including reasons, during the same period, otherwise, the statement of account will be considered correct and agreed upon. 7. The bank is entitled to amend the rate of the creditor or debtor interest at any time upon an ordinary notice. 8. The client draws his properties from the bank by means of cheques which he demands from the bank, and the client alone is responsible for the loss, theft or illegal use of cheques given to him by the bank or drawn to its bearer. Consequently, the client states that he will encase his deposits at the bank by means of the above mentioned cheques bearing his own signature or by banking receipts which he personally signs before the concerned employee. If he chooses to authorise one person or more in all or some of his rights with the bank, he should undertake that this authorisation should be one of the banks authorisations, its kind, the number and the place of its authentication and the name of the deputy, his address, profession and grade of his relationship if it exists. If he cancelled the authorisation he must notify the bank thereof by a registered letter. If is well understood that the bank will not authenticate the authorisation in any of its shapes in changing the address or the correspondence of the client for it is agreed upon from now on that changed in the address of the correspondence should be done according to an application personally signed by the client. It is also agreed upon that the bank will not authenticate any authorisation of the client presented to it if the bank does not receive a notice from the client of its enforcement according to what is mentioned above. The bank will also continue using the authorisation unless they receive a notice from the client of its cancellation in line with the preceding
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details. All this is effected on the clients responsibility without any responsibility on the bank. 9. The number of the clients current account is the same number of the file in which his securities are deposited, and the bank is entitled to charge the deposit costs on them as from the date depositing according to the existing tariff. 10. It is agreed upon that the client is not entitled to use his account in advanced maturity credit operations (i.e. issuance of cheques payable at an advanced date), or repeatedly issuing cheques when the account is overdrawn, otherwise the bank is entitled to close the account automatically without previous notice. 11. I thereby authorise Misr Romanian Bank to collect the value of all coupons cheques and bills, and I guarantee its correctness and the authenticity of the signatures shown on them. I also authorise Misr Romanian Bank to purchase or sell the securities, bonds and goods, to open credits and other banking operations and credit then to my current account held with them. Orders issued by me to the bank concerning these banking operations and others are to be considered as an execution of this authorisation. 12. I hereby authorise Misr Romanian Bank to carry out the clearing among our various debtor obligations (whether we are debtors or guarantors) and our creditor balances, if any, held with them, and this is to be effected at whatever time suitable to the bank even before the date of maturity with full authority to the bank, needless of any notice, excuse or approval. Name and Title................................................................................................. Fathers Name.................................................................................................. Grandfathers Name......................................................................................... Nationality........................................................................................................ Profession......................................................................................................... Work address.................................................................................................... Residence..........................................................................................................
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Kind of account................................................................................................ Rate of interest (creditor)% year 360 days provided that................................. Rate of interest (debtor)% year 360 days provided that................................... Remarks............................................................................................................ Information....................................................................................................... Name of the recommended............................................................................... His address....................................................................................................... Recommenders signature................................................................................ The clients signature....................................................................................... The concerned employee signature..................................................................
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ANNEX No 3
APPLICATION FOR OPENING A CURRENT ACCOUNT FOR A ROMANIAN LEGAL ENTITY CERERE PENTRU DESCHIDERE DE CONT PENTRU PERSOAN JURIDIC ROMN
Date/Data:___/____/_______ day month year zi luna an Name/ ___________________________________________ Denumire _________________________________________________
Address/ ___________________________________________ Sediul___________________________________________ Established as Romanian Legal Entity Organizat ca persoan juridic romn commecial companies societi comerciale regie autonome regii autonome associations and foundations asociaii i fundaii We kindly request and authorize you to open a social cpital account on our name in/ V rugm i v autorizm s deschidei un cont curent n numele nostru n: ROL / Lei
For this purpose we attach hereto the company incorporation documents as they are specified on the reverse side. We hereby mutually agree that our account is governed by the banks General Business Conditions of which we know and which we accept unreservedly. In acest scop anexm documentele de constituire a societii menionate pe verso. Sunt de acord cu faptul c acest cont funcioneaz sub incidena Condiiilor Generale de Afaceri ale bncii pe care le cunoatem i pe care le acceptm fr rezerve.
Forreign Currency / Valut _____________________________________ Signature/Semntura: _______ Stamp/tampila

To be filled by the bank / se completeaz de ctre banc
Banks approval for the accounts no./ Aprobare pentru deschiderea conturilor nr. Signature/ Semntura Date/Data: ____/____/_____ zi luna an
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APPLICATION FOR OPENING A CURRENT ACCOUNT FOR A FOREIGN LEGAL ENTITY CERERE PENTRU DESCHIDERE DE CONT PENTRU PERSOAN JURIDIC STRIN
Date/Data:___/____/_______ day month year zi luna an ___________________________________________
Name/ Denumire
_________________________________________________ ___________________________________________ ___________________________________________
Address/ Sediul
Established as Foreign Legal Entity Organizat ca persoan juridic romn associations and foundations societi comerciale corporations regii autonome commercial reprezentations and reprezentane sau organizaii organizations comerciale We kindly request and authorize you to open a social cpital account on our name in/ V rugm i v autorizm s deschidei un cont curent n numele nostru n:
For this purpose we attach hereto the company incorporation documents as they are specified on the reverse side. We hereby mutually agree that our account is governed by the banks General Business Conditions of which we know and which we accept unreservedly. In acest scop anexm documentele de constituire a societii menionate pe verso. Sunt de acord cu faptul c acest cont funcioneaz sub incidena Condiiilor Generale de Afaceri ale bncii pe care le cunoatem i pe care le acceptm fr rezerve.
ROL / Lei Forreign Currency / Valut _____________________________________ Signature/Semntura: _______ Stamp/tampila

Banks approval for the accounts no./ Aprobare pentru deschiderea conturilor nr. Signature/ Semntura Date/Data: ____/____/_____ zi luna an
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We attach the following documents: Foundation deed of the legal entitz The Court setting-up Decision Registration Certificate Fiscal Code
Evidence of the empowered persons to represent the legal entity in relations with third parties
Other ___________________________________________________________
_________________________________________________________________________ _________________________________________________________________________
___________________________________________________________
Anexm urmtoarele documente: Actul constitutive al societii Hotrrea judectoreasc de nfiinare Certificatul de nmatriculare Codul Fiscal
mputernicire pentru persoanele mandatate s reprezinte societatea n relaiile cu terii
Altele _______________________________________________________
__________________________________________________________________
______________________________________________________ ______________________________________________________
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We attach the following documents:

Recognition Decision of the Romanian Court (in case there is no reciprocity clause with the respectively state) Approval of Romanian Government Fiscal code All legal documents related to the identity, head office, type of society place of registration, power of attorney for the representatives translation into Romanian of the authenticated documents and certified by a notary In case of foreign company's branch it is necessary to present documents providing the establishment of the branch, on the same conditions provided by the previous point In case of foreign subsidiary company setting up in Romania, it is necessary to present documents required by the Law applicable where the company was founded
Other
_______________________________________________________
_________________________________________________________________ _________________________________________________________________ _________________________________________________________________
Anexm urmtoarele documente:

Hotrre judectoreasc de recunoatere (n cazul in care nu exist clauza de reciprocitate) Aprobarea Guvernului Romniei Codul fiscal Toate documentele legale referitoare la identitatea firmei, sediu, tipul societii, locul nmatriculrii, mputernicire pentru reprezentanii societii, traducere n limba romn autentificat de notar In cazul filialei este necesar prezentarea documentelor constitutive ale filialei, n condiiile prevzute la punctul anterior In cazul deschiderii unei filiale in Romnia, este necesar prezentarea documentelor impuse de legea unde s-a nfiinat societatea mam
Altele
_______________________________________________________ _______________________________________________________ _______________________________________________________ _______________________________________________________
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APPLICATION FOR OPENING A CURRENT ACCOUNT FOR INDIVIDUALS CERERE PENTRU DESCHIDERE DE CONT PENTRU PERSOANE FIZICE
Date/Data: ____/____/________ day month year zi luna an Name/Nume
________________________________________ ________________________________________ ________________________________________ ________________________________________
Address/Adresa
B.I. (paaport) _________________ ID (paaport)
CNP: ________________________ Tel.: ________________________
For this purpose I attach hereto a copy n acest scop anexez o copie dup actul of my ID de identitate. I hereby mutually agree that my account is governed by the banks General Business Conditions of which I know and which I accept unreservedly Sunt de acord cu faptul c acest cont funcioneaz sub incidena Condiiilor Generale de Afaceri ale bncii, pe care le cunosc i pe care le accept fr rezerve.
I kindly request and authorize you to open a current account on our name in/ V rog i v autorizez s deschidei un cont curent n numele meu n: ROL / Lei Forreign Currency / Valut _____________________________________
Signature/Semntura: _____________
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Banks approval for the accounts no./ Aprobare pentru deschiderea conturilor nr. Signature/ Semntura Date/Data: ____/____/________ day month year zi luna an Bucureti, ________________
MPUTERNICIRE
SC__________________________________________________________ nregistrat la R.C. sub nr. ___________ avnd cod fiscal _____________ , reprezentat legal de ____________________________________________ n calitate de __________________________________________________ mputernicesc pe d-na/d-nul ______________________________________ BI/paaport cu seria nr. ______eliberat de _______la data de____________ s reprezinte valabil societatea, avnd drept de semntur, fr limit de sum, pentru urmtoarele operaiuni bancare : Depunere de numerar n lei i n valut Retragere de numerar n lei i valut Ordin de vnzare, cumprare lei/valut Semntura documente aferente operaiunilor de import export: DIV, DPVE, etc Ordine de plat n lei Depunere i ridicare documente bancare Ordine de ncasare cecuri Efectuare de schimb valutar Ridicare extrase de cont ncheiere contracte de depozit in numele societii
mputernicirea este valabil pn la revocare Semntura autorizat,
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APPLICATION FOR OPENING A SOCIAL CAPITAL ACCOUNT CERERE PENTRU DESCHIDERE DE CONT DE CAPITAL SOCIAL Date/Data:___/____/_______ day month year zi luna an ___________________________________________
Name/ Denumire
_________________________________________________ ___________________________________________ ___________________________________________
Address/ Sediul
Established as Romanian Legal Entity Organizat ca persoan juridic romn commercial companies societi comerciale regie autonome regii autonome associations and foundations asociaii i fundaii We kindly request and authorize you to open a social cpital account on our name in/ V rugm i v autorizm s deschidei un cont curent n numele nostru n: ROL / Lei
For this purpose we attach hereto the company incorporation documents as they are specified on the reverse side. We hereby mutually agree that our social capital account bears no interest.
n acest scop anexm documentele de

constituire a societii menionate pe verso.
Sunt de acord cu faptul c acest cont nu este purttor de dobnd
Forreign Currency / Valut _____________________________________ Signature/Semntura: _____________ Stamp/tampila

Banks approval for the accounts no./ Aprobare pentru deschiderea conturilor nr.
Signature/
Semntura Date/Data: ____/____/________ day month year zi luna an
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We attach the following documents: Foundation deed of the legal entity -original and 1 copy Headquarters document - original and 1 copy Mandate for the person in charge to open social capital account
Other _______________________________________________________ _______________________________________________________ _______________________________________________________ _______________________________________________________ _______________________________________________________ Anexm urmtoarele documente: Actul constitutiv al societii n original i 1 copie Documentul care atest sediul social n original i 1 copie mputernicire pentru persoana autorizat s deschid cont de capital social Altele _______________________________________________________ _______________________________________________________ _______________________________________________________ _______________________________________________________ _______________________________________________________
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MPUTERNICIRE PENTRU CONTURI PERSOANE FIZICE Dl./Dna. ______________________________________________________ n calitate de titular de continue mputernicesc pe d-na/d-nul ____________ ____________BI/pasaport cu seria nr. ________ eliberat de ____________ la data de___________________ s m reprezinte valabil avnd drept de semntur, fr limit de sum, pentru urmtoarele operaiuni bancare : Depunere de numerar n lei i n valut Retragere de numerar n lei i valut Ordin de vnzare, cumprare lei/valut Ordine de plat n lei Ordine de plat n valut Efectuare de schimb valutar ncheiere contracte de depozit n numele titularului Depunere i ridicare documente bancare Ridicare extrase de cont
mputernicirea este valabil pn la revocare Semntura d-nei/d-nului angajeaz n mod legal titularul ____________ si este recunoscut i opozabil acesteia. Semntura titular
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Ctre / To : THE COMMERCIAL BANK S.A.

Subsemnatul The undersigned B.I. ID (passport) Reprezentant al Representative
V solicitm i autorizm, contrar instruciunilor iniiale, referitoare la depozitul la termen
I/we kindly request and authorize you, despite to my/our initial instructions with reference to time deposit
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Date/Data:
___/____/_______
Business of Banking day month year zi luna an
Ctre / To : THE COMMERCIAL BANK S.A.

Subsemnatul The undersigned B.I. ID (passport) Reprezentant al Representative Cont nr.: Account nr.:
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RISKS MANAGEMENT
Objectives: After studying this chapter you should be able to understand: 8.1 General issues: definition of banking risks, importance of managing the banking risks Managing risks The prudential measures of the National Bank of Romania
8.2 8.3
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8.1 General issues: definition of banking risks, importance of managing the banking risks The financial market is extremely volatile due to the influence of various factors, objective or subjective; the credit institutions being aware of the fact that maximising profit implies a permanent incur of risk. Most definitions of the risk and risk management are focused on the classical function of money, that of intermediary in the field of financial risks through their division. From this point of view it is usually regarded the problem of unexpected losses in bank assets, losses caused by market, credit or liquidity risks. The risk may have a considerable impact over the bank or financial institution, both an impact consisting in the incurred direct losses, and an impact consisting in the effects over the customers, personnel, business partners and even over the bank authority. In general, the risk represents the probability of occurrence of an event that will produce serious consequences for the subject. In the same context, it should be mentioned that for the risk exposure to be actual value of all losses or supplementary expenses the financial institution would or could cover. According to this definition, the risk exposure may be real or potential. It is important to know that the risk is generated by a large number of operations and procedures. Therefore, in the financial field at least, the risk must be considered as a mistune or a complex of risks, usually independent through common targets or the fact that the occurrence of one risk may cause a chain occurrence of other risks. As a consequence, these operations and procedures permanently generate a risk exposure. Banking risks are those risks the banks are confronted with in their current operations, and not only the risks specific to the classic banking activity. It is obviously that a notable banking strategy must include both programs and procedures of managing banking risks, regarding the minimisation of the probability the risks would occur the potential exposure of the bank. The three objectives of the bank management are maximising profitability, minimising the risk exposure and observing the banking regulations. None
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of them has a major influence, as a task of the bank management consists of in establishing the central objective for each period. Banks are also subject to all the risks that their customers face, risks as diverse as crop failure, environmental damage claims or the failure of a new product developed at a high cost. The most significant and persistent risk faced by banks is credit risk - the risk that counterparts will be unable to meet their obligations. Credit risk arises from lending to individuals, companies, banks and governments, from entering into market transactions which give rise to a receipt on maturity, from stock lending and from transactions with supplies. The main types of risks1 involved in the banking activity are: financial risks, delivery risks, and environmental risks. Financial risk arises from any business transaction undertaken by a bank, which is exposed to potential loss. The main financial risks are the following: Credit risk Interest rate risk Liquidity risk Foreign exchange risk Capital risk Credit risk may be defined as the risk that a counterparty of a financial transaction will fail to perform according to the term and conditions of the contract, thus causing the asset holder to suffer loss. This failure may be the result of bankruptcy, a temporary change in market conditions, or other factors adversely affecting the borrowers ability to pay. The most obvious example of a credit risk is the risk that a customer will fail to repay a loan. However, it is important to appreciate that credit exposure extends to a large variety of banks activities including the extensions of commitments and guarantees, acceptances, trade finance transactions, placements and the range of capital markets instruments activity such as foreign exchange, futures, swaps, bonds, options, equities and bullion.
1
Hempel, G.H. Coleman A.B. Bank Management, New York, 1990
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Credit risk may also arise from off balance sheet transactions. A bank may guarantee a clients performance under a contract in return for a fee - giving rise to the risk that the bank may be called upon to fulfil its guarantee at some later date because its client has failed to meet its contractual obligations. This gives rise to a counterclaim against the guaranteed party for the money paid out under the guarantee. Credit risk may take the form of delivery or settlement risk. Where a bank buys securities from a third party or transfers securities under a repurchase agreement, it faces a risk that the counterpart will be unable to deliver the securities on the due date leaving the bank exposed to the possibility that it will not be able to replace the securities at the same price. Interest rate risk A fundamental banking objective is to borrow funds at one rate and to lend them at higher rate. Interest rate risk, sometimes called funding risk, involves the effect in the bank profitability of changes on the market interest rates. Interest rate risk refers to the financial risks caused by the interest rate fluctuations that affect both the profit obtained by the client and the indebtedness degree to the bank. A major increase of the interest rate may determine a financial pressure for the clients activity, which will not be able to repay the amounts due. The main factors that increase the interest rate risk are: volatility of interest rates;, and mismatches between the interest reset dates on assets and liabilities. The main factors that mitigate interest rate risk are: established limits on mismatch position; hedging with financial futures or other instruments; management monitoring exposure. Liquidity risk It is the risk that ocurs when the bank will not be able to meet its cash or payment obligations as they fall due. The risk arises because cash flows on assets and liabilities do not match. Due to the size and spread of the resources, the bank is often called to borrow short and lend long. This gives rise to the risk that depositors may seek to withdraw their funds and the bank may not be able to effect repayment except by raising additional
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deposits at a higher cost, or by a forced sale of assets, perhaps at a loss. Thus, an important aspect of the banking business is the fact that the depositors may withdraw their money whenever they want, for deposits at sight, and at the established term, for deposits at term. If a bank can not meet these obligations, the customers trust in the bank will diminish, even in the whole banking system. The customers will not wish anymore to deposit their money in banks, and there may appear massive withdrawals of funds, with a negative effect over the national economy. The main factors that increase the interest rate risk are: erosion of confidence in the bank, in the market place because of earnings difficulties or other reasons; dependence on one market or a few counterparties for deposits; unstable financial markets; extensive short borrowing or long lending. This is why it is necessary to forecast exactly the changes that may occur in the level and structure of the interest rate, this being correlated with the evolution of macroeconomic indicators. For the current period and for the near future, mainly the banks clients undertake the interest rate risk related to national currency activities. This is caused by the fact that the credit and deposit interest rate modifies continuously because of the fluctuations of the market; the exception is given by the deposit certificates that have a fixed interest. We must always take into consideration the analysis of the structure of the deposits and investments, as well as their evolution. It is desired to minimise the interest rate risk according to the relationship between the interest caring assets and liabilities. The value of the ratio must be as close to 1 as possible. The main factors that mitigate interest rate risk are: maintenance of a high level of liquid assets (e.g. cash, money at call, marketable securities); standby credit facilities with other institutions; availability of related party funding; a lender at last resort to reassure depositors (e.g. Government deposit insurance); maintenance of a closely matched maturity structure between assets and liabilities. Foreign exchange risk is related to interest rate risk and liquidity risk. It arises from a mismatch: this time of currency and assets and liabilities. Thus, the currency may fluctuate in an unexpected direction or higher than it has been anticipated. This type of risk is determined by the exchange
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operation, that affects the situation of the clients who obtain a credit in foreign currency and do not perform exports, or those revenues from exports do not cover the debt contracted. Transactions affected include both onbalance sheet (e.g. loans, deposits), and off-balance sheet (e.g. forward currency contracts) items. Foreign exchange risk is also called currency risk. The main factors that increase currency risk is volatility of exchange rates; significant open currency position. The main factors that mitigate currency risk are: position limits; management monitoring of exposure; use of hedging techniques. In Romania, the supervision of the foreign exchange risk2 is accomplished: a) by banks; b) by the National Bank of Romania, on the basis of the foreign exchange position indicators reported by banks. With a view to limiting the foreign exchange risk the banks have the following obligations: a) to have a record system which permits permanently both the immediate registration of the operations in foreign exchange and the calculation of their results, as well as the determination of the adjusted individual foreign exchange positions and the total foreign exchange position; b) to have a supervision and administration system of the foreign exchange risk on the basis of norms and internal procedures approved of by the banks board of directors; c) to have a permanent control system for checking the observation of the internal procedures, necessary with a view to accomplishing the precedent orders; d) to designate a manager who ensures the permanent co-ordination of the banks foreign exchange activity. Delivery risks3 include the following risks: operational, technological, newproduct, and strategic risk.
2
National Bank of Romania Norm No. 4/2001 concerning the supervision of banks foreign exchange positions, published in Monitorul Oficial al Romniei, Part I, No. 631/2001 Hempel, G.H. Coleman A.B. Bank Management, New York, 1990
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Operational risk, sometimes called burden risk, is the ability of the bank to deliver its financial services in a profitable manner. Both the ability to deliver such services and to control the overhead associated with them are important elements. Technological risk refers to the risk that a delivery system may become inefficient because of new delivery systems. New-product risk is the danger associated with the introduction of new products and services. Lower than anticipated demand, higher than anticipated cost, the lack of management talents in new markets can lead to severe problems with new products. Strategic risk refers to the ability of the bank to select geographic and product areas that will be profitable for the bank in a complex future environment4. The environmental risks include the following risks: defalcation, economic, competitive, regulatory risk. Defalcation risk is the risk of theft or fraud by bank officers or employees. It must be carefully guarded against to avoid substantial losses. Economic risks are associated with national and regional economic factors that can affect the bank performance. Competitive risk arises because more and more financial and non-financial firms can offer most bank products and services. Regulatory risk involves living with some rules that place a bank at competitive disadvantage and ever-present danger that legislators and regulators will change the rules in an unfavourable manner to the bank. Other British authors divide the main risks in two big categories of risks, such as: product market risks, and capital market risk (see Figure No.1, and Figure No.2).
Hempel, G. H. Coleman A.B. Bank Management, New York, 1990
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Figure No 1 Product Market Risk
Credit risk
Strategy risk
Bank settlement risk Operating risk Product market risk
Merchandise risk Human resource risk
Legal risk
Product risk
Source: Aspinwall, R.C., Eisenbeis, R.A Handbook for Banking Strategy, John Wiley and Sons, Inc. 1995
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Strategy Risk (business risk) It is the risk that all the business line will succumb because of the competition or obsolescence. One such example may be represented by the relative disappearance of the traditional market with high credits with low risk for companies, these being replaced by commercial papers. Another example of strategy risk is that in which a bank is not ready or not able to become competitive in a new activity. For example, in the activity of cards issuance, some banks postponed this process and they could not earn a competitive advantage in this field. This conservatory attitude of waiting for the market itself to develop represents a risk. Bank Settlement Risk The financial institutions, as profit centres, function in compliance with licenses that may be revoked and this may lead to the loss of important investments. Thus in USA in the past decades banks nationalisation have taken place. In Romania we can mention the license withdrawal from some banks that although were non-operational, engaged important investments for headquarters and equipment in the moment of withdrawal. Also, another settlement risk may be the withdrawal of dealer license from the Romanian banking market of some Romanian and foreign banks. The settlement risk can be met when a bank specialised in one field becomes a universal bank, and thus it is going to compete with the other banks that act in the same domains. In this category there can be found an additional risk that is the possibility of the regulatory authority to change the operating policies. One example here, is the Romanian Stock Exchange modification of the calculation of the mutual funds assets, regulation that led to the collapse of some institutions. Regulatory authorities may decide who should stay and who should leave the financial market, through the capital adequacy requirements. Thus the National Bank of Romania, by increasing the level of the subscribed social capital from 100 million lei to 250 billion lei, makes many of them lack the possibility to attract supplementary capital and thus, under such circumstances, they may be withdrawn the functioning license.
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Merchandise Risk The merchandise prices may affect banks, as well as other creditors, unforeseen sometimes, having general impact over the savings and debtors. For example, the rising of the energy price may influence the inflation, contributing to the increase of the financial rates based on a fixed interest rate. Also the increase of the oil price may lead to different results in some companies. Human Resources Risk This represents the subtlest type of risk, very difficult to be measured, resulting from the personnel policy: recruitment, training, motivation and maintenance of specialists. If one specialist leaves, the whole activity or only one working system is compromised. The protection against this risk implies the payment of more employees in order to insure the knowledge and experience of the leaving employee. A similar risk is the wrong motivation of the employees. Under certain circumstances it may have significant results. It refers to the lack of stimulants or their wrong application. Legal Risk We encounter two sides of such risks: a) the creditors responsibility in case the debtors claim that the bankruptcy was caused by the fact that the bank had promised it would not withdraw the credit or that it would grant supplementary credits; b) Litigation related to toxic materials deposited on the dispossessed field. These are unforeseen measures difficult to be estimated, which must be taken into consideration by the financial institutions, as they can reach high values. Generally speaking, the capital markets and their risks affect all the companies, especially the financial institutions, where it is hard to make a clear differentiation between the product market and the capital market.
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For example, the interest rate risk for fixed rate credits is a capital market risk; at the same time the fixed rate credit risk may determine the bankruptcy of a poor debtor, and thus, the interest rate risk becomes a credit risk, that is actually a product market risk. The banks supply financial products and services to industry and consumers. The financial services involve their own risks, specific to the capital market on which they function. From the capital market point of view there exist the following types of risk: Figure No. 2 Capital Market Risk
Interest rate risk
Liquidity risk
Capital Market Risk
Currency risk
Discount risk
Basic risk
Source: Aspinwall, R.C., Eisenbeis, R.A Handbook for Banking Strategy, John Wiley and Sons, Inc. 1985
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Discount Risk This is a particular type of error risk, which involves the banks competitors. It refers to the money transfer between national and international banks. This risk is carefully handled by using sophisticated technology for payment pursuit. Thus, only one payment is performed at the end of the day, instead of numerous payments from individual transactions. Basic Risk It is a currency risk variation. In order to protect against the interest rate transactions with various basic assets can be used, being pursued mainly the existing and predictable relationship between them. The FUTURES contracts may be used as hedging instruments. Obviously, the financial institutions, the commercial banks, in their financial service rendering activity, administrate their own risks, but they may also transfer the risk through the hedging transactions. If the bank can not avoid the risk, its burden, and respectively, its costs are both administrated and transferred. A rapid growth of the risk is noticed both on the product market and on the capital market in the financial services, and at the same time the increase in the preoccupation for protection against the risk. The derivatives represent thus, ways to avoid the risks on the capital market. The swaps, options and futures contracts are instruments used for risk transfer. Other types of risks are: The fraud risk is defined as a deception or an act either by stating what is false or by suppression of the truth in order to deceive another, gain an advantage over another. The fraud does not represent a risk only for a bank, but also for its depositors that have entrusted their capital. The country risk is defined as the non-reimbursement act generated by an insolvency determined by the debtors financial position and not by the deterioration of his financial situation. It does not represent a credit risk because the debtors insolvency does not appear.
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The market risk refers to the unfavourable variations of the market value of the positions during the minimum period of time needed to the settlement of the positions. The market risk appears due to the fact that the prices of these financial values are determined on the market, and they are modified. 8.2 Managing risks At the present time, there is no generally accepted system for risk management. By their nature, commercial banks often obtain their profit by performing their activity in certain segments of the market. Banks capacity to ensure against excessive risk depends on: capital size; its bank management quality; its technical expertise; Personnel experience in the corresponding market segment. The banks must have their own system to monitor and control the risk. Generally, banks prudential measures against risk may be the following: Bank management must be aware of the risks resulting from the banks activity, and must be able to measure, monitor and control these types of risks; Bank must have clear policies, as well as risk measurement and control procedures; Bank management must establish the internal limits of risk; Periodical reports must be concluded, analysed and controlled by the banks internal control and its censors. After the uncertainties caused by the 1975 crisis, the necessity to elaborate some rules for the bank administration and the consolidation of the clients security appeared. These rules are expressed through the Cooke Ratios. They refer to the banks liquidity and solvency. For example: Risk coverage index = Risk sharing index = Liquidity index = Own funds Total commitments Risk for one client Net own funds x 100 x 100 = 8% = 40% x 100 = 60%
Own funds + Resources > 5 years Uses > 5 years
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In many states worldwide, the minimum compulsory reserves represent an instrument of the monetary policy. The Central Bank supervises the liquidity indexes that establishe the banks general rating. These indexes are calculated based on the banks financial reports presented periodically to the Central Bank or in this case of a control. Solvency represents the capacity of one natural or legal person, or bank to face the commitments taking into account the resources constituting the patrimony or assets. Solvency is interesting when granting a credit, allowing the identification of possible non-repayment on the due date. For banks, solvency represents the capacity to cover losses for the credits granted without jeopardising the deposits repayment. The major role of the supervision authority is that to prevent the systemic risk by promoting efficient bank supervision which may ensure the accomplishment of the stability and viability of the banking system. For this purpose, In Romania, it was necessary to implement the Banking Rating System and the Early Warning System. This system represents an efficient instrument for the evaluation of the banking institutions in order to identify those banks that are inefficient financially and operationally. The rating system is based on the evaluation of the following six components: capital adequacy; asset quality; management; earnings; liquidity. Each component was evaluated on a scale of values from 1 to 5, taking into consideration the bank performance. Thus, 1 represents the highest level, and 5 the lowest. In Romania, in order to determine the necessary specific credit risk provisions related to one credit or investment, under the NBR Regulation, it is necessary to perform the following steps5: 1 assign credits or investments in the corresponding credit risk categories; 2 determine the basis of calculation for the specific credit risk provision;
Regulation 2/2000 concerning the classification of credits and placements, published in Monitorul Oficial al Romniei, Part I, No.316/2000
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3 apply the provision co-efficient over the basis of the calculation obtained. Banks shall proceed to remove to off-balance sheet all of the sums related to a credit or investment in the following cases: 1 no less than those sums registering a debt service of more than 360 days; 2 those in which the executor formula has been invested: credit contract, as well as contracts of guarantee as the case may be; a definitive legal decision which orders against the credit contract as well as against the contract of guarantee as the case may be, or against the contract of investment; 3 where the procedure of executor style of patrimony in the case of individuals has been initiated; 4 where the procedure of judicial reorganisation or the bankruptcy procedure against the debtor has been initiated. 8.3 The prudential measures of the National Bank of Romania In Romania the loans are granted by banks under their own norms and regulations issued in accordance with the directives of the National Bank of Romania. The main prudential measures issued by the National Bank of Romania are: 1. The classification of credits and investments, as well as the establishment, adjustment, and use of the specific credit risk provisions; 2. Large loans; 3. The minimum capital of the banks; 4. The solvency ratio; 5. Loans granted to the debtors in special relations with a bank; 6. Liquidity.
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1. In order to establish the classification of credits and investments, and/or regularize specific credit risk provisions, banks have the obligation to have an adequate methodology of organizing information and procedures. Banks are obliged to report to the National Bank of Romania the Supervision Division: a) the situation of classification of credits, as well as the necessary of specific credit risk provisions; b) the situation of classification of investments with banks and of the necessary of the specific credit risk provisions; Credits and investments are classified in the following categories6: - standard; watch (only for credits granted to clients of the non-banking sector); substandard; doubtful; loss.
Classification of credits and investments is made through the simultaneous application of the following criteria: - debt service; - initiation of legal proceedings. The relationship between classification categories and criteria is provided for in tables no. 1 and 2 of Annex No 1. Credits granted to one debtor and/or investments established therein, are included in one single category of classification on the basis of the principle of lowering the position through contamination, respective of taking into consideration the weakest among the individual classification categories. 2. The level of a large exposure shall not exceed 20 % of the own funds of the bank, and the total amount of large exposures shall not exceed 8 times the level of the own funds of the bank.
6
Regulation 2/2000 concerning the classification of credits and placements, published in Monitorul Oficial al Romniei, Part I, No.316/2000
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Banks are obliged to report to the National Bank of Romania - Supervision Department the level of the large exposures via the form The situation of large exposures, whose model is provided in Annex No. 2) and the form The situation of groups which represent a single debtor against the bank which registers large exposures, whose model is provided in the Annex No 3). The total amount of net loans granted by the bank to its own staff, including their families, may not exceed 5 % of the own funds of the bank. Banks shall report to the National Bank of Romania Supervision Department the level of the net loans granted to insiders and, respectively that of the net loans granted to their own staff, as well as their families, by the use of the form Situation of the net loans granted to insiders, to their own personnel and as well as to their families, whose model is provided in Annex No. 4 of the present norms. 3. The National Bank of Romania establishes the minimum level of the capital of the banks.7 Under the provisions of the stipulated norms, the minimum level of a bank is established at Lei 250 billion. Banks authorised by the National Bank of Romania as of the date of the entry into force of the norm concerning the minimum level of the capital should attain the level in two steps, these being ordered, beginning with 31.05.2001, for social capital and own funds of no less than 150 billion lei and beginning with 31.05.2002 for a social capital and own funds of no less than 250 billion lei. 4. Considering the credit risk limitation, banks are compelled: a) to have adequate administrative procedures and internal control procedures which allow the supervision and management of the credit risk, as well as the permanent framing of the solvency indicators, of greater exposures and of loans granted to insiders, own personnel, as well as to their families;
National Bank of Romania - Norms no. 9/2000 concerning the minimum capital of the banks and branches of foreign banks, issued in Monitorul Oficial al Romniei, Part I, No. 474/2000.
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b) To ensure an adequate reference to accounting evidence, which shall represent the foundation of prudential bank reports, thus: 1. for the asset accounts and rectifiable liabilities related to those in the balance sheet asset: 1.1 the evidence shall be kept on risk entities, for which the related amounts shall be registered separately; 1.2 the amounts from item 1.1 shall be recorded, at their turn, on credit risk ranks in the following distinctive columns: - Credit risk rank 0%; - Credit risk rank 20%; - Credit risk rank 50%; - Credit risk rank 100%. 2. for the off-balance sheet asset accounts, presented in the Annex No.5); 2.1 the evidence shall be kept on risk entities, for which the related amounts shall be recorded distinctively; 2.2 the amounts from item 2.1 shall be recorded, at their turn, on risk rank of transformation in credit of the off-balance sheet elements, in the following columns: - Credit equivalent 0%; - Credit equivalent 50%; - Credit equivalent 100%. 2.3 the amounts from the item 2.2 shall be recorded based on credit risk rank, in the following distinctive columns: - Credit risk rank 0%; - Credit risk rank 20%; - Credit risk rank 50%; - Credit risk rank 100%; c) to codify, to name and to keep a record, not referring to accounting, for each group of physical persons and/or legal entities which represents a single debtor; the code shall be made of unique alpha numeric sequence and the registration date of the group in the bank evidence and shall keep as long as the modification in the group structure are not relevant; d) to codify and to keep evidence, not referring to the accounting, of each physical person or legal entities which represents a single debtor or which is part of a group of physical persons or legal entities which represents a single debtor and/or part of an insiders group and/or part of a group made of their own personnel and their families; the code shall be made of an
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unique alpha numerical sequence and the date of registration of the physical person and legal entities as a debtor of the bank and shall be permanently kept. In the case of physical persons and legal entity, the unique alphanumerical sequence shall be represented by the personal numerical code and by the fiscal code; e) to conclude transactions which lead to larger exposures based only on a decision taken by the Board of Directors; the decision of the Board of Directors shall be based on a report of the risk committee, which shall include, at least, the analysis of the transaction, of the financial situation and of the reliabilities of the physical persons and the legal entities representing a single debtor, as well as the analysis of the structure of group of physical persons and/or legal entities, in the case in which there represents a single debtor; f) to grant credits to insiders only based on the decision adopted by the Board of Directors; the decision of the Board of Directors shall be based on a report of the speciality divisions which shall include the description of the nature of the special relation, the analysis of the transaction, of the financial situation and of the reliabilities of the insiders; employees of the bank shall be excepted from the application of provisions, and their families; g) to grant credits to their own personnel, including there families, only based on some internal norms approved by the Board of Directors. In order to determine the solvency indicators, large exposures and net loans granted to insiders, own personnel, as well as to their families, banks should take into account the following: a) the bank assets shall be grouped on risk entity, as well as in categories of credit risk, in accordance with the framing criteria presented in Annex No 5; b) in the case of collateral with a risk higher than that of the counterpart, the risk rank (grade) shall be related to the counterpart; c) in the case of an asset element guaranteed with one of the collaterals type provided in Annex No 5, to whom it corresponds a specific rank of risk lower than that corresponding to the counterpart, the guaranteed part of the respective asset element shall be recorded in a category with a lower risk grade, and the not guaranteed part of the asset element shall be recorded in the category corresponding to risk grade related to counterpart;
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d) in the case of an asset element guaranteed with two or more of the types of guarantees provided in Annex No 5, this shall be taken into consideration starting with those which allow the framing of the respective asset in the lowest risk grade categories; e) in the case of securities granted as a loan, the risk entity, as well as the risk grade related to those shall be established taking into consideration the highest of the credit risk grade related to the issuer and the credit risk grade related to debtor, and, in the situation in which the securities granted as loan to be secured with one of the types of guarantees provided in Annex No 5; f) for the rectifiable liabilities elements the risk entity shall be the same as that of the asset elements which corrects, and the framing in credit risk categories shall be made in the credit risk categories corresponding to asset elements which they are correcting, starting with the highest category of risk; g) off-balance sheet elements shall be grouped on risk entities, as well as on credit risk categories for transformation in credit, in accordance with the criteria of framing presented in Annex No 6, after which shall be considered balance sheet elements, and shall be included in credit risk categories, in accordance with the criterias presented in Annex No 5. The minimum limit of the solvency indicator8, calculated as a ratio between the level of own funds and net exposure shall be 12 % and the minimum limit of the solvency indicator, calculated as a ratio between the level of own capital and the net exposure shall be 8%. Banks shall report to the National Bank of Romania the General Department for Licensing, Regulation and Prudential Supervision of the Banking Companies the level of the solvency indicators by the form Solvency of banks, whose model is provided in Annex No 2. 5. Under the norms9 issued by the National Bank of Romania the bank can grant loans to the persons with whom it has special relations with, only under conditions provided by the norms.
NBR Norm 8/1999 concerning the limit of the credit risk of the banks, published in Monitorul Oficial al Romniei, Part I, No. 245/1999. NBR Norm 8/1999 concerning the limit of the credit risk of the banks, published in Monitorul Oficial al Romniei, Part I, No. 245/1999.
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Persons in special relations with the bank are considered: a) b) c) d) e) f) g) h) i) the representatives of the State Ownership Fund in the general meeting of the shareholders of the bank; the banks administrators and the censors, natural persons of the bank, the managers, the directors and the internal auditors of the bank; the censors, legal entities, of the bank and the independent audit of the bank; the executive directors of the bank; any legal entity which exerts effective control of the bank, the main shareholders and its managers; any commercial company that participated at the capital of the bank (at least 10%); the NBRs staff that makes control and supervises the bank; the NBRs members of the Board of Directors; the spouses or the relatives, up to the fourth degree of relation including, of the persons provided by the letters a) and b) and of the managers or main shareholders of the legal entities who have effective control of the bank; any main shareholder and any commercial company being under his effective control, directly or indirectly; The staff of the banking company, etc.
j) k)
Effective control of a bank or of any other commercial company is taken into consideration when a physical or legal person: holds more than 50% of the voting rights or of the registered capital of the bank or of any other commercial company; has the right to appoint or to replace the majority of the members of the Board of Directors of the bank or of any other commercial company; is shareholder or partner and controls alone the majority of the voting rights, according to an agreement concluded with other shareholders or partners of the bank or of any other commercial company; has the power to exert a decisive influence over the management and the policy of the bank or of any other commercial company.
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6. The own funds10 of a bank are made of the following categories of capital: - own capital; - additional capital. The own capital is comprised of: a) the social capital paid; b) premiums related to capital, totally collected; c) legal reserves; d) general reserve for credit risk; e) reserves from the influences of the exchange rate related to the liquidity in hard currency representing the social capital in hard currency, in accordance with the Government Decision no. 252/1996 regarding the regime of the foreign exchange differences related to the social capital in hard currency and other applicable operations, starting with the balance sheet with the submission deadline of 15 April 1996, modified by Government Ordinance no. 23/1996 and by Government Decision no. 213/1999; f) reserves set-up from premiums related to capital and net profit distribution, indicating in the reporting form the symbol and the name of the account; g) reserves from the favourable differences from the patrimony revaluation indicating in the reporting form the name and symbol of the account, as well as of the legal provisions based on which it is constituted; h) the tangible assets fund; i) the fund for increasing their own financing resources;
10
NBR Norm No.7/1999 concerning own funds of banks, published in Monitorul Oficial al Romniei, Part I, No. 206/1999.
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j) the funds set up by banks, indicating in the reporting form of the symbol and the name of the account, as well as the legal provisions based on which it is constituted; k) statutory reserves; l) the reporting result representing undistributed profit; m) the net result of the current financial year representing profit; n) the funds with permanent features being at the disposal of their own units from abroad. For the establishment of the own capital level the following elements shall be deducted: a) the amounts representing the value of their own redeemed shares having in view the reduction of the social capital in the conditions provided at Art. 53 letter b) of Law no. 58/1998; b) the not amortised value of the establishment expenses; c) the net value of the commercial fund; d) the amounts of the net profit of the current financial year representing dividends (in the case of banks which are not under the incidence of the Art. 47 of Law no. 58/1998), the personal participation at profit and the participation share of the manager at the profit. This amounts shall be calculated off balance sheet (outside of accountant), by using for the net profit recorded at the end of each month of the weighted elements in accordance with the distribution of the net profit of this destinations, performed based on the accountant balance sheet of the previous year; e) the amounts representing expenses to be distributed and expenses to be recorded in advance, which must be supported in a deferred manner on expenses during futures periods or financial years; f) the carried forward result representing unsupported loss; g) the net result of the present financial year representing loss; h) distribution of the profit;
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i) the endowment for owns units abroad. Additional capital is comprised of: a) other reserves; b) subordinated debt; c) subventions for investments; d) favourable differences from the revaluation of the patrimony, indicating in the reporting form the name and symbol of the account, as well as of the legal provisions on the basis in which they were constituted. For the determination of the level of the own funds of a bank it shall take into account the following: a) the additional capital shall be taken into consideration at the calculation of the own funds only in the conditions of registration of a positive level of the own capital and in a proportion of not more than 100% of this; b) subordinated debt shall be included in the calculation of the own funds in a proportion of maximum 50% of the own capital and must fulfil the following conditions: - to be totally used; - in the case of subordinated debt on term, the initial maturity must be of at least 5 years; if the subordinated debt is for an indefinite period, it is not reimbursed only at the initiative of the debtor bank and only in the conditions in which the level of the own funds is not altered; - for the calculation of the level of own funds the volume of the subordinated debt shall be gradually decreased by 20% per year in the last 5 years prior to maturity; - the credit contract shall not include the clause of anticipated reimbursement of the subordinated debt in other circumstances than the liquidation of the bank; c) deduction from the level of the own funds of the following elements: - the amounts representing participation in commercial companies, participation securities, and securities of portfolio activities, held with banks and companies with financial activity, corrected by the amounts representing conversion differences, payments to be made for
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participation in commercial companies, for participation securities and for securities for portfolio activities and provisions for depreciation of the participation held in commercial companies, participation securities and securities for portfolio activities; - subordinated credits, granted to banks and companies with financial activities, corrected by the amounts representing provisions for past due and doubtful claims, related to those. Banks have the obligation to determine, monthly, and the level of own funds, according to the methodology of the present norm, based on the dates from the accountant balance sheet of each month. Banks shall send to the NBR - The General Department for Supervision the monthly reporting form within not more than 10 days from the next month. The model of the calculation and reporting form of own funds is presented in the annex no.8. For all prudential banking indicators, whose determination shall be done based on own funds, banks have the obligation to use the last level of own funds resulting from the application of Art. 5. 7. In Romania, the supervision of the liquidity risk shall be realised by: - banks; - the National Bank of Romania, under the liquidity indicator calculated by comparing the effective liquidity with the necessary liquidity on the basis of each maturity band. The minimum limit of the liquidity indicator, calculated as a ratio between the effective liquidity and the necessary liquidity on the basis of each maturity band shall be 1. The effective liquidity is determined by summing up the balance sheet assets and off-balance sheet received commitments, on each maturity band. The necessary liquidity is determined by summing up the balance sheet obligations and off-balance sheet given commitments, on each maturity band. If a surplus of liquidity has been registered in any of the maturity bands (except for the last one), this shall be added to the level of the effective liquidity afferent to the next maturity band.
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Progress test
1. 2. 3. 4. 5. 6. 7. 8. 9.
Define the banking risks. What is the financial risk? List at least three financilal risks and explain them. What is the interest rate risk? What is the liquidity risk? What is the foreign exchange risk? List the delivery risks. List the environmental risks. How does a bank manage all the risks?
10. What is the solvency? 11. What are the main prudential measures used by the National Bank of Romania? 12. What is the minimum level of capital of a bank? 13. How is the solvency ratio calculated? 14. List the debtors in special relations with the bank. 15. How does a bank establish its own funds?
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ANNEX No 1 Table No 1 Criteria of inclusion in the categories of classification of credits, for non-banking sector INITIATION OF JUDICIAL PROCEDURES DEBT SERVICE Maximum of 15 days 16 30 days 31 60 days 61 90 days minimum of 91 days JUDICIAL PROCEDURES HAVE BEEN INITIATED loss loss loss loss loss JUDICIAL PROCEDURES HAVE NOT BEEN INITIATED standard watch substandard doubtful loss
Table No 2 Criteria of inclusion in the classification categories of credits and investments, for the banking sector INITIATION OF JUDICIAL PROCEDURES DEBT SERVICE Maximum of 3 days 4 15 days 16 30 days minimum of 31 days HAVE INITIATED JUDICIAL PROCEDURES loss loss loss loss HAVE NOT INITIATED JUDICIAL PROCEDURES standard substandard doubtful loss
Table No 3 Provision co-efficient related to classification categories CLASSIFICATION CATEGORY Standard Watch Substandard Doubtful Loss CO-EFFICIENT 0 0.05 0.2 0.5 1
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ANNEX No 2 THE SITUATION regarding big exposures Banks denomination .............................................. Date of reference: [ / / ] - thousands lei Own funds (OF) 10% from own funds 20% from own funds 800% from own funds
Net exposure from from the the from the praised Total from the praised Total No off col. 3 = balance off col. 6 = crt. Code Denomination balance sheet balance col.1 + sheet balance col. 4 + assets sheet col. 2 assets sheet col.5 elements element s A B C 1 2 3 4 5 6 TOTAL:
One debtor
Gross exposure
% from the own funds col. 7 = col. 6 * 100/OF 7
Bank Manager, .................................................... (name, surname and signature) Manager of the financial-accounting department, ..................................................................................... (name, surname and signature) Made by: Name and surname: ...................................................... Telephone number / line:.................................................
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ANNEX No 3
THE STRUCTURE of groups which represent one debtor, towards which the bank registers big exposures Banks denomination .................................................... Date of reference: [ / / ]
Group of physical persons or legal entities No crt. 0 Code 1 Denomination 2
Physic persons or legal entities or legal entities from groups composition No crt. Code Denomination 3 4 5
Bank Manager, .................................................... (name, surname and signature) Manager of the financial-accounting department, ........................................................................................ (name, surname and signature)
Made by: Name and surname: ........................................................ Telephone number / line:.................................................
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ANNEX No 4 THE SITUATION regarding the net loans granted to the persons, which are in special relations with the bank, own personnel, as well as to its families Banks denomination ................................................... Date of reference: [ / / ]
Own funds (OP) 5% from own funds - thousands lei 20% from own funds
No. The group crt.
A B 1. Persons which are in special relations, provided by article 1 paragraph 2 letter n) items 5-12 2. Own personnel and its families
Gross exposure Net exposure from the from the Total Total from the praised from the praised col. 6 col. 3 = balance off balance off = col.1 sheet balance sheet balance col. 4 + assets sheet assets sheet + col. 2 elements elements col. 5 1 2 3 4 5 6
% from the own funds col. 7 = col. 6 * 100/OF
Bank Manager, .................................................... (name, surname and signature) Manager of the financial-accounting department, ..................................................................................... (name, surname and signature) Made by: Name and surname: ...................................................... Telephone number / line:.................................................
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ANNEX No 5
CRITERION of framing the assets in credit risk categories Credit Elements taken into account risk rate 0% 1. hard cash and values from gold, metals and jewels 0% 2. assets representing claims about or guaranteed in a deliberate way, irrevocably and unconditionally by or guaranteed with securities issued by the special central public administration of the Romanian state or by the National Bank of Romania 0% 3. assets representing claims about or guaranteed in a deliberate way, irrevocably and unconditionally by or guaranteed with securities issued by the central administrations, central banks of A category countries or European Communities 0% 4. assets representing claims about the central administrations or central banks of B category countries, expressed and financed in the national currency of the debtors 0% 5. assets representing claims guaranteed in a deliberate way, irrevocably and unconditionally by the central administrations or central banks of B category countries, expressed and financed in the national currency common to the guarantor and to the debtors 0% 6. assets guaranteed with collateral deposits sold to the bank itself or with deposit certificates or similar instruments issued by the bank itself and entrusted to this 0% 7. assets inferred from its own funds 20% 8. assets representing claims about or guaranteed in a deliberate way, irrevocably and unconditionally by or guaranteed with securities issued by banks with multilateral development or by the European Bank of Investments 20% 9. assets representing claims about or guaranteed in a deliberate way, irrevocably and unconditionally by the territorial administrations from Romania 20% 10. assets representing claims about or guaranteed in a deliberate
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20%
20%
20%
20% 50%
50% 100%
100% 100% 100%
100% 100%
way, irrevocably and unconditionally by the banks from Romania 11. assets representing claims about or guaranteed in a deliberate way, irrevocably and unconditionally by the local and regional administrations from the A category countries 12. assets representing claims about or guaranteed in a deliberate way, irrevocably and unconditionally by the banks from the A category countries 13. assets representing claims, with maturity of no more than 1 year, about or guaranteed in a deliberate way, irrevocably and unconditionally by the banks from the B category countries 14. elements that are about to be cashed (checks and other values) 15. credits granted for physical persons, guaranteed with mortgages in banks advantage, of values superior to the mortgages set up in other creditors advantage, towards lodgings that are or will be taken into possession by the debtor or which are let out on hire by this 16. receiving incomes 17. assets representing claims about the central administrations or central banks of B category countries, expressed and financed in the national currency of the debtors 18. asset representing claim towards local and regional administrations from the B category countries 19. assets representing claim, with maturity of more than 1 year, towards the banks from the B category countries 20. assets representing claims towards the non-banking sector from the A category countries or the B category countries from Romania 21. intangible assets 22. other assets
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ANNEX No 6
CRITERION of framing the off - balance sheet elements in risk categories transformation into credit Credit risk transformation into credit 100% 100% 100%
Off - balance sheet elements 1. pledges in other banks advantage 2. pledges in clientele advantage 3. securities sold with the possibility to repurchase, for which the option of redemption was firmly expressed 4. doubtful pledges 5. other given pledges 6. cautions, guarantees and other collateral given to other banks 7. guarantees given for clientele 8. securities sold with the possibility to repurchase, for which the option of redemption was not firmly expressed 9. securities given in warranty
100% 100% 50% 50% 50%
0%
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ANNEX No 7
BANKS SOLVENCY I. The structure of the assets from the balance sheet Banks denomination................................ Date of reference: [ / / ] - thousand lei Credit risk rate 0%
Amounts due to the credit Position risk rate 0%, code registere d in the accounts balances assets
Credit risk rate 20%

Amounts due to the credit risk rate 20%, Net registered amount in the s accounts col. 6 = balances col.4of the col. 5 rectified liabilities accounts
ASSETS
Amounts due to the Amounts credit risk due to the rate 0%, Net credit risk registered amount rate 20%, in the s registered accounts col.3= in the balances col.1accounts of the col. 2 balances rectified assets liabilities accounts
A TREASURY OPERATIONS AND INTERBANKING OPERATIONS - Cash and other values - Current account at the central banks - Accounts of banks correspondent - Deposits at banks - Credits granted to the banks - Values received - Values to be recovered
A01
A10 A20 A25 A101 A30 A40 A50
Business of Banking A - Outstanding debts - Doubtful debts - Attached debts CLIENTELE OPERATION'S - Credits granted to the clientele - Credits granted to the financial clientele - Values received - Debtor current accounts - Values to be recovered - Outstanding debts - Doubtful debts - Attached debts SECURITY OPERATIONS AND OTHER OPERATIONS - Securities received - Transaction securities - Investment securities - Investment securities - Discount accounts regarding security operations - Intra- banking discounts - Debtors - Supply accounts - Regulation accounts - Outstanding debts - Doubtful debts - Attached debts B A102 A70 A90 B01 B03 B80 B85 B99 B9J B102 B9K B9V C0A C1A C2A C3A C4A E6A E7A E123 E70 E8A E104 E90 E97 1 2 3 4 5 6
Business of Banking A FIXED ASSETS VALUES - Subordinated credits - Interest within the legal banking companies, participation securities and securities of the portfolio activity - Endowment for the own units from abroad - Fixed assets under way, fixed assets of the operations activity, fixed assets besides operation activity - Leasing and assimilated operations - Simple tenancy - Outstanding debts - Doubtful debts - Attached debts SHAREHOLDERS OR SOCIETIES TOTAL: B F01 F02 1 2 3 4 5 6
F10
F50
F6A
F7A F80 F102 F9A F97 LOC L98
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TABLE - SEQUEL Credit risk rate 50%
thousands lei
Credit risk rate 100%
ASSETS
Amounts due to the credit risk Position rate 50%, code registered in the accounts balances assets
Amounts Amounts Amounts due to the due to the due to credit credit risk the risk rate rate 50%, Net Net credit 100%, registered amounts risk rate registered amounts in the col.9= 100%, in the col. 3 = accounts col.8- registere accounts col.1balances of d in the balances col. 7 col. 2 the accounts of the rectified balances rectified liabilities assets liabilities accounts accounts
A TREASURY OPERATIONS AND INTERBANKIN G OPERATIONS - Cash and other values - Current account at the central banks - Accounts of banks correspondent - Deposits at banks - Credits granted to the banks - Values received......... - Values to be recovered - Doubtful debts - Attached debts
10
11
12
A01
A10 A20 A25 A101 A30 A40 A50
- Outstanding debts A102 A70 A90
Business of Banking A CLIENTELE OPERATION'S - Credits granted to the clientele - Credits granted to the financial clientele - Values received - Debtor current accounts - Values to be recovered - Doubtful debts - Attached debts SECURITY OPERATIONS AND OTHER OPERATIONS - Securities received - Transaction securities - Investment securities - Investment securities - Discount accounts regarding security operations - Intra- banking discounts - Debtors - Supply accounts - Regulation accounts - Outstanding debts - Doubtful debts - Attached debts B B01 B03 B80 B85 B99 B9J 7 8 9 10 11 12
- Outstanding debts B102 B9K B9V C0A
C1A C2A C3A C4A E6A E7A E123 E70 E8A E104 E90 E97
Business of Banking A FIXED ASSETS VALUES - Subordinated credits - Interest within the legal banking companies, participation securities and securities of the portfolio activity - Endowment for the own units from abroad - Fixed assets under way, fixed assets of the operations activity, fixed assets besides operation activity - Leasing and assimilated operations - Simple tenancy - Outstanding debts - Doubtful debts - Attached debts
SHAREHOLDERS OR SOCIETIES
B F01 F02
10
11
12
F10
F50
F6A
F7A F80 F102 F9A F97 LOC L98
TOTAL:
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Table sequel - thousands lei ASSETS A TREASURY OPERATIONS AND INTERBANKING OPERATIONS - Cash and other values - Current account at the central banks - Accounts of banks correspondent - Deposits at banks - Credits granted to the banks - Values received - Values to be recovered - Outstanding debts - Doubtful debts - Attached debts CLIENTELE OPERATION'S - Credits granted to the clientele - Credits granted to the financial clientele - Values received - Debtor current accounts - Values to be recovered - Outstanding debts - Doubtful debts - Attached debts
A
1
Position code B A01 A10 A20 A25 A101 A30 A40 A50 A102 A70 A90 B01 B03 B80 B85 B99 B9J B102 B9K B9V
B
Net presentation from the balance assets col.131 13
13
col. 13 = col. 3 * 0% + col. 6 * 20% + col. 9 * 50% + col. 12 * 100%
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SECURITY OPERATIONS AND OTHER OPERATIONS - Securities received - Transaction securities - Investment securities - Investment securities - Discount accounts regarding security operations - Intra- banking discounts - Debtors - Supply accounts - Regulation accounts - Outstanding debts - Doubtful debts - Attached debts FIXED ASSETS VALUES -Subordinated credits - Interest within the legal banking companies, participation securities and securities of the portfolio activity - Endowment for the own units from abroad - Fixed assets under way, fixed assets of the operations activity, fixed assets besides operation activity - Leasing and assimilated operations - Simple tenancy - Outstanding debts - Doubtful debts - Attached debts SHAREHOLDERS OR SOCIETIES TOTAL:
C0A
C1A C2A C3A C4A E6A E7A E123 E70 E8A E104 E90 E97
F01
F02 F10
F50
F6A
F7A F80 F102 F9A F97

LOC L98
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II. The structure of the off balance sheet elements:

Equivalent credit 0% Off balance sheet elements Position code Amounts due to the credit risk rate 0% Amounts due to the credit risk rate 20% Amounts due to the credit risk rate 50% Amounts due to the credit risk rate 100%
A - Pledges in other banks advantage - Pledges in the clientele favour - Surety, guarantees and other gradations given to other banks - Gradations given to clientele - Receiving securities - Given pledges - Doubtful pledges TOTAL
B N1B
N1R
N3B
N5A N8B2 P120 Q80 X
At this position the balance of the account 9219 Other receivable securities shall not be taken into consideration.
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Equivalent credit 50% Off balance sheet elements Position code Amounts due to the credit risk rate 0% Amounts due to the credit risk rate 20% Amounts due to the credit risk rate 50% Amounts due to the credit risk rate 100%
A - Pledges in other banks advantage - Pledges in the clientele favour - Surety, guarantees and other gradations given to other banks - Gradations given to clientele - Receiving securities - Given pledges - Doubtful pledges TOTAL
B N1B
N1R
N3B
N5A N8B2 P120 Q80 X
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Net exposure Amounts from the Amounts Amounts Amounts off Off balance due to the Position due to the due to the due to the sheet credit risk balance code credit risk credit risk credit risk sheet elements rate rate 0% rate 20% rate 50% 100% elements col.131 A B 9 10 11 12 13
Equivalent credit 100%
- Pledges in other banks advantage - Pledges in the clientele favour - Surety, guarantees and other gradations given to other banks Gradations given to clientele - Receiving securities - Given pledges - Doubtful pledges TOTAL
N1B N1R
N3B
N5A N8B2 P120 Q80 X
col. 13 = 0% * (col. 1 * 0% + col. 2 * 20% + col. 3 * 50% + col. 4 * 100%) + 50% * (col.5 * 0% + col. 6 * 20% + col. 7 * 50% + col. 8 * 100%) + 100% * (col. 9 * 0% + col. 10 * 20% + col. 11 * 50% + col. 12 * 100%) 2 At this position the balance of the account 9219 Other receivable securities shall not be taken into consideration.
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III. Calculation of the solvency indicators Own capital total (form Calculation of own funds, rd. 35, col. 3) col. 3) Total of net exposure from balance assets (form I, rd. TOTAL, 3 col. 13) Total from the net exposure from the off balance sheet elements 4 (form II, rd. TOTAL, col. 13) SOLVENCY INDICATORS (minimum 8%) rd. 5 = rd. 1 * 100 / (rd. 3 + rd. 4) SOLVENCY INDICATORS (minimum 12%) rd. 6 = rd. 2 * 100 / (rd. 3 + rd. 4) 6 5 1
Own funds calculation (form Calculation of own funds, rd. 44, 2
Bank Manager, .................................................... (name, surname and signature)
Manager of the financial-accounting department, ........................................................................................ (name, surname and signature)
Made by: Name and surname: ........................................................ Telephone number / line:.................................................
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ANNEX No. 8 THE CALCULATION OF THE OWN FUNDS Name of the bank ........................................... Date of reporting: [ / / ]
Elements taking into account A No.line Account Adjusted Adjusted value number value B 1 2 3
Paid-in social capital (account balance 5012) Premium related to capital (balance of the account 511) Legal reserves(acc.balance 512) General reserve for credit risk (account balance 514) Amounts recorded in the account Other reserves, Reserves from influences of foreign exchange related to the appreciation of availabilitys in hard currency representing the social capital in hard currency, in accordance with the Government Decision no. 252/1996 (account balance 519, analytical distinct) Amounts recorded in the account Other reserves representing premiums related with capital (balance account 519, analytical distinct) Amounts recorded in the account Other reserves distributed from the net profit (account balance 519, analytical distinct) of which: - ................................... - ................................... - ...................................
1 2 3 4
x x x x
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A Amounts recorded in the account Other reserves, analytical distinct Reserves from favourable differences from the revaluation of the patrimony (balance of the account 519, analytical distinct), of which: - ........................................... - ........................................... - ........................................... Amounts recorded in the account Tangible assets fund (balance of account 5281) Amounts recorded in the account Other funds, analytical Fund for increasing their own financing sources (balance of account 528, analytical distinct) Amounts legally recorded in the account Other funds, others than those included at line 9 and 10 (balance of account 528, analytical distinct), of which: - ........................................... - ........................................... - ........................................... Statutory reserves (balance of account 513) The reported result representing the undistributed profit (balance of account 581) Net result of the current financial exercise representing profit (current balance of account 591) Elements assimilated to the capital Total (line 1 to 15)
10
11
12 13
x x
14 15 16
x x x
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A Amounts recorded in the account Own shares representing the value of the own shares redeemed in the view of social capital reduction, in the conditions provided under the Article 53 letter b) of the Law no. 58/1998 (balance of account 30214) Expenses for constitution (balance of account 4412) The amortisation of the expenses for constitution (balance of account 46112) Not amortised value of the established expenses (line 18 - line 19) Commercial fund (balance of the account 4411 + balance of account 451) Amortisation of the commercial fund (balance of the account 46111 + balance of the account 4621) Provisions for depreciation of the commercial fund (extract balance of the account: 49221, 49231) Net value of the commercial fund (line 21 - line 22 -line 23) Dividends *) The participation at the profit of the personnel The participation quota of the manager in profit
*
17
18 19
x x
20
21
22
23 24 25 26 27
x x x x x
Shall be completed in accordance with the provisions of Art. 2 paragraph 2 letter d) of the presents norms, mentioning that for the date of 31 December shall not be recorded in the remake reporting form and resented by the banks in accordance with the Art. 7 of the present norms.
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A Distribution from net profit to funds Expenses to be distributed and expenses recorded in advance (balance of account: 374,375) The reported result representing the unsupported loss (debtor balance of account 581) Net result of the current exercise representing loss (debtor balance of account 591) Distribution of the profit (balance of account 592) Endowment for the own units from abroad (balance of account 421) Total deductible elements (line 17+ line 20+line 24 to 33) Total own capital (line 16 - line 34) Amounts recorded in the account Other reserve, others than those included at line 5, 6, 7 and 8 (balance of account 519) Amounts recorded in the accounts Subordinated debts on term and Subordinated debts with unlimited term (balance of accounts: 531, 532) Amounts recorded in the account Subvention for investment (balance of account 541) Amounts recorded in the account Revaluation differences (balance of account 516, analytical distinct), of which: -......................................... -......................................... -.........................................
B 28 29
2 x x
30
31 32 33 34 35 36
x x x x x x
37
Maximum 50% of line 35
38
39
Business of Banking
A Total additional capital col. 1 = col.1, line 36-39; col.3 = col.3, rd.36 to 39 (in the limit of max. 100% of col. 3, line 35) Amounts representing participation in legally commercial companies, participation securities and portfolio securities, hold with banks and companies with financial activities (balance of accounts: 4111, 4112, 4121, 4122, 413 +/balance of the acc. 414 balance of the acc: 418, 491 Amounts recorded in the accounts Subordinated credits on term and Subordinated credits on unlimited term, granted to other banks and companies with financial activities (Balance of accounts 401, 401, 481, 482 - balance of acc.499) Total deductible elements (line 41 + line 42) Total own funds
B 40
2
Maximum 100% of line 35
41
42
43 44
x x
Banks and Lending
BANKS AND LENDING
Objectives: 9.1 9.2 9.3 9.4 9.5 Introduction Analysing a new lending proposition Lending money Credit analysis Working capital analysis and financial projections
Banks and Lending
9.1 Introduction Lending money is one of the basic functions of a bank. It is the interest earned from banks that brings in most of the revenue to pay the expenses, including staff salaries of the bank and give a sufficient surplus to pay shareholders a dividend and retain funds in reserves accounts for expansion of the bank. For the Romanian banks, there are the following sources of funds: bank deposits (in Romania about 70%-90% of the volume of funds) divided in: *Short-term bank deposits expressed in domestic currency (ROL), or foreign currency; *Long term bank deposits expressed in domestic currency (ROL), or foreign currency; borrowed funds including: * Loans borrowed from other banks (in domestic or foreign currencies); *Refinance of the National Bank of Romania, which has the following forms1: structural credit; auction credit; special credit; credit granted with derogation from regulation; Lombard credit; preferential credit (frozen credit from 1993 to be reimbursed); own funds2 including: *Own capital (paid up capital; reserve fund, profit, other funds); *Supplementary capital (risk fund, other funds).
1
National Bank of Romania Regulation no. 1/2000 concerning the transactions on the monetary market realised by the NBR, issued in Monitorul Oficial al Romniei no. 142/2000. National Bank of Romania Norms no. 7/1999 concerning the own funds of banks, issued in Monitorul Oficial al Romniei no. 206/1999,
Banks and Lending
It should be remembered that the funds that are put out on loans belong to customers. It is their money that is put at risk, so that if a bank is continually making bad or unprofitable loans, this will sooner or later be reflected in the deposits. Before giving an advance, it is necessary for the manager to know the purpose of the loan. The lending officer may wonder whether the loan is for a legal purpose, or not. A loan means immediate possession of resources in exchange of a future payment promise involving also an interest payment that rewards the lender.3 Types of credit or loan Generally, banks have their specific lending policies, which may change from time to time due to the market conditions or government regulations. Their policies are essentially based on the evaluation of the related risks such as the credit risk, interest rate risk and concentrated risk. The lending may be also authorised at a branch level if the branch portfolio allows that. In order to make proper lending decisions, banks purposely observe a set of general lending principles such as age and state of health, stability, integrity and honesty, sources of income, regular expenditure, existing connections, ability to manage financial affairs as well as margin, purpose, amount, repayment capability and security. As corporations, companies, individuals or the government represent the category of bank customers; the types of loans vary accordingly and can be generally divided into country loans, business loans and personal loans. Country loans So, as to be able to achieve national political, social and economic goals, governments may need finance and, in this respect, the international financial institutions are expected to grant them a large variety of loans including apex, distressed, economic recovery, emergency reconstruction,
3
Basno Cezar, Dardac Nicolae, Floricel C.- Moned, Credit, Bnci Ed. Didactic i Pedagogic, Bucureti, 1994
Banks and Lending
sovereign, standby loans as well as balloon, call, carryover, equity, hard and soft loans, colons, indexed, outstanding, jeopardy, jumbo, non-accruing or non-performing loans, overage, participation and package loans, pipeline, pooled, premature, programme, project and sector loans, secured, quality, quick disbursing loans, senior, subsidiary, syndicated, time-slice, top-rated, revolving, working capital loans, sub-loans etc. Corporate lending As corporations and companies represent the major category of clients, for the corporate lending banks do analyse a set of basic and additional criteria such as the ability of continuing business, the expected future cash flows, security and collateral, the rate of return to the bank as well as the level of the whole business which the bank has done with them. The usual procedures which banks apply in the loan granting to corporate borrowers specifically include submission of the application and required information, evaluation of the information, initial evaluation of the proposed security, negotiation, approval, legal examination of the security, signing of the contract, disbursement of the amount and recovery of the capital and interest. The credit granted to companies, whether public or private, generally comprises loans for working capital and for fixed assets, financing such as overdrafts, term loans, syndicated loans, and revolving credit and working capital loans. Loans for Working Capital: Overdrafts Overdrafts are usually granted to those companies desirous to use the credit amount not as a whole but rather in accordance with their needs and for a certain period without having to pay interest on the entire amount but on the term agreed for interest calculation. In such cases, whenever the company gets excess of capital it can repay parts of the credit and, consequently, decrease the amount outstanding. Export Financing As most major companies deal with exports, banks can offer short time credit to exporters until they recoup the money from importers, upon a collectibles guarantee for the lending bank.
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Loans for Fixed Assets Financing Such loans essentially include short-term, medium-term and long-term loans with respect to maturity. The security for such a lending may be uncovered, covered by cash equivalent, by personal guarantees or mortgage assets, collateral and, according to the type of repayment, it may comprise equal capital amortisation, equal instalment payment, specific terms, fixed or floating interest etc. When loans in foreign currency are expected to be granted, banks usually tend to hedge their positions in the foreign currency but, very often, they rather speculate. Syndicated Loans Unlike the participation loans, the syndicated ones consist of an agreement specifying that two or more banks accept to directly lend to the same borrower or borrowers. In such a case, one of the banks plays the role of the agent bank while the others participate by own portions in the syndicate, the risks being shared by all of them. Retail Lending Besides the corporate lending, the personal lending is also an important activity of banks. Before credit is granted to individuals, the bank thoroughly analyses the income status of the applicant, the stability, the permanency of his or her cash inflows, guarantees by third parties as well as the existing collateral. The usual procedures in the lending to individuals include the receipt of the applications and required information, evaluation of the collectibles and collateral, decision on the loan amount, approval from the proper committee, legal evaluation and examination of the collateral, signing the contract and disbursement of the amount. Specifically, the retail lending includes the categories of consumer credit and house financing. The Consumer Credit Individual borrowers, including professionals, sole traders, partnerships, students and youth, clubs, associations and societies may be granted personal loans, including the following facilities: overdrafts, credit card, revolving credit, acceptance credits, hire purchase, conditional sale, credit sale, probate advances, instalment and non-instalment credit. Under such arrangements, the interest rate may be fixed, variable, obtained either at the sale point or at the bank.
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Personal Loans They are of a fixed amount, for a fixed period of time and at fixed interest rates and they are usually spent on the purchase of personal items, travels, holidays etc. These are rather similar to loan accounts, with regular payments, mentioning that the interest on the total loan is calculated before the advance is given, then once it has been accepted, the principal and interest are debited to the loan account and the customer repays the total sum by regular instalments. No security is required for a personal loan as most banks will incorporate some form of insurance, so that in the event of the customers death, there will be no charge to his dependants. Overdrafts Banks can grant overdrafts to individual customers at an agreed interest rate. Under such a facility, the borrower can take the needed amount for a particular desired period and does not have to pay interest on the entire amount. Thus, an overdraft occurs when a customer is permitted by the bank to have a debit balance on the current account, up to an agreed amount. Interest is charged at a given percentage above the base rate. Loan accounts Loans are another way of lending money. For this method a loan account is opened with a credit to the current account and a debit to the loan account. Repayments are usually by regular monthly debits to the current account and credit to the loan account. Interest is charged either quarterly or half yearly to current account or loan account at the option of the customer. This method is particularly useful where the customer wishes to make regular payments on the amount borrowed, while from the banks point of view the monitoring of a loan account is easier than an overdraft. Loans are often given to businesses for the purchase of fixed assets or to an individual for the purchase of customer durable goods. Credit Cards The facility of the credit card enables the customer to borrow up to certain limited amounts either at lending places or at points of sale and to withdraw cash from cash dispensers whenever he wants.
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Budget accounts This account is for those persons who find it difficult to monitor their expenditure. It is a form of borrowing and the interest is incorporated in the banks overall charges. Revolving Credit Under such an arrangement, customers disposing of such types of accounts are given the option of borrowing amounts up to a certain multiple of their deposit. Some banks offer the customer an arrangement in which he or she places a regular amount of money into this account and then has the facility to withdraw, without further authority, up to thirty times the regular credit. The House Financing Specifically, the amounts lent by banks for house financing represent a certain percentage of the house total value and the repayment period vary from 15 to 50 years. The interest rate is also variable and essentially is based on short-term and long-term rates determined as rollover mortgages. The repayment patterns of such loans include the following types: annuity mortgages with constant monthly instalments, endowment mortgages repaid at maturity upon a life assurance contract, only-interest mortgages for a certain period, gradually increasing payments and linear mortgages with equal capital repayments and decreasing interest. Credits actually represent the relation between two entities in which one entity has the money (creditor) and gives to the other entity (debtor) a certain sum of money that the latter has to return in an agreed time period and under certain conditions. Based on this, the credits in the Romanian business banking system are classified by the following characteristics4: 1) Depending on the maturity date: - short-term credits; - medium-term credits; - long-term credits. 2) Depending on the type of insurance: - non-insured credits; - insured credits.
4
Dr. Cirovic M.: Theory on Credits, Skoplje 1996
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3) Depending on the type of creditors: - banking credits; - commercial credits. 4) Depending on the type of debtors: agricultural credits; industrial credits; real estate credits; personal credits.
5) Depending on the type of destination: - consumer credits; - commercial credits; - industrial credits; - credits for starting up companies; - credits for operations with the papers of value, investment credits; - seasonal credits; - importing credits; - exporting credits; - construction loans; - small business loans. 6) Depending on the domicile of creditor: - domestic; - foreign. 7) Depending on the domicile of creditor. Fixed interest rate loans; Variable interest rate loans; Floating interest rate loans.
8) Revolving lines of credits etc.
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9.2 Analysing a new lending proposition There are five stages5 to any analysis of a new lending proposition: 1. Introduction of the customer; 2. The application by the customer; 3. Review of the application; 4. Evaluation; 5. Monitoring and control. Introduction Lenders do not have to do business with people they do not feel comfortable with. An important source of new business for most lenders is introductions from professional advisers such as accountants and solicitors. But, a bank is not obliged to lend to customers introduced in this way. The application (see Annex No. 1) can take many forms but should include a plan for repaying the loan and an assessment of the contingencies, which might reasonably arise, and how the borrower would intend to deal with them. It might be in detailed written form, or not. Review of the Applicaton During this stage all the information must be tested. It is sometimes difficult to remember all the points to be covered during an interview and many lenders use a check list (a mnemonics) including: character (about the individuals character); capital; capability/ability; purpose/destination; amount; repayment; terms; security/insurance.
Bankers lending techniques issued by the Chartered Institute of Bankers, London 1994.
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Ability - this aspect relates to the borrowers ability in managing financial affairs and is similar to character (about skill, experience of the manager). Purpose - The lender will want to verify that the purpose is acceptable (legal, moral etc.). Amount - Is the customer asking for either too much or too little? There are dangers in both and it is important therefore to establish that the amount requested is correct. The amount requested should be in proportion to the customers own reasons and contribution. Repayment - It is important that the source of repayment is made clear. Where the source of repayment is income, the lender will need projections to ensure that there is a surplus of funds to cover the repayment after meeting other commitments. Insurance - The canons of lending should be satisfied of available security. Evaluation - The aim of the evaluation is to establish the risk involved. Listing the pros and cons of a proposition is helpful. As a summarise, It should be mentioned that before any loan is granted, the following questions must be answered by the customer: how much is required? the purpose of the loan (legal, moral and within the policy of the government and the bank, National Bank of Romania); length of time the advance is requested? (how long the money is required and whether the outstanding debt will be repaid monthly, quarterly etc). the source of repayment - the answer to this question is important to the bank. Any customer must have sufficient resources to repay (capital + interest) the bank within the stipulated agreed time. The sources of the repayment could be from wages, dividends, an inheritance, profits and so on.
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9.3 Lending money Banks have as one of their basic functions lending money to both physical and juridical persons. The banks charge a certain interest rate on these loans, that represents the earnings used to pay expenses, such as salaries and wages of the workers, rents, other administrative expenses, give interest payments to those holding their money in deposits at the bank, pay shareholders dividends and also retain funds as reserves for the own expansion of the banks. Bank loans finance different groups in the economy. Manufacturers, distributors, service firms, farmers, builders, homebuyers, commercial real estate developers, consumers, and others all depend on bank credit. The ways in which banks allocate their funds can strongly influence the economic development of the community and nation. Every bank bears a degree of risk in its granting of credit, and, without exception, every bank experiences some loan losses when certain borrowers fail to repay their loans. Whatever the degree of risk taken, loan losses can be minimised through highly professional organisation and management of the lending function. The composition and quality of a banks loans should be reflected in its loan policy. The policy sets out the banks lending philosophy and specifies procedures and means of monitoring lending activity. A written loan policy should serve to obtain three results: - produce sound and collectible loans; - provide profitable investment of bank funds; - encourage extensions of credit that meet the legitimate needs of the banks market. A meaningful loan policy will express strategies in concrete terms. The desired loan mix should be quantified. The loan mix expresses the diversification sought by the bank in its loan placements. Diversification reduces the level of default risk that is associated with large concentrations of loans in a single category. The banks liquidity strategy should be indicated, because it acts as a constraint on lending activity and because liquidity is partly determined by the maturity structure of the loan portfolio. The desired size of the loan portfolio expresses the banks intended aggressiveness in expanding its loan portfolio. A highly aggressive loan policy has both a bright side and a dark
Banks and Lending
side. The bright side is that a large loan portfolio might increase bank earnings. The dark side is that an aggressive policy might lead to lower credit standards, marginal loans, and an unacceptable amount of risk. Most borrowers are exposed to risks that threaten their ability to repay their bank loans. Key-man life insurance is especially important to protect against loss if death or disability strikes the borrower or one of the borrowers indispensable employees. A catastrophic fire or flood may interrupt the borrowers business or destroy the loans collateral. The loan policy should indicate the types of borrowers who must be insured. The policy must designate the bank as the loss payee, or when the cash value of a life insurance policy is offered as protection, it must be properly assigned to the bank. An increasingly common form of protection is the credit life policy written by the bank. It is simply term life insurance written on consumer loan customers. It pays off outstanding balances due to the bank in the event of the customers death. A somewhat different form of protection is obtained through reinsurance. If the borrower defaults, reinsurance pays out and the insurance company pursues collection on its behalf on the banks defaulted note. Reinsurance premiums are rather costly, and policy should indicate what classes of borrowers, if any, should be under reinsurance programs. Most banks conduct loan reviews to reduce losses and monitor loan quality. Loan reviews consist of a periodic audit of the on-going performance of some or all of the active loans in a banks loan portfolio. Its essence is credit analysis, although, unlike the credit analysis conducted by the credit department as part of the loan approval process, credit analysis in loan review occurs after the loan is in the books. Other than its basic objective of reducing loan losses, some intermediate objectives of loan review are as follows: - to detect actual or potential problem loans as early as possible; - to provide incentive for loan officers to monitor loans and report deterioration in their own loans; - to enforce uniform documentation; - to ensure that loan policies, banking laws, and regulations are followed; - to inform management and the board about the overall condition of the loan portfolio; - to aid in establishing loan loss reserves.
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Whatever means are used to conduct loan reviews, the following points should be covered: - financial condition and repayment ability of borrower; - completeness of documentation; - consistency with loan policy; - perfection of security interest on collateral; - legal and regulatory compliance; - apparent profitability. When a problem loan is detected, the responsible officer should take immediate corrective action to prevent future deterioration and minimise potential loss. 9.4 Credit analysis Credit analysis is the process of assessing the risk of lending to a business or individual*. The so-called credit risk must be evaluated against the benefits that the bank expects to derive from making the loan. The direct benefits are simply the interest and fees earned on the loan and possibly, the deposit balances required as a condition of the loan. Indirect benefits consist of the initiation or maintenance of a relationship with the borrower that may provide the bank with increased deposits and demand for a variety of bank services. Credit risk assessment has both qualitative and quantitative dimensions; the former are generally the more difficult to assess. The steps in qualitative risk assessment are primarily gathering information on the borrowers record of financial responsibility, determining his or her true purpose for wanting to borrow funds, identifying the risks confronting the borrowers business under future industry and economic conditions, and estimating the degree of commitment the borrower will have regarding repayment. The quantitative dimension of credit risk assessment consists of the analysis of historical financial data and the projection of future financial results to evaluate the borrowers capacity for timely repayment of the loan and,
Source: Murray, Andrew Credit Analysis, Eastern Publishing Ltd., 1998
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indeed, the borrowers ability to survive possible industry and economic reverses. The essence of all credit analysis can be captured in four basic factors or lines of inquiry: - the borrowers character most bankers agree that the paramount factor in a successful loan is the honesty and goodwill of the borrower; - the use of loan funds determining the true need and use of funds requires good analytical skills in accounting and business finance; - primary source of repayment the analysts accounting and finance skills are crucial in determining the ability of the borrower to repay a loan from cash flows. He must ascertain the timing and sufficiency of these cash flows and evaluate the risks of cash flows falling short. - secondary source of repayment the collateral value should cover, in addition to the loan amount and interest due, the legal costs of foreclosure and interest during foreclosure proceeds. Even if the collateral is the preferred secondary source of repayment, others can be guarantors and co-makers, but in such cases, the collection usually requires expensive litigation and results in considerable ill will between the bank, borrower, and guarantor. In credit investigation, banks usually resort to the following sources of information: - customer interview it provides the most important information needed in credit investigation, including the type and amount of the loan required, sources and plans of repayment, eventual collateral and guarantors, previous and current creditors, primary customers and trade suppliers, accountants, main officers and shareholders etc. - internal sources credit files on any current or previous borrowings, checking account activity, other previous or current deposits, liabilities, income sources, assets, expenses and revenues etc. - external sources of information specialised service agencies, newspapers, magazines etc. Under the National Bank of Romanias regulation6 the principal and credit are defined as follows:
6
Regulation No. 2/2000 concerning the classification of credits and placements, issued in Monitorul Oficial al Romniei No. 316/2000
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a) The principal represents the amounts advanced by the bank to the debtors in the form of loaned capital, including also in this category when becomes due the banks obligations resulting from agreements to lend and to provide guarantees, as well as deposits placed at other banks; b) Credits The credit categories shall be classified depending on debt service and initiation of legal proceedings (e.g. credits granted to clients from the non-banking sector, credits granted to banks, credits granted to clients of the non-banking sector etc.). Before granting a credit/loan, a bank makes a trustworthiness analysis of the customers. The main trustworthiness ratios are: Indebtedness level Total liabilities total assets Current asset short term liabilities x 100
Immediate Liquidity
x 100
Solvency Ratio
Owners equity x 100 owners equity + liabilities net profit turnover Total revenues total expenses x 100
Profit margin Coverage of expenses with revenues
x 100
The main principles of granting credits are: - The banking prudence; - The creditworthiness of the borrowers; - The credits granted should be profitable both for the bank and for the borrowers;
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- The credits have a destination precise and mandatory which can not be changed by the borrowers; - Credits are granted under guarantees that are written the credit contract. The guarantees must cover the maximum amount of credit, amount consisting in the principal and interest. - The bank shall reserve the right to verify to its customers (borrowers) the permanent existence and the integrity of the ensured guarantees during the whole period of the credit. In the case in which the bank shall establish the non-observance of the contractual terms, it shall withdraw the credits before the maturity date; - During the validity of the credit, the beneficiaries of the credits have the obligation to deposit to the bank their balance sheet and the financial statement; - Under the provisions of the banking law, the loans granted to a single debtor, shall not exceed 20% of the capital and reserves of the bank. In order to receive the credit, the economic agents should accomplish the following conditions: to be recorded as a company, under the provisions of the law; to have the capital paid off; to carry out legal and efficient activities; to have good indicators; to have opportunities to re-imbursement at maturity both the credits and interests; to possess moral and materiel guarantees; to agree the contractual terms etc. 9.5 Working capital analysis and financial projections Historically, the major role of banks in commercial lending has been to finance non-permanent additions to working capital, defined simply as all current assets. Such additions enable the business to increase its cash balances and inventory in anticipation of seasonal bulges in sales and temporarily to extend larger amounts of credit to its customers as an aftereffect of such sales. Working capital loans are said to be self-liquidating because repayment occurs with an orderly reduction in inventories as sales rise, followed by reductions in receivables after collections are made on
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credit sales. The repayment of such loans is largely independent of longterm profitability and long-term cash flows. The measure known as net working capital, defined as current assets minus current liabilities, indicates the amount of a firms working capital that is financed by long-term or so-called permanent sources of funds. Net working capital is a good indicator of a firms liquidity because it identifies the part of a firms most liquid assets that is supported by reliable (long-term) funds; that is, it is the amount of current assets that is not subject to claims by holders of current liabilities. A corollary measure of liquidity is net liquid assets, which is a rough indication of the absolute currency amount of liquidity in the firm. Subtracting from current assets the amount invested in inventory and all current liabilities derives it. Inventory is subtracted because its liquidity is often suspected. Sources and uses of funds analysis decreases in assets and increase in liabilities constitute sources of funds, whereas increases in assets and decreases in liabilities are uses o funds. It can be used to make simple financial projections. More detailed projections are probably warranted in the form of cash budgets. The preparation of cash budgets requires projecting specific cash inflows and cash disbursements on a monthly or even more frequent basis. The cash budget more closely identifies the amounts and timing of specific draws against a credit line extended by a bank, or, alternatively, it identifies periods of excess cash in which short-term money market investments can be considered. In the final analysis of a loan, lenders must rely upon cash flow to repay loans. Cash flow from a firms operations, although not directly available, can be derived through adjustments to the firms balance sheet and income statement. Thus, it should be mentioned that the borrowers ability to repay a loan is mostly a matter of financial analysis. Historical financial analysis is twodimensional. Time series analysis is used to spot evolving financial strengths and weaknesses with the perspective of the passage of time. Crosssectional analysis permits the analyst to determine how effectively the
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borrower has performed in relation to other firms with like market opportunities and risks. Under the provisions of the Law No 58 the Banking law, the credit documents needed for the conclusion of the convention between the bank and a potential client (see Annex No. 2) are the following: Application form (see the Annex No. 1); Current financial situation of the applicant and of any of its guarantors, including the projected cash flows for the repayment of credit and principals; Description of the guarantees for the entire payment of the debt, and if necessary an analysis of the goods representing the guarantee; Description of the credit conditions containing the credit value, the interest rate, the repayment procedure, the scope for using the credit; Specimen of signature for each person that authorised the credit and the name of the bank; Annual Balance Sheet and Profit and Loss Account for the last three years of operation (plus annexes); Companys Overview; Description of the current activity/ financial info; The cash-flow statement for the entire loan period; Description of the credit conditions containing the credit value, the interest rate, the repayment procedure, the scope for using the credit; Specimen of signature of each person that authorised the credit and the name of the bank.
Banks and Lending
Progress Test
1. What is the meaning of loan? 2. What are the sources of funds used by the Romanian banks? 3. List and comment the five stages of the analysis of a new lending proposition. 4. List and comment 5 types of loans. 5. What are personal loans? 6. What is the revolving credit? 7. List all the types of loans classified by maturity, destination and pricing. 8. Describe lending money. 9. List the main ratios calculated by a bank in order to establish the trustworthiness. 10. List the elements of the application form. 11. List the main documents submitted by a customer to a bank in order to receive a loan.
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ANNEX No 1
CREDIT REQUEST Company: X SRL Represented by: Mr. X (authorised to sign)
WE REQUEST the following facility: Overdraft Loan Line for L/Gs, L/Cs In amount of: ___135,000_______Currency___ USD_ Multicurrency __ Object of facility: purchase of 400 sqm piece of land Validity: Reimbursement: at the end of the validity period Several instalments Securities proposed: Cash collateral Letter of guarantee Assignment of receivables _______________________________ _______________________________ _______________________________ from 31/08/00 to 30/11/00
Mortgage on land/buildings ________________________________ Pledge business assets/shares _______________________________
Please find attached the necessary documents for each type of security. The bank has the right to choose the securities for the credit facility.
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ANNEX No 2
LOAN AGREEMENT NO /31.07.200_ The Romanian Bank S.A. registered in the Register of Trade under no Branch hereby called the bank, represented by L. C. as general manager, and The company X SRL, registered in the Register of Trade under no.hereby called the borrower, represented by Mr. Y, as general manager, has agreed upon the following: 1. The bank grants the borrower a loan amounting USD 135,000, for 90 days, with an annual interest rate of 9.5%, in order to pay for a piece of land of 400 sqm, located in Bucharest. 2. The loan is granted through the account no. 3. Payment settlement is money transfer, as a general rule for all instalments, the possible cash payments being approved in the long run as the necessities require. 4. The loan is granted on a temporary basis, until stocks are constituted and expenses recorded, by direct discount of payment documents, in conformity with the approval ceilings the bank disposes of at the time. 5. During loan employment and collection, the bank is allowed to adjust the interest rate in accordance with the evolution of inflation and cost of financial resources. The new interest rate is to be applied to the loan balance of the date of changing. The borrower is to be informed within 5 days, in writing, with no other specification. In case that, after being notified, the borrower does not pay the rest of the principal and interest within less than 10 days since notification, the bank is entitled to consider the new interest level as accepted and payment of the newly computed amount (rest of principal and interest) as granted, with no other specifications. 6. The interest and fees for the loan granted are computed and paid monthly, beginning with a month after the loan is granted; cashing being performed directly by the bank, out of the borrowers direct account, based on statement of account. Interest computation period is since the 21st of the last month till the 20th of the current month.
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Computed interests that could not be cashed by the end of the month (on the last working day of the month) are to be recorded in the account Uncollected interest till 30 days. In case that these amounts cannot be cashed due to lack of cash of the borrower, they are to be transferred from the above-mentioned account to Uncollected interest longer than 30 days account. These amounts will be adjusted with a rate of 0.4 for every day of delay taking care that penalties will not amount more than the initial amount due. 7. Dates and amounts to be collected: DATE August, 30, 2000 September, 30, 2000 October, 30, 2000 TOTAL PRINCIPAL 45,000 45,000 45,000 135,000 INTEREST 1,068.75 712.5 356.25 2,137.5 TOTAL AMOUNT 46,068,75 45,712.5 45,356.25 137,137.5
8. The loan (principal and interest) is allowed to be pre-paid, partially or entirely. Any breach of the clauses of the present contract entitles the bank to cancel the loan, unconditionally, and to get payment from the borrower for the possible damages. In case that within 30 days since the date the bank is informed about the borrowers inability to pay the due amounts of principal and interest, the borrower is still not able to pay these amounts plus penalties, the whole principal and interest become eligible and the bank will proceed to liquidate, according to law, the guarantees, to cover the loss. 9. The borrower is committed to secure the loan concluding a collateral contract with the bank, specifying hereby the precise characteristics of pledged goods. According to the contract, the pledged goods remain in the borrowers possession, with a preferential claim of the bank in case of the borrowers default. 10. The bank has the right to check observance of the terms by which permanent availability and integrity of the pledged goods are insured, during the entire life of the loan.
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11. Alteration, degradation, improper maintenance or use of the pledged goods, as well as legal ascertainment of changes in their value, entitles the bank to cancel the unsecured loan before stated maturity. 12. The borrower is committed to: employ the loan only for the specified destination; pay the principal, interest and fees on their agreed upon maturities; observe banks regulation and to properly record all transactions concerning granting, employing and collecting the loan; submit its Balance Sheet to the bank; submit, on banks request, all documents revenues and expenses budget, Income Statement, as well as all documents concerning guarantees, goods or process employing borrowed money.
13. The bank is entitled to cancel the loan in case the borrower submits unreal data, beginning collection 5 days after notifying the borrower in writing. 14. The bank does not take political or natural disaster risks and is not responsible of the legal value (authenticity) of submitted documents. 15. Mutual bonds that are not specified in the present contract must observe credit rules as well as all banks regulation in force at the moment. 16. The borrower must declare other loan agreements with other banks, in force at present, together with the collateral backing up these loans. 17. Any litigation between the hereby-stated parts is to be solved in the Court. 18. The present contract has legal force and power of executor title. 19. The contract is concluded, today, July 31, 2000, in 4 copies, 3 remaining with the bank and one with the borrower.
The Romanian Bank SA General Manager, L. C
The Company X SRL General Manager, X
Glossary
THE BANKING SYSTEM IN ROMANIA (accounting) ledger = Cartea - mare; account = cont; ~ foreign exchange = devize n cont; ~ payable = cont creditor; ~ receivable = cont debitor; ~ settled = cont achitat; bank ~ = cont bancar; current ~ = cont curent; foreign exchange ~ = cont n devize; on ones ~ = pe cont propriu; personal ~ = cont personal; profit and loss ~(P&L- in UK) = cont de profit i pierdere; sales ~ = cont de vnzri (al agentului / comisionarului); sight ~ = depozit la vedere; statement of ~ = extras de cont; the running of an ~ = micarea contului; to keep open accounts = a ine contabilitatea / conturile; income and expenditure account = cont de venituri i cheltuieli; accountant = contabil; certified ~ = contabil autorizat; accounting = contabilitate;
Glossary
applicant = solicitant, petiionar; assets = bunuri; active; audit = verificarea conturilor de ctre o societate specializat; activitate desfurat de o persoan specializat numit auditor; auditing commission = comisia de cenzori; balance = sold; bank ~ = sold bancar; credit ~ = sold creditor; debit ~ = sold debitor; balance of payments = balan de pli; balance of trade = balan comercial; balance sheet = bilan contabil; bank = banc; ~ deposit = depozit bancar; ~ loan = mprumut bancar; agricultural ~ = banc agricol specializat n acordarea de credite pentru dezvoltarea agriculturii; central ~ = banc care realizeaz politica economic a guvernului; clearing ~ = banc de compensare, n acest caz, banca este membr a unei case de compensaie, specializat n decontarea cecurilor; commercial ~ = banc comercial specializat n constituirea de depozite, efectuarea de transferuri de fonduri; poate s fie o societate pe aciuni sau o banc particular; discounting ~ = banc specializat n scontarea cambiilor; Federal Reserve Bank = Banca Central a Statelor Unite ale Americii; Industrial ~ = o banc care face parte dintr-un grup de case mici financiare, care primete investiii de la persoane fizice; issuing ~ = instituie financiar care gestioneaz o nou emisiune de aciuni; joint-stock ~ = banc constituit ca societate pe aciuni;
Glossary
merchant ~ = banc de afaceri, este o instituie specializat n efectuarea operaiunilor n domeniul industrial i al business-ului. banking = activitate bancar; banking Directives = Directive bancare emise de Uniunea Europeana; bankruptcy = faliment, incapacitate de plat; bankers bank = funcie a unei Bnci Centrale banc a bancilor; banc care refinaneaz sistemul bancar; banks own capital = capitalul propriu al bncii; BIS = Bank for International Settlements = Banca Internaional a Reglementelor; bill = titlu, bon; Bill of Exchange = bank draft = cambie; Board of directors = Consiliu de administraie; ~meeting = edina Consiliului de administraie; bond = (aici) obligaiune; book - keeping = contabilitate; double-entry ~ = contabilitate n dubl partid; borrow (to) = a mprumuta; borrowed reserves = rezerve atrase; rezerve mprumutate; branch = sucursala unei banci; building society = societate ipotecar; n UK este o instituie financiar care ofer ipoteci, fondurile acesteia provenind din depozitele constituite de publicul larg; capital = n sens larg, avuie acumulat;
Glossary
(aici) se refer, n special, la resursele unei persoane fizice, ale unei organizaii, ale unei bnci; capital market = piaa de capital; capital structure = structura capitalului; capital assets = fixed assets = fonduri fixe; cash = bani lichizi, numerar format din bancnote i monede; cash flow = flux de numerar; ceiling of gold = plafon pentru aur; Central Bank = Banca Central; charge = tax; chart of accounts = planul de conturi; chattel = bunuri mobile; claim = (aici) crean; commission = comision; commitment fee = comision de angajare; credit co-operative = credit union = cooperativ de credit; credit institution = instituie de credit; creditor = creditor, persoan care deine creane bneti asupra altor entiti; currency = bancnote i monede folosite ca moned naional a unei ri; foreign ~ = valut; convertible ~ = valut convertibil; hard ~ = valut forte;
Glossary
reserve ~ = valut deinut de Banca Central; currency position = poziie valutar. dead line = termen limit; debentures = titluri de credit; titluri de valoare emise de societi cu rspundere limitat n schimbul unor mprumuturi pe termen lung; debt = datorie, obligaie; bad ~ = datorie care nu a fost i nici nu se sper a fi achitat; National Debt = datoria guvernului; debtor = debitor o persoan sau o socieate comercial care datoreaz bani, bunuri sau servicii unei alte persoane; deficit = depirea veniturilor de ctre cheltuieli sau a activelor de ctre pasive; buget ~ = un buget neechilibrat cauzat de cheltuielile mai mari dect veniturile; trade ~ = o balan de pli neechilibrat n care exporturile au fost depite de exporturi; deposit = depozit; discount = scontare; ~ house = cas de scontare; ~ market = piaa scontului; ~ rate = rata scontului. Early Warning and Rating System = sistem de avertizare timpurie i de stabilire a rating-ului de ar; electronic banking = activitate bancar derulat electronic; endowment capital = capital de dotare; European Bank for Reconstruction and Development (EBRD) = Banca European pentru Reconstrucie i Dezvoltare (BERD);
Glossary
European Community (EC) = Comunitatea European (EU); European Central Bank (ECB) = Banca Central European; European Union (EU) = Uniunea European; exchange = schimb, pia; exchange control = control valutar; exchange rate = curs de schimb; fixed ~ = curs de schimb fix; floating ~ = curs de schimb fluctuant; managed floating ~ = curs de schimb cu fluctuare dirijat; managed ~ = curs de schimb controlat; flexible ~ = curs de schimb flexibil; pegged ~ = curs de schimb legat; crawling ped ~ = curs de schimb trtor sau cu paritate glisant; spot ~ = curs de schimb la vedere; forward ~ = curs de schimb la termen; external assets and liabilities = active i pasive externe; field of activity = domeniu de activitate; financial leasing = leasing financiar; fiscal year = an fiscal; foreign assets = active externe; foreign liabilities = pasive externe; foreign currency/foreign exchange currency = valut; General Meeting of the Shareholders = Adunarea general a acionarilor;
Glossary
gross profit = profit brut; headquarter premises = cldirea sediului central; in bail = n custodie; international foreign reserves = rezerve internaionale; International Monetary Fund (IMF) = Fondul Monetar Internaional (FMI); issue guarantees (to) = a emite scrisori de garanie bancar; joint-stock company = societate pe aciuni; lender of last resort = creditor de ultim instan; legal entity = legal person = persoan juridic; legal tender = national currency = moned naional; legal framework = cadru legal; liability = obligaie, datorie, pasiv; majority state-owned capital = cu capital integral de stat; majority private capital = cu capital integral particular; majority domestic capital = cu capital integral intern (autohton); majority foreign capital = cu capital integral strin; management of foreign exchange reserves = administrarea rezervelor externe; maturity = tenor = maturitate, scaden; maximal exposure = expunere maxim; merger = fuziune;
Glossary
minimum compulsory reserves = rezerve minime obligatorii; monetary survey = situaie monetar; monetary, foreign exchange, credit and payments policy = politic monetar, valutar, de credit i pli; money issue = emisiune bneasc; money circulation = circulaia banilor; money market = piat monetar; money supply = broad money = mas monetar; bani n sens larg; mortgage = ipotec; net foreign position = poziia net extern; off - balance sheet = n afara bilanului; open an account with (to) = a deschide un cont la; own capital = capital propriu; pledge = (aici) gaj, zlog, amanet; promissory notes drawn or endorsed = bilete la ordin trase sau andosate; rate of interest = rata dobnzii pltit pentru atragerea capitalului utilizat ntr-o afacere; central bank discount ~ = rata de scont a Bncii Centrale; accrued ~ = plata unei dobnzi datorate, dar care nu a fost primit; bank ~ = rat oficial a dobnzii stabilit de Bncile Centrale; termenul nu se mai folosete n U.K. fiind nlocuit cu minimum lending rate; rate of return = rata profitului;
Glossary
real estate assets = active imobiliare; rediscount = rescontare; refinance (to) = a refinana; reserve tranche = tran de rezerv; retail banking = activitate bancar cu amnuntul; revenue and expenditure budget = bugetul de venituri i cheltuieli; savings (s.) = (aici) economie (de bani); savings banks = bnci de economii/case de economii; security = (aici) efect de comer, titlu de valoare; settlement = (aici) decontare; shareholder = acionar; solvency = solvabilitate; special drawing rights (SDR) holding = deinere de drepturi speciale de tragere (DST); stock = aciune (aici), stoc; stock exchange = burs de valori; subsidiary = filial; reserve fund = fond de rezerv; conclude an agreement (to) = a ncheia un acord; grant a credit (to) = a acorda un credit;
Glossary
grant interest (to) = a bonifica dobnd; issue banknote and coins (to) = a pune n circulaie bancnote i monede de metal; lend to the banking companies (to) = refinance the banking system (to) = a acorda mprumuturi bncilor / a refinana; open and keep an account (to) = a deschide i a menine un cont; redeemable = recuperabil; render (to) = provide banking services (to)= a acorda/ a presta servicii bancare; two tier levels = pe dou nivele; Treasury = Trezorerie, departamentul economic i financiar central al unui guvern; vault cash = ghieu de casierie; warehouse receipt = recipis / chitan warrant; warrant = warrant; weight (to) = (aici) a pondera; withdraw (to) = a retrage bani.
THE BANKING SYSTEM IN ENGLAND

accountants department = departamentul de contabilitate; bankrupt = faliment; buying rate = curs de cumprare;
Glossary
charter/law/act = act de constituire a unei instituii sau organizaii economice, lege; coinage = batere de monede; currency issue = emisiune monetar; discount = discounting = scontare; discount houses = casa de scontare; discount market = pia a scontului; discount rate = tax a scontului; fiduciary issue = note issue = emisiune fiduciar de bancnote; foreign exchange market = pia valutar; foreign exchange rate = curs de schimb valutar; Governments bank = banca guvernului; hub = centru de activitate / de interes; joint - stock banking company = societate bancar pe aciuni; lender of the last resort = creditor de ultim instan; lending institutions = instituii care acord mprumuturi; instituii de mprumut; merchants bank = banc de afaceri; money market = piaa monetar; mutual fund = fond mutual; overdraft = descoperit n cont; sold debitor; sum tras din cont fr acoperire.
Glossary
rate of interest = rata dobnzii; selling rate = curs de vnzare; subsidiary = filiala unei banci; borrow (to) = a da cu mprumut; draw a cheque (to) = a trage un cec; lend, lent, lent (to) = a lua cu mprumut; National Debt = datoria guvernului; retail bank = activitate bancar cu amnuntul; Treasury = Trezorerie (n SUA: Ministerul Finanelor); Treasury bills = bilete de trezorerie; trust bank = banc de custodie; turnover = cifr de afaceri;
OTHER BANKING SYSTEM IN THE WORLD

chairman = preedinte; Board of Governors = consiliul guvernatorilor; money supply = mas monetar discount rate = taxa scontului; savings banks = bnci de economii; vault cash = numerar n casierie; pension and retirement funds = fonduri de pensie;
Glossary
failure = eec, faliment; Federal Deposit Insurance Corporation = FDIC = Fondul federal de asigurare al depozitelor; merge (to) = a fuziona; Federal Reserves = Fed = este o agenie independent, creat n 1913, care supervizeaz i verific bncile de stat care fac parte din Sistemul Federal Reserve; European System of Central Banks = ESCB = Sistemul European al Bncilor Centrale; European Central Bank = ECB = Banca Central European; minimum reserves = rezerve minime obligatorii;
MONEY SERVICES
advise = sfat, informaie; (aici) aviz; Airmail Transfer = transfer prin pota aerian; application form = formular de cerere; at sight/at presentation = la vedere/la prezentare; available funds = fonduri disponibile; Bankers draft = polia bancherului; banking clerk = funcionar bancar; banknotes = bancnote; bearer = purttor;
Glossary
bearer bonds = titluri la purttor; blank endorsement = andosare n alb; by air = pe calea aerului; by cable = telegrafic; by endorsement = prin andosare; by ordinary trasfer of debts = prin simplul transfer al creanelor; cash = numerar, bani lichizi; cashier = casier; certificate cheque = cec certificat; cheque = cec; cheque payable to bearer = cec la purttor; client = customer = client; coins = monede; collect (to) = a ncasa; collection process = procesul de ncasare; compulsory mentions = meniuni obligatorii; cross = barare; crossed cheque = cec barat; drawee = tras; drawee bank = banca trasului, n acest caz banca pltitoare; drawer = trgtor;
Glossary
duties = ndatoriri; sarcini; endorse (to) = a andosa; endorsement = andosare; endorser = persoan care efectueaz andosarea; exchange risk = risc valutar; expenses = cheltuieli; general cross = barare general; give instructions (to)= a da instruciuni; holder = deintor; input messages = mesaje de intrare; interest charges = cheltuieli cu dobnd; interest incomes = venituri din dobnzi; International Money Order = mandat de plat internaional; International Payment Order = ordin de plat internaional; not to order = nu la ordin; notify and pay (to)= a notifica i a plti; order form = formular de ordin; output messages = mesaje de ieire; overseas bank = banc cu sediul n strintate; owner = proprietar;
Glossary
passbook = carnet de cec; payee = beneficiary = beneficiarul unei pli; paying bank = banca pltitorului; payment by cheque = plat prin cec; payment in cash = plat cu numerar sau n bani lichizi; postal orders = mandat potal; proceeds = venituri; remit funds aboard = a remite fonduri n strintate; remittance by post = remitere prin pot; remittance telegraphically = remitere telegrafic; remitter = remitent; securities = titluri de valoare; simple remittance = remitere simpl; special cross = barare special; special endorsement = andosare special; specimen signatures = specimen de semnturi; Standing order = ordine de plat permanente; Telegraphic transfer (TT)= transfer telegrafic; be valid (to) = a fi valabil; travellers cheque = cec de cltorie;
Glossary
ELECTRONIC BANKING SERVICES

debit cards = cri de debit; Electronic banking services = servicii bancare electronice, adic servicii efectuate prin calculator; electronic cash = numerar electronic; electronic cheque = cec electronic; electronic money = moned electronic, bani electronici; electronic signature = semntur electronic; fraud = fraud; network = reea; ~ transmission = reea de transmisie; password = parol; PIN = Personal Identification Number = numr personal de identificare; POS = Point of Sale Terminal = locul vnzrii; record (to) = a nregistra; user = utilizator; telephone banking = banc la domiciliu.
OTHER ELECTRONIC BANKING SERVICES

Electronic Funds Transfer = EFT = Transfer Electronic de Fonduri; money transfer = transfer de bani; Automated Teller Machine = ATM = ghieu automat de numerar;
Glossary
EFT-POS = Electronic Funds Transfer to the Selling Points Terminals = transferul electronic al fondurilor la locul vnzrii; credit cards = cri de credit; store cards = carduri de magazin; debit cards = cri de debit; retailer = detailist; magnetic strip = band magnetic; cash dispensing = distribuitor de numerar; balance inquiry = solicitarea soldului contului; POS = Point of sale = punct de vnzare; keyboard = tastatur; Joint-stock banks = bnci pe aciuni Money market = pia monetar.
BANKER - CUSTOMER RELATIONSHIP

accountant = contabil; Act/charter/law = lege; adequate level of solvency = nivelul adecvat al solvabilitii; application to open an account = cerere pentru a deschide un cont; banker/bank = banc; Banker-customer relationship = relaia dintre banc i client; banking procedures = proceduri bancare;
Glossary
building societies = societi de construcii; creditor = creditor; current savings deposit = depozit curent de economii; customer/client = client; deal (to) = (a face o) tranzacie (cu); debtor = debitor; deputy = (aici) delegat; adjunct; disbursement = plat, achitare; duties and rights = obligaiuni i drepturi; forgery = fraud; insurance company = societate de asigurri; legal person = persoan juridic; lend (to )= a mprumuta (pe); license/authorisation = licen / autorizaie; licensed deposit taking institutions = instituii acreditate s constituie/primeasc depozite; mortgage = ipotec; natural person = persoan fizic; overdrawn = fr acoperire; proceeds = venituri; recognised banks = bnci acreditate;
Glossary
sealed = sigilat; sight interest = dobnda la vedere; solicitor = avocat; theft = furt; be entitled to (to) = a fi mputernicit (s); be supplied with (to) = a fi alimentat cu; complete/conclude a contract (to) = a ncheia un contract; finish/terminate/cancell a contract (to) = a rezilia un contract; mortgage (to) = a ipoteca; open an account with (to) = a deschide un cont; pass on (to) = a statua; vest somebody to do something (to) = a investi pe cineva s fac ceva; Trustee Savings Bank = bnci de ncredere specializate n deinerea economiilor (un fel de CEC);
RISKS MANAGEMENT
credit institution = instituie de credit; risks management = administrarea riscurilor; financial risks = riscuri financiare; foreign exchange risk = risc valutar; liquidity risk = risc de lichiditate;
Glossary
interest rate risk = riscul ratei dobnzii; operational risk = risc operaional; own funds = fonduri proprii; commitments = angajamente; solvency = solvabilitate; banking rating system and the early warning system = sistem de avertizare timpurie i de stabilire a rating-ului de ar; level of large exposures = nivelul expunerilor mari; minimum level of the capital = nivelul minim al capitalului; administrative procedures = proceduri administrative; internal control procedures = proceduri de control intern; classification of credits = clasificarea creditelor; large loans = mprumuturi mari; loans granted to the debtors in special relations with a bank = mprumuturi acordate debitorilor care se afl n relaii speciale cu banca; liquidity = lichiditate; debt service = serviciul datoriei; doubtful credit = credit ndoielnic; interest rate risk = riscul ratei dobnzii; off balance sheet items = elemente n afara bilanului contabil; prudential measures = msuri de prudenialitate;
Glossary
credit risk = riscul de credit; watch credit = credit n observaie; doubtful credit = credit ndoielnic; loss credit = credit de pierdere; shareholder = acionar; own capital = capital propriu; grant a credit (to) = a acorda un credit; financial-accounting department = departamentul financiar-contabil; assets = active;
BANKS AND LENDING

accountant = contabil; auction credit =credit de licitaie; borrowed funds = fonduri atrase (mprumutate); capability = ability = capacitate; abilitate; currency risk = riscul de schimb valutar; fixed interest rate loan = mprumut cu rata dobnzii fix; floating interest rate loan = mprumut cu rata dobnzii flotanta; legal person = persoan juridic; lending = mprumut;
Glossary
lending facilities = faciliti legate de acordarea mprumutului; liabilities = pasive; liquidity risk = riscul de lichiditate; Lombard credit = credit lombard; loss = pierdere; market risk = riscul pieei; minimum capital = capital minim; operational risk = riscul operaional. own capital = capital propriu; paid up capital = capital vrsat; physical person = persoan fizic; preferential credit = credit preferenial; purpose = destination = scop / destinaie; repayment = plat; solicitor = avocat; (amer. procuror); solvency ratio = rata solvabilitii; special credit = credit special; standard credit = credit standard; structural credit = credit structural; substandard credit = credit substandard;
Glossary
supplementary capital = capital suplimentar; weight (to) = a pondera; variable interest rate loan = mprumut cu rata dobnzii variabil; watch credit = (aici) credit n observare
Bibliography
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Business of Banking (Volumul I)

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Business of Banking (Volumul I)

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FOREWORD

Ligia GeorgescuGolooiu March 2002

Professor Gabriela Anghelache PhD in Finance Chief of Money Department

The Banking System in Romania

THE BANKING SYSTEM IN ROMANIA

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

Source: the National Bank of Romania Annual Report per 2000

The Banking System in Romania

Banks operating in Romania, by the type of the capital

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

Open accounts in ROL and in foreign currencies;

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The National Bank of Romania Annual Report per 1998-2000

The Banking System in Romania

The Banking System in Romania

Specific regulations in line with European standards on:

The Banking System in Romania

Increased rigorousness in bank licensing and supervision by: -

3. Smooth-functioning of the Bank Deposit Guarantee Fund.

The Banking System in Romania

The Banking System in Romania

IMF Money and Financial Statistics Manual, Washington, 2000

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

The Banking System in Romania

33 Under its law, the National Bank of Romania is responsible for:

a maintaining compulsory reserves in accordance with applicable regulations;

The Banking System in Romania

The Banking System in Romania

ANNEX No 1 BANKS OPERATING IN ROMANIA

1991 1991 1994

Alpha Bank Romnia

The Banking System in Romania

Subject to special settlement regime of interbank operations

The Banking System in Romania

2000 2000 1991

Branch Branch Branch Branch

1987 1979 1996 1996

Source: National Bank of Romania Annual Report 2000

Organization Chart of the NATIONAL BANK OF ROMANIA as of 31 December 2000