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What is exactly Banking? 

 

A banker or bank is a financial institution that acts as a payment agent for customers, and borrows and lends money. In some countries such as Germany and Japan banks are the primary owners of industrial corporations while in other countries such as the United States banks are prohibited from owning non-financial companies.

The first modern bank was founded in Italy at Genoa in 1406, its name was Banco di San Giorgio (Bank of St. George).

Banks act as payment agents by conducting checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and ATM.

Banks borrow money by accepting funds deposited on current account, accepting term deposits and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current account, by making installment loans, and by investing in marketable debt securities and other forms of lending.

Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account.

Banks borrow most funds borrowed from households and non-financial businesses, and lend most funds lent to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings to.

 

Definition

The definition of a bank varies from country to country.

Under English law, a bank is defined as a person who carries on the business of banking, which is specified as:

  • conducting current accounts for his customers
  • paying cheques drawn on a him, and
  • collecting cheques for his customers.

In most English common law jurisdictions there is a Bills of Exchange Act that codifies the law in relation to negotiable instruments, including cheques, and this Act contains a statutory definition of the term banker: banker includes a body of persons, whether incorporated or not, who carry on the business of banking' (Section 2, Interpretation). Although this definition seems circular, it is actually functional, because it ensures that the legal basis for bank transactions such as cheques do not depend on how the bank is organised or regulated.

The business of banking is in many English common law countries not defined by statute but by common law, the definition above. In other English common law jurisdictions there are statutory definitions of the business of banking or banking business. When looking at these definitions it is important to keep in mind that they are defining the business of banking for the purposes of the legislation, and not necessarily in general. In particular, most of the definitions are from legislation that has the purposes of entry regulating and supervising banks rather than regulating the actual business of banking. However, in many cases the statutory definition closely mirrors the common law one. Examples of statutory definitions:

  • "banking business" means the business of receiving money on current or deposit account, paying and collecting cheques drawn by or paid in by customers, the making of advances to customers, and includes such other business as the Authority may prescribe for the purposes of this Act; (Banking Act (Singapore), Section 2, Interpretation).
  • "banking business" means the business of either or both of the following:
  1. receiving from the general public money on current, deposit, savings or other similar account repayable on demand or within less than [3 months] ... or with a period of call or notice of less than that period;
  2. paying or collecting cheques drawn by or paid in by customers

Since the advent of EFTPOS (Electronic Funds Transfer at Point Of Sale), direct credit, direct debit and internet banking, the cheque has lost its primacy in most banking systems as a payment instrument. This has lead legal theorists to suggest that the cheque based definition should be broadened to include financial institutions that conduct current accounts for customers and enable customers to pay and be paid by third parties, even if they do not pay and collect cheques.

 

Electronic funds transfer or EFT refers to the computer-based systems used to perform financial transactions electronically.

The term is used for a number of different concepts:

  • cardholder-initiated transactions, where a cardholder makes use of a payment card
  • electronic payments by businesses, including salary payments
  • electronic check (or cheque) clearing

 

 Card-based EFT

Credit cards
Credit cards

EFT may be initiated by a cardholder when a payment card such as a credit card or debit card is used. This may take place at an automated teller machine (ATM) or point of sale (EFTPOS), or when the card is not present, which covers cards used for mail order, telephone order and internet purchases.

Card-based EFT transactions are often covered by the ISO 8583 standard.

Transaction types

A number of transaction types may be performed, including the following:

  • Sale: where the cardholder pays for goods or service.
  • Refund: where a merchant refunds an earlier payment made by a cardholder.
  • Withdrawal: the cardholder withdraws funds from their account, e.g. from an ATM. The term Cash Advance may also be used, typically when the funds are advanced by a merchant rather than at an ATM.
  • Deposit: where a cardholder deposits funds to their own account (typically at an ATM).
  • Cashback: where a cardholder withdraws funds from their own account at the same time as making a purchase.
  • Inter-account transfer: transferring funds between linked accounts belonging to the same cardholder
  • Payment: transferring funds to a third party account
  • Inquiry: a transaction without financial impact, for instance balance inquiry, available funds inquiry, linked accounts inquiry, or request for a statement of recent transactions on the account.
  • Administrative: this covers a variety of non-financial transactions including PIN change.

The transaction types offered depend on the terminal. An ATM would offer different transactions from a POS terminal, for instance.

Authorization

EFT transactions require communication between a number of parties. When a card is used at a merchant or ATM, the transaction is first routed to an acquirer, then through a number of networks to the issuer where the cardholder's account is held.

A transaction may be authorized offline by any of these entities through a stand-in agreement. Stand-in authorization may be used when a communication link is not available, or simply to save communication cost or time. Stand-in is subject to the transaction amount being below agreed limits. These limits are calculated based on the risk of authorizing a transaction offline, and thus vary between merchants and card types. Offline transactions may be subject to other security checks such as checking the card number against a 'hotcard' (stolen card) list, velocity checks (limiting the number of offline transactions allowed by a cardholder) and random online authorization.

A transaction may be authorized via a pre-authorization step, where the merchant requests the issuer to reserve an amount on the cardholder's account for a specific time, followed by completion, where the merchant requests an amount blocked earlier with a pre-authorization. This transaction flow in two steps is often used in businesses such as hotels and car rental where the final amount is not known, and the pre-authorization is made based on an estimated amount. Completion may form part of a settlement process, typically performed at the end of the day when the day's completed transactions are submitted.Authentication

EFT transactions may be accompanied by methods to authenticate the card and the card holder. The merchant may manually verify the card holder's signature, or the card holder's Personal identification number (PIN) may be sent online in an encrypted form for validation by the card issuer. Other information may be included in the transaction, some of which is not visible to the card holder (for instance magnetic stripe data), and some of which may be requested from the card holder (for instance the card holder's address or the CVV2 value printed on the card).

EMV cards are smartcard-based payment cards, where the smartcard technology allows for a number of enhanced authentication measures

 

What are credit cards?

A credit card is a system of payment named after the small plastic card issued to users of the system. A credit card is different from a debit card in that it does not remove money from the user's account after every transaction. In the case of credit cards, the issuer lends money to the consumer (or the user) to be paid to the merchant. It is also different from a charge card (though this name is sometimes used by the public to describe credit cards), which requires the balance to be paid in full each month. In contrast, a credit card allows the consumer to 'revolve' their balance, at the cost of having interest charged. Most credit cards are the same shape and size, as specified by the ISO 7810 standard. The most common credit card size, known as ID-1, is 85.60 × 53.98 mm. 

 

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