Principles and Practices of Banking

BBA 6th Semester (Finance)

Department of Business Administration
Premier University

Chapter 1
Introduction to Banking
[Definition & Functions]
 Introduction

Bank is a business organization. Like all other business institutions, banks’ major
objective is also to earn profit. It is mentionable that banks do not sell ready goods like
other producers. But definitely, a bank is a service-selling institution. The service of
bank is considered as its product. So, many people say that a bank is that kind of
business institution whose profit earning will be impossible by selling more if its
products’ virtual quality is not ensured.

Assoc. Prof. Rajib Datta, Finance, PUC 2

 Differences Between Bank and Banking
A bank is one kind of financial institution which deals with money and other monetary instruments
and conducts business. Bank receives deposits from one group of people and lends it to other groups
of people. By this process, the bank earns a profit.

 Origin: Entrepreneurs are the father of bank.

 Definition: Bank is a financial institution which receives a deposit from a group of
people and lends it to other groups of people.
 Purpose: The success of a bank depends on the efficient banking system.
 Success: The success of an efficient banking system.
 Legal: As the bank is created from a law it has a legal entity.
 Liability: Banks are liable to their customers for their functions.
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Assoc. Prof. Rajib Datta, Finance, PUC

 Differences Between Bank and Banking
Generally, it is said that what a bank does is banking. A bank is an institution and banking is the activities of that
institution. For example- collecting deposit; discounting of bills, draft, making pay order, money transfer, giving
aid to business etc. The Oxford Dictionary: “Banking is the business of a banker and the keeping or management
of a Bank.”

 Origin: Bank is the father of banking.

 Definition: Banking means the activities undertaken by banks which include personal banking and
commercial banking and corporate banking.
 Purpose: The purpose of banking is to help the bank to perform its task.
 Success: The success of banking depends on the banker’s efficiency in planning and management.
 Legal: It has no specific law under which the functions of banking are performed.
 Liability: The liabilities of banking functions are on the owner of a bank. 4

Assoc. Prof. Rajib Datta, Finance, PUC

 What is Meant by Bank

Bank is a financial institution that collects society’s surplus cash and gives a
part of that as loan to investors for earning profit. So, bank is an
intermediary institution that makes relationship between the owner of
surplus savings and the investor of deficit capital. In this process, banks earn
profit by receiving interest from the borrowers who want to take short term
and long term loans and making relatively lower interest payment to the
depositors for providing their funds for use by the bank.
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 Some widely accepted definitions of banks are given below:

A) Bank is an institution that is registered by central bank and mainly perform the

following activities –
1. Receives current deposit and give the withdrawal facilities to clients through cheque
2. Receives term deposit and pay interest on it
3. Discounting notes, approving loans, and invest in government and other credit instruments
4. Collect cheque, draft and note, etc.
5. Issue draft and cashier’s cheque
6. Notification of depositors’ cheque
7. Act as a trustee in accordance with government permission
- Dictionary of Banking & Finance
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B) A commercial bank is a trader of substitute currencies such as currency, cheque
and bill of exchange.
-New Encyclopedia Britannica.
C) A bank provides service activity and acts as an intermediary between creditor
and lender. In a broader sense, it is said that bank is the heart of complex financial
structure.
-American Institute of Bankers.
D) A banker is one, who in the ordinary course of his business, receives money
which he repays by honouring checks of person from whom or on whose account
he receives it.
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Assoc. Prof. Rajib Datta, Finance, PUC -Professor Hart.
 Banking System Around the World
In the prevailing world, commercial bank management systems are more or less similar in
principle. Dissimilarities exist in the scope of commercial banking activities in different
countries. Communist countries’ commercial banking system are completely different.
Capitalist countries differ in respect of the free market economic banking activities. From
this perspective, we can divide the major commercial banking systems in different countries
in the following groups:

 1. Anglo-American Banking System

 2. German Universal Banking System
 3. Japanese Main Banking System
 4. Indian Lead Banking System 8

Assoc. Prof. Rajib Datta, Finance, PUC

 1. Anglo-American Banking System

 This system is prevalent in most of the countries in the world along with
Bangladesh.

 There are difference between commercial banking and investment banking.

 Commercial banks can not operate investment banking activities.

 Separate investment banks are established in these countries for the

operation of investment banking activities.

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 2. German Universal Banking System

 This system is prevalent only in Germany.

 There is no difference between commercial banking and investment

banking in this system.

 Commercial bank can operate any type of business activities.

 Commercial bank can buy up to 40% share of corporate firms and

participate in the ownership of the firm.

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 3. Japanese Main Banking System

 This system is closely related to the relationship banking.

 In this system there are difference between investment banking and commercial
banking.
 But commercial have no restriction to participate in the ownership of corporate
firms.
 This is the hybrid form of the above two systems. That is bank can not participate
in the investment banking activities.
 The bank can buy 5% share of any companies and participate in the
ownership. 11

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 4. Indian Lead Banking System

 This system was developed in India by the end of 1960.

 Every lead bank performs extra responsibilities with the existing

commercial banking system.

 This system divides the country’s geographical area in different segments

and only one leader bank is selected for each area.

 That area’s each and every commercial bank and other operating financial
institution loan activities are transacted according to the lead bank.
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 Banking Issues in the 21st Century
Financial Systems evolve through time, Passing through three phases:
 Phase one:
This phase is bank oriented where most external finance is raised through the bank loans
which in turn is funded through savings. Banks are the most important financial
intermediaries in the financial systems and interest income is the main source of revenue.
 Phase two:
This phase is market oriented. Households and institutional investors begin to hold more
securities and equity and non banking financial institutions offer near bank products such as
money market accounts.
 Phase three:
In this phase trading, underwriting, advising and asset management activities have become
more important for banks than the traditional core banking functions. 13

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 The position of the banking sector at the beginning of the new century:

1. It will be wise to begin with the performance of banks measured by banks

profitability: It is mentionable that in 1980 Japanese banks were very profitable,
became even more so. But banks profit elsewhere either trend less or slipping. The
recovery to average levels in 1999 was short lived.

2. The growth of bank assets: In the 1970s, banks asset grew rapidly in nominal terms
across the 14 countries. But more restrictive monetary policies and lower inflation
contributed to the sharply lower growth of banks assets almost everywhere in the 1980s
and 1990s.

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3. Bank Foreign Assets:
 Foreign assets growth rates tended to outpace domestic asset in all three decades.
 The average ratio of total assets to nominal GDP for most industrial countries
rose in 1970.
 For Switzerland, banking assets had been more than 100% off national income in 1970s
& very nearly so for Japan and Germany.
 In other countries, there had been a steady rise from 40% to 60% of national income in
1970s to well over 100% by the 1970s.
4. Employee Cost: While profitability was fairly static, banks were looking for other
sources of income by expanding into non- interest income areas.
5. Share Price Performance: The relative share price performance of banks gives the most
important idea of what the market thinks about future prospects of the bank compared to
the other sectors. 15

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 Bangladesh Bank (BB) Central Bank of Bangladesh

Bangladesh Bank (BB) has been working as the central bank since the
country’s independence. It’s prime jobs include issuing of currency,
maintaining foreign exchange reserve and providing transaction facilities of all
public monetary matters. BB is also responsible for planning the government’s
monetary policy and implementing it thereby.

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 Establishment (Bangladesh Bank)

Bangladesh Bank, the central bank and apex regulatory body for the country's
monetary and financial system, was established in Dhaka as a body corporate
vide the Bangladesh Bank Order, 1972 (P.O. No. 127 of 1972) with effect
from 16th December, 1971. At present it has ten offices located at Motijheel,
Sadarghat, Chittagong, Khulna, Bogra, Rajshahi, Sylhet, Barisal, Rangpur
and Mymensingh in Bangladesh; total manpower stood at 6341 (officials
4879, subordinate staff 1462) as on April 22, 2021.

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 Functions of Bangladesh Bank
BB performs all the core functions of a typical monetary and financial sector regulator, and a number of
other non core functions. The major functional areas include:

 Formulation and implementation of monetary and credit policies.

 Regulation and supervision of banks and non-bank financial institutions, promotion and
development of domestic financial markets.
 Management of the country's international reserves.
 Issuance of currency notes.
 Regulation and supervision of the payment system.
 Acting as banker to the government.
 Money Laundering Prevention.
 Collection and furnishing of credit information.
 Implementation of the Foreign exchange regulation Act.
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 Managing a Deposit Insurance Scheme.
Assoc. Prof. Rajib Datta, Finance, PUC
 Functions of Bangladesh Bank
A. General functions:
1. Issue of notes and coins B. Purposeful functions:
2. Government bank 1. Control currency market
3. Banker’s bank 2. Stabilize exchange rate
4. Lender of the last resort 3. Maintain gold standard
5. Reservoir of foreign currency 4. Stabilize price level
6. Clearing house 5. Employment opportunities
7. Credit control

C. Expansion and development functions: D. Other functions:

1. Development of agriculture sector
1. Adviser and representatives of government
2. Development of industrial sector
2. Economic research
3. Development of natural resources

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 Overview of Financial system of Bangladesh

 The financial system of Bangladesh is comprised of three broad fragmented sectors:

 Formal Sector,
 Semi-Formal Sector,
 Informal Sector.

The sectors have been categorized in accordance with their degree of regulation.

 Formal Sector: The formal sector includes all regulated institutions like Banks, Non-
Bank Financial Institutions (NBFIs), Insurance Companies, Capital Market
Intermediaries like Brokerage Houses, Merchant Banks etc.; Micro Finance
Institutions (MFIs).
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 Semi Formal Sector: The semi formal sector includes those institutions which are
regulated otherwise but do not fall under the jurisdiction of Central Bank, Insurance
Authority, Bangladesh Securities and Exchange Commission (BSEC) or any other
enacted financial regulator. This sector is mainly represented by Specialized Financial
Institutions like House Building Finance Corporation (HBFC), Palli Karma Sahayak
Foundation (PKSF), Samabay Bank, Grameen Bank etc., Non-Governmental
Organizations (NGOs) and discrete government programs.

 Informal Sector: The informal sector includes private intermediaries which are
completely unregulated.
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Assoc. Prof. Rajib Datta, Finance, PUC 22
 Banking Sector of Bangladesh

The banking sector in Bangladesh consists of several types of institutions. Bangladesh

Bank is the central bank of Bangladesh and the chief regulatory authority in the banking
sector.

Pursuant to Bangladesh Bank Order, 1972 the Government of Bangladesh reorganized the
Dhaka Branch of the State Bank of Pakistan as the central bank of the country, and named
it Bangladesh Bank with retrospective effect from 16 December 1971. Other than the
Central Bank itself, banks in Bangladesh are primarily categorized into two types:
Scheduled and Non-Scheduled banks.

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 Scheduled Banks
Scheduled banks are licensed under the Bank Company Act, 1991 (Amended up to 2013).
Currently, there are 61 scheduled banks in Bangladesh.

 State-owned commercial banks (SOCBs)

There are 6 state-owned commercial banks (SOCBs) which are fully or majorly owned
by the Government of Bangladesh.
1. Sonali Bank Limited
2. Janata Bank Limited
3. Agrani Bank Limited
4. Rupali Bank Limited
5. BASIC Bank Limited
6. Bangladesh Development Bank 24

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 Specialized Banks (SDBs)

3 specialized banks are now operating which were established for specific objectives
like agricultural or industrial development. These banks are also fully or majorly owned
by the Government of Bangladesh.

 Bangladesh Krishi Bank

 Rajshahi Krishi Unnayan Bank

 Probashi Kollyan Bank

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 Private Commercial banks (PCBs)
There is a total of 43 PCBs in Bangladesh are in operation right now. They are majorly
owned by private entities and classified into two types.
 Conventional PCBs

In total 33 conventional PCBs are now operating in the industry. They perform the banking
functions in conventional fashion i.e. interest-based operations. Example: AB Bank Limited,
Bangladesh Commerce Bank Limited, Bank Asia Limited , BRAC Bank Limited.
 Islami Shariah Based PCBs

There are 10 Islami Shariah-based PCBs in Bangladesh and they execute banking activities
according to Islami Shariah-based principles i.e. Profit-Loss Sharing (PLS) mode. Example:
Al-Arafah Islami Bank Limited, EXIM Bank Limited, First Security Islami Bank Limited.
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 Foreign Commercial Banks (FCBs)
In total 9 FCBs are operating in Bangladesh as the branches of the banks which are
incorporated in abroad.
 Bank Al-Falah Limited (United Arab Emirates)
 Citibank N.A (United States of America)
 Commercial Bank of Ceylon PLC (Sri Lanka)
 Habib Bank Limited (Pakistan)
 HSBC (Hong Kong)
 National Bank of Pakistan (Pakistan)
 Standard Chartered Bank (United Kingdom)
 State Bank of India (India)
 Woori Bank (South Korea) 27
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 Non-Scheduled Banks

Non-scheduled banks are licensed only for specific functions and objectives, and do
not offer the same range of services as scheduled banks. There are now 5 non-
scheduled banks in Bangladesh.
 Ansar VDP Unnayan Bank
 Karmashangosthan Bank
 Grameen Bank
 Jubilee Bank
 Palli Sanchay Bank

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 Non-Bank Financial Institutions (NBFIs)
Non-bank financial institutions (NBFIs), simply known as financial institutions (FIs), are those types of
financial institutions which are regulated under Financial Institution Act, 1993 and controlled by Bangladesh
Bank. Now, 34 NBFIs are operating in Bangladesh while the maiden one was established in 1981. Out of the
total, two are fully government owned, one is the subsidiary of a SOCB, 15 were initiated by private domestic

initiative and 15 were initiated by joint venture initiative. Example,

 Agrani SME Financing Company Limited

 Bangladesh Finance and Investment Company Limited (BD Finance)
 Bangladesh Industrial Finance Company Limited (BIFC)
 Bangladesh Infrastructure Finance Fund Limited (BIFFL)
 Bay Leasing & Investment Limited
 Delta Brac Housing Finance Corporation Ltd. (DBH) 29

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 Specialized financial institutions (semi formal sector)

 Bangladesh House Building Finance Corporation (BHBFC)

 Palli Karma Sahayak Foundation (PKSF)

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 Commercial Banks

A commercial bank is –

 A type of financial institution and intermediary

 Provides transactional
 Savings
 Money market accounts and that accepts time deposits.

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 Major Factors Contributing to Economic Growth

 Economic growth in Bangladesh has been helped largely by export earnings from the
ready-made garments (RMG) sector; remittances sent by migrant workers; growth in the
agricultural sector; expansion in Medium, Small and Micro Enterprises (MSMEs);
decline in the rate of population growth; and the government's safety net programmes.

First, considerable expansion has taken place in the RMG sector since the late 1970s.
Today, it is the most important industry in the country; and Bangladesh is the second
largest apparel exporter of western brands, after China. The RMG sector accounts for
around 82 per cent of total exports. (The Financial Express, July 05, 2018).
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 Factors Contributing to Economic Growth

Second, being a labour surplus country, annually about 0.5 million Bangladeshis migrate abroad in
search of jobs. According to the Bureau of Manpower Employment and Training (BMET), the total
number of Bangladeshi labour migrants was around 11.5 million in 2017. The figure represents about
4.5 per cent of the country's population and 11 per cent of its labour force (BMET 2018). With
increase in the number of migrant workers, there has been considerable increase in the amount of
annual remittance. (The Financial Express, Jan 11, 2019).

Third, agriculture sector witnessed remarkable progress, despite continued loss of arable land. There
has been a sharp increase in food grain production during the last over four decades. The increase has
been made possible as a result of a liberalised input market and expansion of irrigation, encouraging
farmers to adopt the new seed-fertiliser technology. (The Financial Express, Jan 11, 2019).
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Assoc. Prof. Rajib Datta, Finance, PUC

 Factors Contributing to Economic Growth

Fourth, small and medium enterprises (SMEs) has played a vital role in promoting
economic growth, poverty reduction, and employment generation. The Government of
Bangladesh highlighted the importance of SMEs in its Industrial Policy; and it has been
identified as a 'thrust sector' by the Ministry of Finance. However, to efficiently run
SMEs, allocation of adequate funds and skill development of both entrepreneurs and
workers are critically needed. (The Financial Express, Jan 11, 2019).

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 Management of Commercial Bank
Management is a universal concept which is necessary for the success of not only profit
oriented business organizations but also for non-trading and non-profit organizations such
as – family, club, religious institutions, self-serving organizations and nationalized
institutions.

But from the very outset, “bank” popularly means only commercial banks. Although
different types of banks are found at present, only commercial banks are the major
participants in the banking world. Commercial banks more or less have been performing
all types of activities of specialized banks. The usual activities of commercial bank and
specialized banks are almost the same.
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Assoc. Prof. Rajib Datta, Finance, PUC
 Role of Banks in Economic Growth
Commercial banks have been playing an important role in the economic development of
Bangladesh. They provide investible funds to both the public sector, and specially the
private sector. Further, banks have played a significant role in respect of the four major
drivers of economic growth in Bangladesh as discussed earlier.

The banking sector, however, is faced with various challenges, which include among others,
weak management, poor governance, lack of strong leadership, and non-compliance with
ethical standards leading to various types of banking scams such as money laundering and
Non-Performing Loans (NPLs).

Bangladesh is an import-dependent country. It needs to import raw materials, accessories

and machineries to foster development of the industrial sector, including the RMG sector.
Banks have been facilitating payment, finance and risk management services to the sector.
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(The Financial Express, Jan 11, 2019). Assoc. Prof. Rajib Datta, Finance, PUC
 Rationale of Increasing Importance of Bank Management

The only way to achieve a handsome amount of profit compared to similar kinds of
organizations is to establish skilled & efficient management in any organization. The bank
is a profit-oriented organization; therefore, its management procedure is more challenging
as the regulatory system always is time to control bank management. The following
diagram shows how the bank management becomes more challenging over time.

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 Changing Regulations of Banks
(1)

Determining Factors of
Increasing Importance
of Bank Management

Increasing Competition due Changing International

to changing Technological
Development (2) Relationship (3)
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Assoc. Prof. Rajib Datta, Finance, PUC

So above diagram shows the dayby day, bank management becomes more
complicated due to the effect of these three determinants. A small description of
these three factor are given below:

 Changing Regulation for Banks:

It is a normal phenomenon to change banking procedure from time to time in the same
country or in different countries according to public benefits. Banks regulatory
authorities are more careful to prevent bank failure, to ensure the safety of the fund of
depositors and ensure loan distribution for all.

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 Some techniques followed by the bank regulatory authorities to control over the
activities of commercial banks are:
 Direction for the right price of bank services.
 Introduction of deposit insurance.
 Direction for adequate liquidity.
 Direction for capital adequacy.
 Direction for approval & non approval of bank loan operation.
 Recruitment of directors and direction regarding recruitment and directing their duties and
responsibilities.
 Loan supervision, review and examination.
 Direction for adequate reserve etc. 40

Assoc. Prof. Rajib Datta, Finance, PUC

 Increasing Competition due to Changing Technological Development:
Number of served clients and quality & dimensions of services are the basis of
competition. The bank which provides better service with high quality is capable of being
successful in competition. Two banks jointly create new services that provide the customer
with a sustainable competition advantage. The new benefit or service that bank offers is
unique and different from that of the other organization requires the commercial banks to
participate in the multidimensional competitive environment. The client of one bank may
go to another bank of the same locality just because of better service. So, in order to
withstand competition bank management needs to innovative and challenging.
Technological environment absorbs more investment and new training. So the
management of bank creates new strategy of banking services adjusted in competitive
banking business.
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Assoc. Prof. Rajib Datta, Finance, PUC

 Changing International Relationship:
In international banking business, the bank faces extensive amount of
legislation in the event of a new problem. International relations, global or
bilateral, create more competition in banking business. Other factors,
such as changes in international trade and commerce, laws of fund
transfer, change in social and cultural factors establish new operational
management system which challenge the banking business.

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 To the Students:
To learn more regarding the contents of this chapter the students are
suggested to read the following book- Bank Management – A Fund
Emphasis (Latest Edition) by - Dr. A R Khan.

Thank You All

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