CHAPTER 1 BANKING AND FINANCIAL INSTITUTION OVERVIEW

Money is one of the greatest inventions of mankind; without money the existence of the modern economic organization
would not have been what it is at present. It is said that “Money is the blood and soul of men and whosoever has none
wanders dead among the living”. Besides, many economists and experts have upheld the significance of money in their
definitions. To quote

Mountiford Longfied: “Money, as it is, the most useful means of exchange is also the most useful and
convenient measure of value”
Alfred Marshall: "Money is the centre around which economic science clusters”
Karl Marx: He wanted to abolish the very existence of money, for he considered it as a means for the
exploitation of the poor, has stated in his Das Capital, that “Although gold and silver are not by
nature money, money is by nature gold and silver”
Somerset Maugham: a famous playwright goes further to say “Money is like a sixth sense without which you
cannot make a complete use of the other five”

With the importance of money, finance assumes its importance since it plays a vital role in the economic growth of a
country. Finance is as old as human life itself.

‘Finance’ which is originally a French word, was adopted by English speaking communities to mean “the management
of money” in the 18th century.

Today, finance has evolved into an academic discipline of higher importance and it has emerged to be a branch of
Economics. Though finance easily relates to exchange, it is not just restricted to the exchange and management of money
alone, but it is an art of managing various available resources like money, assets, investments, securities et

Finance is the soul of economic activities which relies on certain resources which are to be pooled in terms of money. It is
a prerequisite for obtaining physical resources, which in turn are required to perform productive activities and for carrying
business operations. Hence, finance is an organic function and inseparable part of economic activity.

The activities dealing with finance are organized in a system known as “Financial System” or “Financial Sector”.
Financial system is concerned with the functioning and activity of certain components, the most important being-money,
credit and finance. It is a complex, well-integrated set of sub-systems of financial institutions, markets, instruments, and
services which facilitate savings, transfer and allocation of funds efficiently and effectively.

Economic activity and growth are greatly facilitated by the existence of a financial system developed in terms of
efficiency of market in mobilizing savings and allocating them among competing users.

Financial system intermediates with the flow of funds between those who save a part of their income to those who invest
in productive assets. It mobilizes and usefully allocates scarce resources of a nation.

As a system, it aims at establishing and providing a regular, smooth, efficient and cost effective linkage between
depositors and investors. A well-developed financial system allows for the transfer of resources from depositors to
investors and thus plays a crucial role in the functioning of the economy. A typical complex structure of a financial system
in an economy is presented in Chart -1

Principle features of a Financial System are:

 As a system, it provides an ideal linkage between depositors and investors, thus encouraging both
savings and investment,
 It promotes efficient allocation of financial resources for socio-economic productive purposes,
 It influences both quality and pace of economic development, and
 It facilitates the expansion of financial markets over space and time.
Chart-1 FINANCIAL SYSTEM IN AN ECONOMY

Formal Financial System consists of four components:

 Financial Institutions,
 Financial Markets,
 Financial Instruments and
 Financial Services.

Financial Institutions (banking and non-banking institutions) are intermediaries that mobilize
savings and facilitate the allocation of funds in an efficient manner.

Financial Markets (money market and capital market) are a mechanism enabling participants to
deal in financial claims.

Financial Instrument is a claim against a person or an institution for the payment at a future
date a sum of money and/or a periodic payment in the form of interest or dividend.

Financial intermediaries also provide key Financial Services such as merchant banking, leasing,
hire purchase, credit-rating, and so on.

The financial system comprises of a variety of intermediaries, markets and instruments that are
related as shown in Chart-1. It provides the principal means by which savings are transformed into
investments, therefore given its role in the allocation of resources, the efficient functioning of the financial
system is critical to a modern economy.
Banking System

Banks are a huge part of our lives. In this lesson, we will explore the banking system. We will learn about different types of
banks as well as how they each function.

What Is a Banking System?

When you sit back and think about it, banks are often a huge part of our lives. We deposit our paychecks, take out loans,
and set up savings accounts, all at a bank. But what do banks do? What are the different types of banks? Let's start
finding some answers to these questions by looking at the different types of banks that make up a banking system.

A banking system is a group or network of institutions that provide financial services for us. These institutions are
responsible for operating a payment system, providing loans, taking deposits, and helping with investments.

The functions of the banking system can be classified into primary functions and secondary functions.

Primary functions: The primary or banking functions include two components namely depositing and
disbursement of loans.
Depositing function of the banking system has come to be highly developed providing a range of
deposit option. Some of the popular deposits are saving deposits, fixed deposits, current
deposits and recurring deposits.
Disbursement of loans from the capital of savings constitute the determinant for the bank’s earnings,
as
the loans disbursed are charged with an interest rate levied to the borrowed amount. Some of
the key loan advancements include loans, cash credits, overdraft and discounting of the bill of
exchange.

Secondary functions: Accompanying the primary functions are a pair of secondary functions which the bank
performs, namely agency functions and general utility functions.
 Agency functions refer to services like funds transfer, cheque collections, portfolio
management, etc. performing the role of an agent to the customer.
 General utility functions refer to the special facilities or services which banking institutions
provide, namely locker facilities, project reports, foreign exchange, etc. Not all utilities are
provided by every bank, their disposal depends on the resources and nature of the banking
institution.

Name of Banking-Type Firm Definition or Description

 
Commercial banks Sell deposits and make loans to businesses and individuals
Money center banks: Are large commercial banks based in leading financial centers
Community banks Are smaller, locally focused commercial and savings banks
Savings banks Attract savings deposits and make loans to individuals and families
Cooperative banks Help farmers, ranchers, and consumers acquire goods and services
Mortgage banks Provide mortgage loans on new homes but do not sell deposits
Investment banks Underwrite issues of new securities by their corporate customers
Merchant banks Supply both debt and equity capital to businesses
Industrial banks State-chartered loan companies owned by financial or non-financial corporations
International banks Are commercial banks present in more than one nation
Wholesale banks Are larger commercial banks serving corporations and governments
Retail banks Are smaller banks serving primarily households and small businesses
Limited-purpose banks Offer a narrow menu of services, such as credit card companies and subprime lenders
Bankers banks Supply services (e.g., check clearing and security trading) to banks
Minority banks Focus primarily on customers belonging to minority groups
National banks Function under a federal charter through the Comptroller of the Currency
State banks Function under charters issued by banking commissions in the various states
Insured banks Maintain deposits backed by federal deposit insurance plans (e.g., theFDIC or PDIC)
Member banks Belong to the Federal Reserve System
Affiliated banks Are wholly or partially owned by a holding company
Fringe banks Offer payday and title loans, cash checks, or operate as pawn shops and rent-to own firms
Universal banks Offer virtually all financial services available in today’s marketplace.
Virtual banks Offer their services only over the Internet.
 
The Competitive Challenge for Banks

For many centuries banks were way out in front of other financial-service institutions in supplying savings and investment
services, payment and risk protection services, liquidity, and loans. They dominated the financial system of decades past.
But this is no longer as true today. Banking’s financial market share generally has fallen as other financial institutions have
moved in to fight for the same turf. In the United States of a century ago, for example, banks accounted for more than two-
thirds of the assets of all financial-service providers.

Some authorities in the financial-services field suggest this apparent loss of market share may imply that traditional
banking is dying. Certainly as financial markets become more efficient and the largest customers find ways around banks
to obtain the funds they need (such as by borrowing in the open market), traditional banks may become less necessary.
Some experts argue that the reason we still have thousands of banks scattered around the globe—perhaps many more
than we need—is that governments often subsidize the industry through cheap deposit insurance and low-cost loans.

Still others argue that banking’s market share is falling due to excessive government regulation, restricting the industry’s
ability to compete. Perhaps banking is being “regulated to death,” which may hurt those customers who most heavily
depend on banks for critical services—individuals and small businesses. Other experts counter that banking is not dying,
but only changing —offering new services and changing its form—to reflect what today’s market demands. Perhaps the
traditional measures of the industry’s importance (like total assets) no longer reflect how truly diverse and competitive
bankers have become in the modern world.

Key trends affecting all financial service firms:

 Service proliferation: widening service menu

 Rising competition : rapid growing of competitors

 Government deregulation: the easing of gov. rules

 An increasingly interest service mix of funds : facing better educated more interest sensitive customers.

 Technological change and automation : increasing automation of production

 Consolidation and geographic expansion : declining numbers and larger size of providers

 Convergence : the tendency for all financial firms to look alike (offering similar services)

 Globalization : geographic diversification

OVERVIEW OF THE PHILIPPINE FINANCIAL SYSTEM

The Bangko Sentral ng Pilipinas

The Bangko Sentral ng Pilipinas (BSP) was created by the Republic Act No. 7653, otherwise known as the New Central
Bank Act of 1993.

The BSP is now the Philippines’ central monetary authority that provides policy directions in the areas of money, banking
and credit.

The BSP’s powers and functions are exercised by its Monetary Board, consisting of seven members appointed by the
president of the Philippines.

One of the government sector members of the Monetary Board must be a member of the Cabinet designated by the
President of the Republic, which position is currently held by the Secretary of Finance. • The New Central Bank Act
authorizes the Governor of BSP to appoint up to three Deputy Governors, subject to the approval of the Monetary Board.

The Banking Institution

The structure of the Philippine Financial system is dominated by a banking system. Bangko Sentral (Central Bank) is the
official central bank in the Philippines. The BSP monitors and compiles various indicators on the Philippine banking
system.

The Banking Institution in the Philippines can be categorized as:

- Private banking
- Government banking

The private banking institutions are comprised of commercial banking such as universal banks and ordinary
commercial banks; thrift banks like savings and mortgage banks, private development banks, and stock savings
and loan association; and the rural banks. •

The Government banking institutions, on the other hand, consist of Philippine National Bank, Development
Bank of the Philippines, Land Bank of the Philippines, and the Philippine Amanah Bank

Private Banking Institution

1. Commercial Banking Institutions. The Banks that fall under commercial banking institutions are the
ordinary commercial banks or non-expanded commercial banks. These banks continue to account for the
bulk of the total resources of banking industry.

2. The Thrift Banks. Thrift banks are primarily engaged in mobilizing the small savings of the people. They
provide funds for agriculture and industry at reasonable interest rates. The small producers like farmers,
fishermen, craftsmen, and poor consumers can rely on such banks for financing their production and
consumptions inputs.

The following banks fall under the category of Thrift Banks

• The Savings and Mortgages Banks. The primary function of a savings and mortgage bank is to
receive time deposit of different types and to invest its funds in long term investment.
• The Savings and Loan Association. Very similar to the savings and mortgage banks are the savings
and loans associations nowadays. However, these institutions may either be stock or non-stock
corporations.
• The Private Development Banks. This is quite different from the government institution of the same
name. It is a government entity, formerly the Rehabilitation Finance Corporations.
• The Rural Banks. Rural Banks fulfill the investment function by allowing small farmers to finance their
needs through the granting of loans for capital or other uses.

Government Banking Institutions

 The Philippine National Bank.
- The Philippine National Bank (PNB) operates under the provision of
Executive Order No. 80, the 1996 revised charter of PNB. (But now it’s private already)
 The Development Bank of the Philippines.
 - The Development Bank of the Philippines (DBP) started operating in 1935 as the National Loan and
Investment Board. Its first mission was to coordinate and manage trust funds.
 The Land Bank of the Philippines.
-The Agrarian Reforms Code created the Land Bank of the Philippines (LBP) to finance the acquisition
and distribution of agricultural estates for division and resell these small landholders.
 The Al-Amanah Islamic Investment Bank of the Philippines.
-The Al-Amanah Islamic Investment Bank of the Philippines (Islamic Bank) was created under Republic
Act No. 6848 for the purpose of promoting and accelerating the socio-economic growth of Mindanao,
particularly the provinces of Cotabato, Lanao del Sur, Lanano del Norte, Zamboanga del Sur, Zamboanga
del Norte, and Sulu.

Non-Bank Financial Institution

These are other financial institutions which engage in specific functions. They provide services related to claims, financial
information, and advice, manage portfolios of financial assets on behalf of other economic units, buy and sell claims on
institution from clients, and assist in finding sources for those economic units seeking loans. These either private or
government non-bank financial institution.

Private Non-Bank Institutions

1. Investment House/Banks.
The term “investment house” is defined to mean as “any enterprise” which engages in the underwriting of
securities of other corporations “. Underwriting is the act or process of guaranteeing the distribution and sale
of securities of any kind issued by another corporation. Securities are written evidences of ownership,
interest, or participation in any enterprise, or written evidences of indebtedness of a person or enterprise.
2. Securities Brokers/dealers.
Pursuant to the provision of the Revised Securities Act, no broker, dealer, or salesman must engage in
business in the Philippines as such broker, dealer, or salesman or sell any securities, including securities
exempted under the said law.
3. Building and Loan Associations.
A building and loan association is a special type of savings institution. Because of its very nature, however, it
falls under this category in view of the fact that it also receives savings from members and lends fund to them.
4. Credit Unions.
A credit union is another type of savings institutions. It also has for its purpose the inculcation
of the habit of thrift, frugality, and the idea of helping one another.
5. Private Insurance.
Private insurance companies contribute to the country’s socio- economic development as well as to the
insured.
6. The Pawnshop.
Pawnshop provides credit to small borrowers who are not qualified to obtain small loans from financial
institution. In pawnshop, the cost of borrowing and terms of payment are generally fair.
7. Trust Companies.
A trust company is any corporation formed or organized for the purpose of acting as trustee or administering
any trust or holding property or on deposit for the use.
8. Non-Stock Savings and Loans Association.
A non-stock savings and loans associations is a corporation engaged in the business of accumulating the
savings of its member.
9. Financing Companies.
Financing companies or partnerships, except those regulated by the Bangko Sentral, the Insurance
Commissioner, and the Cooperative Administration Office which are primarily organized for the purpose of
extending credit facilities to consumer and to industrial, commercial, or agricultural enterprises.
10. Other Non-Bank Financial Institutions.
These are financial institution that are unknown to many people. Fund managers, lending investor, and
venture capital corporations are among these institutions.

Government Non-Financial Institution

1. The Government Service Insurance System.

On May 13 May 1937, the Government Service Insurance System (GSIS) started its operation. Presently,
the GSIS administers the following: Life Insurance Fund, Retirement Fund, Health Insurance Fund/Medicine,
State Insurance Fund/Employees’ Compensation, General Insurance Fund/Property Insurance, and Barangay
Officials’ Life Insurance.
2. The Social Security System.
On 1 September 1957, the Social Security System (SSS) started its operation. At first SSS granted only
death, disability, sickness, and old-age benefits under its social security program for the
workers/employees in the private sectors. As its capacity the funding and administrative experience grew,
other benefits have added to the program such as hospitalization benefits under the Medicare program,
employees’ compensation benefits, and maternity benefits.

2. Philippine Export and Foreign Loan Guarantee Corporation.

The Presidential Decree No. 1080 entrusts the Philippine Export and Foreign Loan Guarantee
Corporation (PEFLGC) to undertake the following:
• To guarantee approved foreign loans, in whole or in part, granted to any domestic entity,
enterprise, or corporation, majority of the capital of which is owned by citizen of the Philippines.
• To guarantee Philippine banking and financial institutions against loss that may be incurred in
connection with:
1. The grant of loans/credit accommodations to exporters, producers of export products, or
contractors with approved service contactors abroad, provided that such exporters, producers or
service contractors are Filipinos or entities majority of the capital of which are owned by citizens of
the Philippines; and
2. the issuance of standby letters of credit or of letters of guarantee, as the case may be, to secure
the performance of approved service contracts abroad entered into by any domestic
entity, enterprise, or corporation, majority of the capital of which are owned by citizen of
the Philippines.

3. The National Home Mortgage Finance Corporation.

The National Home Mortgage Finance Corporation’s (NHMFC) primary purpose is to develop and provide
a secondary market for home mortgages granted by public and/ or private home financing institutions.
Article: Are robots taking over the world’s finance jobs?
The year is 2030. You’re in a business school lecture hall, where just a handful of students are attending a
finance class.

The dismal turnout has nothing to with professorial style, school ranking or subject matter. Students simply
aren’t enrolled, because there are no jobs out there for finance majors.

Today, finance, accounting, management and economics  are among universities’ most popular subjects
worldwide, particularly at graduate level, due to high employability. But that’s changing.

According to consulting firm Opimas, in years to come it will become harder and harder for universities to sell
their business-related degrees. Research shows that 230,000 jobs in the sector could disappear by 2025, filled
by “artificial intelligence agents”.

Are robot-advisers the future of finance?

A new generation of AI

Many market analysts believe so. Investments in automated portfolios rose 210% between 2014 and 2015,
according to the research firm Aite Group.

Robots have already taken over Wall Street, as hundreds of financial analysts are being replaced with
software or robo-advisors.

Now, banks and financial institutions are rapidly adopting a new generation of Artificial Intelligence-enabled
technology (AI) to automate financial tasks usually carried out by humans, like operations, wealth
management, algorithmic trading and risk management.

For instance, JP Morgan’s Contract Intelligence, or COIN, program, which runs on a machine learning system,
helped the bank shorten the time it takes to review loan documents and decrease the number of loan-servicing
mistakes.

Such is the growing dominance of AI in the banking sector that, Accenture predicts, within the next three years
it will become the primary way banks interact with their customers. AI would enable more simple user
interfaces, their 2017 report notes, which would help banks create a more human-like customer experience.

Customers at Royal Bank of Scotland and NatWest, for instance, may soon be interacting with customers with
the help of a virtual chatbot named Luvo.

Luvo, which was designed using IBM Watson technology, can understand and learn from human interactions,
ultimately making the flesh-and-blood workforce redundant.

In the US, claims a 2013 paper by two Oxford academics, 47% percent of jobs are at “high risk” of being
automated within the next 20 years – 54% of lost jobs will be in finance.

This is not just an American phenomenon. Indian banks, too, have reported a 7% decline in head count for two
quarters in a row due to the introduction of robots in the workplace.

Perhaps this is unsurprising. After all, the banking and finance industry is principally built on processing
information, and some of its key operations, like passbook updating or cash deposit, are already highly
digitized.
Top 7 Financial Services Trends that will Dominate 2018

Brickendon forecasts key trends impacting the financial sector next year

Without a doubt, 2017 has been a rocky year for financial services; with political upheavals, economic
uncertainty and planning for numerous regulatory changes coming into effect in 2018.
In 2017, Brexit was the talk of the town, with “uncertainty” a word bouncing around the finance sector. As such,
the key focus was on the financial services industry crafting their post-Brexit strategy, namely how to continue
having access to both EU and UK markets and in turn catering to their clients’ needs.
According to Brickendon the award-winning global management and technology consultancy, while political
events will continue impacting financial services, including Brexit negotiations, next year digitalisation and data
will dominate alongside Robotic Process Automation and Blockchain, making larger waves in the sector and
paving the way for uncapped growth and innovation.

Financial Services Trends

A Data Future. Access to it, and the ability to mine data, will be central to everything that happens in the future
of financial services. Now that the data is loaded, and the toolsets are understood and available, 2018 will see
it being used for operations and technology processes.

The Rise of Robots. Robotic Process Automation (RPA), which uses software robots or ‘bots’ to mimic
human activity, has the potential to unlock yet more value by freeing up employees to focus on value-added
work – ultimately transforming the way the financial services sector operates. In 2018, we will see how this will
impact RegTech, data analytics and ultimately how organisations service their clients. A gamechanger for the
industry will be the start of the processes to replace people with robotics and machine learning.

The Reality of Blockchain. The use of the distributed ledger technology will no longer be just hypothetical.
The opportunities for financial services who invest in such technology are endless from reducing operational
costs to improving efficiency.

Simplifying Digitalisation. Business is becoming more about the user experience. Automated user interfaces
can go a long way to helping this and embracing digitalisation is key in making it happen. The upcoming year
will be all about the simplification of processes and digitalisation.

The Changing Political Climate. Brexit will remain a buzzword and continue to make headlines. As more
details of the UK’s departure from the EU become clear, we will see banks and institutions adapting
accordingly. Many will have to keep a close eye on their strategy if they are to survive and thrive in 2018.

Banking Regulations. 2018 will be a turning point for financial regulation. Alongside General Data Protection
Regulation (GDPR) and Markets in Financial Instruments Directive (MiFID II), the requirements for central
clearing and the second Payments Services Directive (PSD2) will force significant changes to the banking
environment, with the innovators and disrupters emerging as the winners.

FinTech Collaboration: One of the largest technology shakeups in banking in recent years has been the use
of advanced data analytics techniques to catch rogue trading activities within banks. In 2018, banks will have
to decide whether to service clients in house or through a third party to stay competitive.
Name: _____________________________________

1. In what way Robots (A.I.) can be an advantage(s) and disadvantage(s) of in the world of
Finance? Explain your answer.

2. What are your thoughts on this “Are robots taking over the world’s finance jobs?”. Discuss your
answer.

3. Why are some banks reaching out to become one-stop financial - service conglomerates?
Is this a good idea, in your opinion?

4. What do you think the financial - services industry will look like 20 years from now?
What are the implications of your projections for its management today?