Commercial Bank and Checking Accounts

What is the Iimportance of Bank in the Economy?

The role of banks in an economy

We all think we know what a bank is and what it does. And not without reason:

most people have had experience of at least one bank, even if it is only through

having a salary account or withdrawing cash from an ATM.

My aim in talking to you today about the role of banks in an economy is not to

lecture you from high on banking theory. Although my goal is simple, it appears

almost unattainable: to promote a slightly better understanding of what a bank

can do and what a bank should do. Before this question can be answered, we need

to look at what banks actually do and how they do it. Here we are not in the

exclusive domain of bank employees and specialists. As we have seen over recent

months, these matters can affect ordinary citizens and voters very quickly.

At several stages before, during and after the campaign on the part of the federal

government, cantonal authorities and business community to save Switzerland's

national airline, the feeling was very much one of "it's up to the banks to do

something". In letters to the press and in some articles, a great number of

contradictory, confused and in many cases unrealistic hopes, accusations and

expectations were laid at the banks' door. For example, the banks were criticised for

not stopping to recommend Swissair bonds to investors long before the crisis

broke, but at the same time they were pilloried for failing to grant far more credit

to Swissair during the crisis. Contradictory reactions such as these are

understandable up to a point. They are a measure of the shock, uncertainty and

helplessness experienced by many people in Switzerland, and not just the average

man in the street. As understandable as these reactions were from the

psychological perspective, however, they proved to be extremely unhelpful in

practice. Any "Bank of Joe Public" that would have attempted, even for a moment,

to satisfy the expectations held of it would not only have failed to save the airline;

it would most probably have faced bankruptcy itself, destroying its clients' deposits,

employees' jobs and owners' capital in the process.

Banks are widely held to be powerful and rich. This view is generally based on the

very accurate observation that banks deal with vast amounts of money. A quick

look at a bank's balance sheet quickly puts this perception into perspective: in

contrast to industrial companies, more than 90% of a bank's balance sheet consists

of loans and deposits; the proportion of tangible assets such as buildings,

machinery, etc. is minimal. What is generally most striking in a bank's balance

sheet, however, is that the (unweighted) portion of equity rarely exceeds 5%. The

proportion of borrowings is far higher. This is, of course, in the nature of the

business: banking means working with and managing outside capital entrusted to

a bank by, for example, people like yourselves, the companies you work for or your

pension fund. Unlike the people who actually own this capital, banks have very

limited powers when it comes to deciding what should be done with the money.

Regardless of how individual aspects are structured, a bank's business policy will

always have to be geared in equal part to the clients of that bank and its owners.

Clients choose a bank because they trust it not to lose their money and because

they expect a specific level of value added and are willing to pay fees and

commissions in return. The same applies to the owner who makes his or her capital

available to the bank, thereby taking on certain risks and expecting to benefit from

part of the profit.

A bank's activities in all its divisions can basically be simplified as follows: it

transfers money and information, and in doing so transforms money, maturities

and risks. In the rest of my speech, I intend to use the example of four lines of a

bank's business to examine how it does this, the value added it creates, the risks it

encounters and the restrictions to which it is subject: (1) lending and deposit

business, (2) securities issuing, (3) asset management and (4) foreign exchange

trading.

Lending and deposit business

A bank's role as an "intermediary" is clearest in the credit and deposit business.

Clients "bring" to the bank their savings, i.e. the money they have chosen not to

spend. The bank transfers this money to its credit clients in the form of loans. What

is on the face of it extremely simple is nevertheless fraught with a great many risks.

A bank's loans lack liquidity, either partially or totally. This means that the bank

cannot sell them in return for demand deposits or central bank funds whenever it

likes. On top of this, a borrower's credit rating may change during the life of a loan,

thereby changing the value of the loan at that point in time, which reflects the

interest and amortisation payments expected in the future. Due to the lack of a

secondary market, credits are mostly carried in balance sheets at their nominal

value, with provisions and write-offs only being formed or effected if there are any

indications that the borrower may have trouble meeting payments or is actually in

arrears. In some cases, credits may even become entirely worthless if borrowers

become insolvent and bankrupt.

On the other side of the balance sheet, a bank guarantees its creditors the nominal

value of their deposits plus interest due, irrespective of the profit or otherwise

made in lending transactions. Furthermore, the amounts a bank owes are generally

more liquid than the amounts it is owed; in other words, creditors can call in the

amounts the bank owes them more quickly than the bank can call in what is due to

it from its borrowers. One of the banks' fundamental roles in the economy is to

"transform" maturities in this way at its own risk. This is part of the service it offers

as intermediary and a form of risk management.

Another function which the banks perform within an economy is rating and

selecting the loans they finance. The supply of client deposits is limited; the

demand for credit generally less so. This being the case, credits have to be subject

to a selection process. The reason why this selection process cannot be performed

solely via the price (or rate of interest) is that lending transactions are not the same

as cash transactions, where payment is provided immediately upon a product or

service being rendered. Instead, the borrower undertakes to make future payments

of interest and principal. As a consequence, the bank cannot base itself solely on

the ability to pay as presented at that particular point in time; it also has to

attempt to make some sort of assessment with regard to the borrower's ability to

pay in the future.

Through their activities as "agent", another essential function performed by the

banks is to reduce risks overall. A bank that uses deposits from a large number of

private households to finance loans to a large number of companies is leveraging

the advantages of diversification. Insofar as depositors take the decision to

withdraw their funds independently of one another, the bank benefits from the

Law of Large Numbers , given that it is not anticipating a situation where all

depositors withdraw their savings at the same time. Diversification places a role in

the lending business, too, this time over a large number of companies and sectors:

a proportion of individual risks is evened out on aggregate and the bank functions

in much the same way as an insurance company.

As financial intermediaries, banks have a responsibility towards both their

borrowers and creditors. Their prime responsibility is that towards their creditors

(Implementing Ordinance on Banks and Savings Banks, 1998; Swiss Federal Law on

Banks and Savings Banks, Article 4.). Together with protecting the function and

reputation of the banks, the main aim of the law on banks and savings banks is to

protect creditors. The Federal Banking Commission's regulatory and supervisory

activities are all geared primarily to this aim.

There is no similar protection under public law for those who have been lent money

by a bank. The rights of such borrowers are covered in particular by the private

contract which they have entered into with the bank. Within such contracts, banks

generally undertake to provide specific products or services. They also contract to

fulfil their due diligence and fiduciary responsibilities towards their borrowers.

There is no legal obligation upon a bank to grant a loan to its clients under certain

circumstances. Indeed, the banks could not possibly be subject to such an

"obligation to contract", and for an obvious reason: it would be diametrically

opposed to the aim of protecting creditors. This said, there have been and there are

still banks which function mainly upon the principle of providing cheap loans or

allowing co-operative structures to become self-sufficient in loan provision. Some

examples of this are the Swiss cantonal banks founded in the 19th century, the

Raiffeisen banks and community development banking in the United States.

Securities issuing

Loans account for only part of the long-term financing provided by the banks.

While bank loans are often the only source of outside financing for many small and

medium-sized enterprises, a substantial proportion of the capital raised by larger

companies comes from the issuing of securities. This is also reflected in overall asset

structures: banks hold around CHF 1,100 billion in bonds in their clients' portfolios,

compared to the client deposits of CHF 900 billion carried in the banks' balance

sheets.

In a securities issue, a bank or group of banks generally agrees to underwrite the

entire amount of the issue. The securities acquired in this way are then offered for

public subscription for the account and at the risk of the bank or banks involved.

The risk that not all the securities will be placed with clients is carried by the bank.

The issuer, for its part, has immediately available to it the entire proceeds from the

transaction, regardless of how successful the offering has been. For a bank to be

successful with an offering, it has to be able to gauge market conditions correctly

at the time of the issue and has to have access to as broad a base of custody

account clients as possible, in order to place the securities with these clients.

Securities issues are a volatile source of earnings, as we have seen over recent

months with IPOs in particular. They can be lucrative, especially if they do not only

involve the simple issuing of fixed-income paper but are structured around more

complex transactions in several currencies with the aim of, for example, financing

an acquisition. In transactions such as these, the in-depth analysis and specialist

knowledge a bank provides are critical.

The universal banks active in the issuing sector face a whole range of potential

conflicts of interest, given that issues often involve various parties from within and

outside the bank and that these parties are not motivated by the same interests:

the issuance unit is interested in the offering, securities trading is looking for high

revenues, asset management clients expect the bank to safeguard their interests

irrespective of its role in the issuing transaction, the lending unit may have

information on the issuer that is otherwise not in the public domain, etc. Defusing

and controlling potential conflicts such as these places enormous demands on a

bank's organisational structure, processes and compliance activities. Only when a

bank succeeds in controlling the potential conflicts and managing them on a

transparent basis can the different stakeholders involved be sure that their

legitimate interests are equitably upheld.

Asset management

Asset management covers a range of banking activities: portfolio management,

investment advisory, securities trading and lending business (collateral loans,

securities lending and borrowing). With a discretionary portfolio management

agreement, clients authorise a bank to undertake, for their account and at their

risk, all the actions it deems appropriate within the framework of the normal asset

management activities of a bank. Clients expect their assets to be managed

professionally and in their best interests. The bank contracts to exercise its

undertaking to the best of its knowledge and abilities, taking into account clients'

circumstances but acting as it sees fit within the scope outlined as part of the

investment goals defined with the client.

What is clear from this is that the singularly most important factor in asset

management, independently of any law or regulation, is the trust a client has in his

or her bank. Our Association's Portfolio Management Guidelines form part of the

regulations which a bank must observe. These guidelines specify that a bank which

accepts portfolio management agreements must have appropriate professional

organisational structures which are commensurate with the activities involved, that

concentrations of risk must be avoided, that, where there are no instructions to the

contrary, the bank must invest in securities for which there is a ready market, etc.

The asset management business places exacting requirements on banks and

bankers in terms of the expertise and ethical issues involved. Under no

circumstances can a bank simply "do as it pleases" in the portfolios it manages for

clients, nor should it be allowed to do so.

Foreign exchange trading

The last business I mentioned was foreign exchange trading, an activity which has

been unjustly attacked as "casino capitalism". Various factors have given rise to this

perception. First, without a doubt the massive amounts traded in the foreign

exchange markets every day. According to figures from the Swiss National Bank, for

example, in April 2001 foreign exchange trades in Switzerland alone amounted to

CHF 121 billion each working day. (For the purposes of comparison, the global

figure was USD 1,210 billion.) The vast majority of this trading takes place between

financial intermediaries, the aim being to exploit even the slightest differences

between exchange rates (arbitrage). Only a very small proportion of these trades is

used to finance foreign trade and hedge foreign currency positions. Furthermore,

the fact that serious economic crises such as the one Argentina is experiencing at

present are almost always currency crises may fuel suspicions that it is currency

traders with their speculative attacks that trigger such developments.

In fact, the very opposite is true. Many people may fail to see the point of the vast

amounts of arbitrage transactions, since they are not primarily used for financing

purposes. In reality, however, they underpin liquidity in the markets, thus helping

them to function smoothly. In less liquid markets, new information would

inevitably lead to much greater volatility in rates. A distinction has to be made in

the case of protracted currency over- or undervaluations (in terms of interest rates

and purchasing power parity), which are a genuine problem, as they could result in

the misallocation of resources.

The scope available to banks

But what is the actual function of a bank within an economy? By granting loans,

processing payments, accepting deposits, carrying out investments, etc. it is

creating added value for its clients, employees, service providers and shareholders.

In this, it is no different from any other company. The real difference lies in the

extent of the potential damage were a bank to collapse: Then it would not only be

employees losing their jobs, shareholders losing their capital and clients their

provider; clients could potentially lose their entire savings and financial assets. This

explains why banks are so heavily regulated and so strictly monitored.

Nevertheless, the economic benefits generated by a bank are basically no different

from the economic benefits generated by a doctor, teacher or train driver: by

exercising, to the best of their knowledge and abilities, their specialist function in

competition with others, companies and their employees make their contribution

to economic benefit. And their motivation need not be a selfless one. Pilots do not

fly planes to generate economic benefit, just as bankers do not grant credits for

any such selfless reasons. Economic utility is created as a "by-product" anywhere

women and men function successfully, and this does not apply solely to their jobs.

Even though a banker grants loans to many companies and sectors of the

economy, this does not mean he can do their work or bear their responsibilities.

The argument of economic goals and responsibility is generally seized on by

politicians when it is a matter of re-distributing capital, risks, profits or costs.

Although not strictly wrong, the economic responsibility argument has the major

political advantage that it can be flexibly deployed for absolutely anything. You will

look long and hard - and probably in vain - for any "handy" definition of a bank's

economic responsibility that is at the same time general enough. Which is why my

suggestion is the following: bankers act responsibly when they ensure that their

house is in order and resist the temptation to pass off poor financial performance

as a contribution to the economy.

When you become past due on a credit card or default on a loan, the creditor reports the information to one of three credit agencies (Equifax, Experian or Transunion). When you charge-off a checking account, your bank may report the information to a different agency; this agency is called ChexSystems. Most banks participate in ChexSystems service, by running consumer reports to qualify applicants, as well as reported delinquent accounts. If you owe another bank money and want to open a new bank account, you'll have to be resourceful.

1. • 1

     Order your ChexSystems consumer report. You are entitled to a free copy annually; visit the ChexSystems website to make your request.

   • 2

     Receive your free report by mail in seven to 10 business days. Examine the report to determine if the delinquent account is listed; if it's not, you have nothing to worry about; you can open a bank account anywhere.

   • 3

     Pay off the delinquent account, if possible. It won't remove the delinquent account from ChexSystems, however, it will change the status to paid, which may help you open a new bank account.

   • 4

     Visit the bank where you want to open an account. Meet with a personal banker to discuss your options. Explain your situation and furnish proof the old account is paid, if possible.

   • 5

     Apply online for a bank account. Most banks allow you pre-qualify for checking accounts on their website. This will avoid any potential face-to-face embarrassment.

   • 6

     Consider a credit union, rather than a bank. While most banks use ChexSystems, many credit unions do not. A credit union checking account may offer the same conveniences as a bank checking account.