The financial system (banks)

• Banks are financial intermediaries which link between lenders and borrowers (where the supply of funds is matched to the demand of funds).
• They provide the following services:
• Expert advice: advise customers on financial matters (e.g. the best way of investing their money or obtaining finance).
• Expertise in channelling funds: They channel funds to those areas that yield the highest return so customers get high interest rates.
• Maturity transformation: They lend for longer periods of time than they borrow.
• Risk transformation: They can absorb the loss (if some customers didn’t pay) because of the interest they earn on all other loans.
• Transmitting payments: money can be transferred from one person or institution to another without having to rely on cash (e.g. credit cards, cheques, .. etc).
• There are 2 main types of banks:
• Retail banking: they operate bank accounts for individuals and businesses, attracting deposits and granting loans at published rates of interest.
• Wholesale banking: they deal in large-scale deposits and loans, mainly with companies and other banks and financial institutions. Interest rates and charges may be negotiable.

Liabilities:

• Customers’ deposits in banks are liabilities. This means that the customers have the claim on these deposits and the banks are liable to meet the claims.
• There are 4 major types of deposits:
• Sight deposits: any deposits that can be withdrawn on demand by the depositor without penalty. The most familiar form of them are current accounts (issued with cheques or debit cards).
• Time deposits: They require notice of withdrawal or where a penalty is charged for withdrawals on demand. They pay higher interest rate than sight accounts. The most familiar forms of them are the deposit and savings accounts.
• Sale and repurchase agreements (repos): An agreement between two financial institutions whereby one in effect borrows from another by selling it assets, agreeing to buy them back (repurchase them) at a fixed price and on a fixed date.
• Certificates of deposit (CDs): They are issued by banks to customers (usually firms) for large deposits of a fixed term (e.g. 100,000 SR for 18 months). They can be sold by one customer to another, so they are liquid to the depositor but illiquid to the bank.

Assets:

• Banks’ assets are its claims held on others.
• There are 3 major categories of assets:
• Cash and reserve balances: Banks hold a certain amount of their assets as cash to meet the day-to-day demands of customers.
• Short-term loans:  There are 3 form of them:
• Market loans: made to other banks or financial institutions.
• Bills of exchange: made either to companies or to the government.
• Reverse repos:
• Longer-term loans: made to customers both personal customers and businesses. They are of four main types:
• Fixed term: repayable in instalments over a set number of years, typically 6 months to 5 years.
• Overdrafts: often for an unspecified term.
• Outstanding balances on credit-card accounts.
• Mortgages: typically for 25 years.