Banking Definition And the System

Published: 2021-05-03
Views: 571
Author: Contributor
Published in: Banking

Among the well-known banking definition is considered to be a type of financial institution that handles deposits, advances, and other financial services.

It collects funds in the form of deposits to those that want to save and loans money for those that need it.

Features of a bank

The characteristics of a bank include, but not limited to:

• Acceptance of deposit 
• Payments and withdrawals, 
• Banking activities 
• Company and utility services
• Provision of loans

Fundamentals of a stable banking system

The following are some of the fundamentals of a stable banking system:

The secret of effective banking is to allocate capital among different types of assets in such a way as to strike a balance between profitability and liquidity.

This will enable cash circulation to meet any claim, and at the same time enough income for the bank to pay its way and earn profits for its shareholders.

However, modern bankers still consider a few other important factors which include:

Security

Another important aspect of a sound banking system is its security. Since the bank holds people's deposits, it must ensure that their money is secure.

As a result, it should make risk-free loans and investments while avoiding unnecessary dangers.

The bank will become insolvent if its debtors do not repay the loans on time and the bank loses money on its assets.

Consequently, the bank's depositors lose money and face difficulties as the bank must ensure that its deposits are secure.

Elasticity 

The flexibility of banking operations, on the other hand, should not be mistaken for rigidity.

Rather, the banking system's lending activities should be flexible enough. It should be able to easily extend and contract the supply of loanable funds in compliance with the country's central bank's directives.

Profitability

A healthy banking system should be able to make enough money.

Profits are needed for the business to be viable. It must pay corporation tax, pay interest to depositors, distribute dividends to shareholders, pay wages to employees, and meet other expenses, just like every other company.

It must follow prudent loan and investment strategies to achieve this, unless the bank raises money, it will be unable to function properly.

Liquidity

Liquidity is one of the most important aspects of a healthy financial system. Only a small portion of the bank's assets are held in cash. 

Other assets must meet the liquidity requirement in order to be easily converted into such.

A commercial bank is required to pay cash to its depositors on demand. This is only possible if the bank has shares that can be liquidated quickly.

To ensure liquidity, central banks have made it mandatory for commercial banks to hold a certain percentage of their reserves in cash.

Stability

A sound banking system must be able to maintain its stability. It should work in a logical manner.

There should be no excessive credit contraction or growth. The interests of the business community would be harmed if the bank restricts the production of credit when it is most needed by trade and industry.

However, if credit is expanded when economic conditions do not permit it, it will result in a boom and inflation.

The banking system should maintain a consistent lending strategy. A prudent credit management policy by the country's central bank will assist in achieving stability in commercial banks' banking operations.

Expansion

A sound banking structure needs to be implemented throughout the world.

It should be concentrated not only in large cities and towns but also in rural areas and underdeveloped areas.

Deposits will only be mobilized and credit facilities made available to trade, manufacturing, agriculture, and other sectors if the banking system is widely expanded.

This is particularly true in a developing world, where the banking system must expand in all areas to provide these services.

This is essential for the formation of capital and the expansion of the economy.

Reserve Management

The concept of effective reserve management must be followed by a sound banking system. In the event of an emergency, a bank retains a certain amount of money in the reserve to satisfy customer demand.

Despite the fact that the money in reserve is idle, the bank cannot afford to take the risk of keeping a small sum in reserve.

Functions of Central Bank in Reserve Management

The central bank has certain constitutional limits in terms of maintaining minimum reserves with itself and with the bank.

However, the amount of reserve money a bank can keep is determined by its own intelligence, experience, and scale.

Without holding too much or too little currency, the bank should manage its reserve policy in an efficient and effective manner. It must strike a balance between benefit and protection.

In any economy, banks play a crucial role.

They run the payment system, provide credit to large sections of the economy, and mainly serve as a safe haven for depositors' money.

By converting comparatively small liquid deposits into larger assets, the financial system assists in allocating money from those with surplus who are the depositors to those in deficit who are the borrowers.