The faith of the people in the financial sector was shaken due to the crisis faced by the countries in Europe and America. When we look back, we can make out the reasons for this happening.One reason that emerges is the failure of the bankers to play their role effectively.
Therefore, it is very important for every banker to understand his/her role. The role can be better appreciated, once we understand the basics of banking.
Banking is a simple activity. Primarily it is based on trust. The bankers mobilise savings from people and pay interest on that. The savings thus mobilised is lent by the bankers to the borrowers to earn interest. The difference between the interest earned and the interest paid is the income for the bank. Further, the bank also earns income by offering payment and collection services, fund management, trading in securities and services related to foreign currencies and equities. The income earned from these activities is Non-Interest Income.
If an organisation fails in payment and collection services, the whole financial system will come to grief. Therefore, the Central Banks will allow only the banks to offer this service.
It is important to note that "Interest Income on advances" is "bread and butter" for the banks, whereas "Non-Interest Income" is the "jam" for the banks.
The bankers have come a long way. However, there was not much change in the way banking was done for 150 years since the beginning of banking. Even in 1980s, cheque collection used to take 45 days and there was strong resistance for change in banks!
However, change was inevitable and computers were introduced in banks. One after another,
technology based solutions were launched and there was change for better. Now, there is instant transfer of money. Cash withdrawal and many other facilities are available through ATMs throughout the day.
Even in such a changed scenario there is no change in the role of banks i.e., "financial intermediation". It refers to bringing together "savers" and "users of money". We may contrast this with "financial dis-intermediation", which refers to the direct relationship between "savers" and "users". The extent of these depends on the deepening of financial market.
It is necessary to understand why people save and why people borrow. Once we understand that, we realise that the entire activity is based on trust.
Let us say, two persons are living in adjacent flats. Mr.A and Mr.B will see and greet each other every day. Mr.A wants to deposit his money and Mr.B wants to borrow money. Instead of transacting between themselves, both of them will come to a bank to meet their financial need. Because, it is a matter of trust.
Actually, the foundation of all human transaction, including financial transactions, is trust. Please remember, a relationship developed over a period of several years can be destroyed by a single incident which creates suspicion.
Therefore, it is absolutely necessary for the bankers not only to be honest but also appear to be honest in each and every action.
The people who want to save are basically transferring the risk to bankers because they trust the bankers. Similarly, borrowers who borrow money from the banks are risk takers. And, the bankers, being financial intermediaries are the risk bearers.
Once we understand this complex relationship, we can realise the importance of "risk assessment."
The banks are lending the valuable savings of some people to some other people. Every care should be taken to assess the trustworthiness of borrowers, so as to ensure the safety and liquidity of the money, which was accepted on trust. Further, banks should be very efficient in risk management also.
To conclude, Bankers should learn lessons from history to ensure safety and liquidity of the savings of millions of people which they hold in trust. Collapse of 230 years old Barings Bank (a British Merchant Bank) due to illegal actions of one individual in 1995 is an eye opener for everyone. Recent developments in the financial markets should serve as a caution to every banker, about the need to maintain high ethical standards in his / her transactions.. Their ability to continuously learn alone can help them to adopt to the changes and develop as Professional Bankers to face the challenges of banking in future.
Photo: SBI HQ at Mumbai