The banking system of the Russian Federation

The term “bank” as we know it now appeared in 15^th century in Italy from the Italian word “banca” meaning 'bench', the table at which a dealer in money worked. Now “bank” is a special financial institution which offers savings and check accounts, makes loans and provides other financial services, making profits mainly from the difference between interest paid on deposits and charged for loans, plus fees for accepting bills and other services.

In the ancient temples of Egypt, Babylonia and Greece, the gold and silver deposited for safekeeping were then loaned at high interest rates and was a simple form of banking, which in fact does exist now. The Greeks, Romans and Byzantines developed private banking to a certain extent. In the Medieval times, banking was dominated by the Jews and Levantines because of the strictures of the Christian Church were against interest and because many other occupations were largely closed to Jews. With the growth of industry and trade, banks developed rapidly throughout the 18th and 19th centuries. Different countries evolved different forms of banking individual to its economic and social life. The ancestors of the modern banks were often designed for a specific purpose. The Bank of Venice (1171) and the Bank of England (1694) were chartered regarding loans to the government while the Bank of Amsterdam (1609) was chartered to receive deposits of gold and silver.

The Bank of Barcelona in Spain is considered to be the first bank to offer most of the basic banking operations we are familiar with. Merchants founded it in 1401 and this bank held deposits, exchanged currency, and carried out lending operations. The bank check is believed to have been introduced by this bank. The institutions that laid the foundation for modern banks of deposit and transaction were the Bank of Amsterdam (1609), the Bank of Venice (1587), and the Bank of Hamburg (1619). A committee of city officials managed each of these banks.

Powerful statesmen and wealthy private bankers, who controlled the banking industry for over 300 years, line Europe's banking history. The Medici family in Florence and the Fuggers in Germany are most popular. The Rothschild family, founded by a German financier Mayer Amschel Rothschild, was perhaps the most influential bankers in all of Europe and in the world in the 19th century.

3. The modern banking system of the world. Commercial banks

Banks, as we have already discussed, are authorized financial institutions that perform four main functions. They accept deposits from people and commercial companies, and use them to make loans and investments, arrange payments and provide a number of other services for customers.

People keep their savings in banks for several reasons. Funds are generally safer in a bank than elsewhere. A bank account provides a convenient way to pay bills. People who deposit money in a bank are actually lending it to the bank, that typically pays interest for the use of the funds.

Banks help to promote economic growth in different ways and so their role in the development of any country can not be overestimated.

Non-financial (Commercial) firms borrow money from banks to develop their activities - buy new equipment and build new factories. People who do not have enough savings to pay immediately the full price of a house, an automobile, or other products also borrow from banks. In these ways, banks help to promote the production and sale of goods and services, and so help to create jobs.

Banks nowadays are not dying out - they are changing. Typically, we see a cycle of innovation. Banks develop a complex new product, extract some rents for a while, and, eventually, the product becomes well understood and is offered by the market. Banks then move on to new products.

Like all businesses, banks try to earn profits. They have traditionally done so in very simple way by accepting deposits at one rate of interest and then lending and investing those funds at a higher rate (and continue doing so). But large banks also earn fees from other activities, such as brokerage (buying and selling securities for other investors) or selling insurance.

So, coming closer to the main subject of this Chapter we may define modern banking system as a combination of different kinds of banks performing on the territory of a country. Banks have been traditionally distinguished to different types according to their functions. In most developed countries of the world there is a so called two-tier banking system, which consists of commercial banks, whose activity will be described below and one central bank, whose business differs from the commercial banks'.

To understand the growing role of commercial bank in the economy of the country we have to answer several questions.

The first one is: «What is a commercial bank? »

We have already defined the term bank above and it is important to mention that financial experts sometimes use the word “bank” to refer only to a commercial bank because other institutions (savings and credit unions and insurance companies) do not perform all the functions of commercial banks or more restricted from regulatory point of view.

Now commercial banks offer a more diverse set of products and services than ever before (in addition to their primary functions of making loans and investments and handling demand as well as savings and other time deposits) often crossing business lines in their effort to make sure their clients get the financial services they need.

The second one: “What do banks do for their customers?”

Here I would like to concentrate only on some basic commercial banking services which include:

Safeguarding deposits

Deposits in a bank are relatively safe. Banks keep cash and other liquid assets available to meet withdrawals. Liquid assets include securities that can be readily converted to cash. Banks are also insured against losses from robberies. But the most important safeguard is the fact that in most countries, governments have established deposit insurance programs. The insurance protects people from losing their deposits if a bank fails.

A bank not only keeps savings safe but also helps them grow. Funds deposited in a savings account earn interest at a specified annual rate. Many banks also offer a special account for which they issue a document called a certificate of deposit (CD). Most CD accounts pay a higher rate of interest than regular savings accounts. However the money must remain in the account for a certain period, such as one or two years, to earn the higher rate of interest. Banks also offer money market accounts. These accounts pay an interest rate based on the prevailing rates for short-term corporate and government securities.

Providing a means of payment

People who have funds in a bank checking account can pay bills by simply writing check and mailing it. A check is a safe method of settling debts, and the canceled check provides proof of payment. Customers may also ask a bank to automatically pay recurring bills, such as telephone and mortgage payments, by a process called direct deposit deduction. Many banks allow people to pay bills electronically by telephone or through the Internet computer network.

Many banks offer credit cards. People can use the cards to pay for their purchases at stores and other businesses

The bank then pays the businesses directly and sends the customer a monthly bill for the amount charged. The cardholder can usually choose to pay only part of the bill immediately. If so, he or she must pay a finance charge on the unpaid balance.

Making loans and credits

Banks receive funds from people who do not need them at the moment and lend them to those who do. For example, a couple may want to buy a house but have only part of the purchase price saved. If one or both c them have a good job and seem likely to repay a loan, a bank may lend them the additional money they need. To make the loan, the bank uses funds other people have deposited. They also lend money to companies who may use it to buy equipment, inventory, supplies or to fund expansion efforts. Credit is particularly important to companies that rely on seasonal sales or face other situations, which can affect their cash flow.

Cash management services

That means investing of excess funds in safe investment vehicles that brings the company or a person income without putting its capital at risk.

International trade services

This is a rapidly growing area because very many companies operate across borders. This may include helping clients exchange currencies, reconcile accounting differences between countries, meet local legal or regulatory requirements, keep assets safely in trust around the globe, set up relationships with local banks or branches of their main bank in other countries, and guarantee their creditworthiness to investors, bankers and merchants so that they can do business abroad.

Other services include:

Corporate finance, insurance products, leasing services, brokerage services.

The third question: “Why do banks perform those services?”

Most of commercial banks in the world are private firms with a public purpose.

It is owned by stockholders who buy shares in it. In return for acquiring a bank's stock, stockholders expect the bank ultimately to pay them cash dividends from its profits. So they seek to maximize shareholder wealth by earning profits. But they can earn a profit only by taking risk, and that is why banking in general is management of different types of risks. (I would like just to mention these types not trying to analyze all of them in particular because it is a very complicated problem that demands special investigation).

-- Credit risk

-- Interest rate risk

-- Liquidity risk

-- Price risk

-- Foreign exchange risk

-- Compliance risk

-- Strategic risk

-- Reputation risk

It is absolutely important to stress that a major obligation of a bank is to permit depositors to withdraw their funds upon demand. But no bank has enough cash readily available to satisfy its depositors if all were to demand their funds at the same time. Banks know from experience, however, that such a demand-called a run-rarely occurs. If people are confident they can withdraw their funds at any time, they will leave them on deposit at the bank until needed. As a result, banks can loan and invest a large percentage of the funds deposited with them. In most countries, the government limits the percentage of a bank's funds that can be used for loans and investment. The government through the central bank simultaneously sets a minimum percentage of funds that must be kept on reserve for meeting withdrawals.

For better understanding of a banks activities and its' structure we have to understand what are principal sources and uses of funds for commercial banks. Basically they are as follows:

Assets (use of funds)

Loans

commercial and industrial (C&I) loans

real estate loans

consumer loans

Investments

short-term, liquid securities (e.g., Government securities)

long-term securities

Cash

Other assets

Buildings, equipment, etc.

Liabilities (sources of funds)

Deposits

Non-deposit sources of fund

Equity

Relatively small compared to debt sources of funds.

Highly leveraged compared to non-financial firms.

The inner structure of any commercial bank depends on the set of business functions this or that bank performs now or is going to perform in the nearest future according to the strategies of management and needs of its clients.

Usually the inner structure of a commercial bank looks like following:

High management of the bank, who effects general strategic long term management,

Departments:

Credit/Loan department - responsible for issuing credits to commercial companies and loans to individuals. Sometimes if the volume of both types of operations is very high these departments are separated.

Treasury Department/Assets and Liabilities department - Responsible for calculating a budget of a bank based on cash flow of assets and liabilities,

Funding the bank activity and internal operations, effecting foreign exchange transactions, operates on capital and money market on behalf of the customers of the bank and on it s own behalf. (in some banks these departments are separated)

Settlements Department - responsible for all types of payments (including international) made by bank itself or its' customers. It effects direct currency payments and documentary operations - Letters of Credit and Collections which are very popular in international trade.

Corporate finance department - responsible for providing long term funds for large industrial and commercial companies- customers of the bank by effecting market operations (like issuing customers bonds - to attract additional to bank credit funds for long term projects).

Correspondent banking Department - provides correspondent relations (opens accounts) with local and foreign banks, monitors financial standing of the above banks, sets limits for operations with local and foreign bank and controls these limits, coordinates activities of the bank's departments in respect of cooperation with other banks.

Personnel (Human Resources) Department -

conducts and the matters of all kinds related to banks' staff,

develops the bank's personnel policy and takes necessary measures for it's effective application, informs the employees of regulations, rights and social security, develops on effective training system

Retail Banking Department -

introduces new products and technologies in all branches of a bank

Provides different types of transfers within home country and abroad:

Transfers from bank account, transfers without opening an account,

Issues and services debit and credit cards

Legal Department - responsible for legislation of banking activity, represents the bank's interests in courts. The role of this department very important.

Accounting Department-

Carries out control of the operations of the bank, supervises financial and economic activity.

Economic Analyses and Banking Development Department

Regional Development Department

- builds and develops bank's funds in different areas of the country and abroad, supervises the of the bank's branch network

It is important to mention that some banks may have different structure, which may better reflect its' operations, for example Investment banks (they can also be attributed to commercial banks) will have different structure because they are concentrated mostly on medium and long term investments and not for retail business.

4. Central banks

Most countries also have agencies called central banks. Although they are called banks, they do not accept deposits or lend money to the public.

Central banks, which in most countries are government agencies, perform financial services for national governments.

Their chief responsibility is to help stabilize interest rates, prices, and overall economic activity. Central banks do so by influencing the money supply, which is the total quantity of money in a country, including cash and bank deposits.

Only central bank of a country has the right to issue money in circulation. Central banks also perform a variety of services for other banks. For example, they serve as a lender of last resort: they make emergency loans to banks that need cash for unexpected deposit withdrawals. Central banks also handle the clearing of checks, the process by which banks settle claims against one another that result from the use of checks.

The functions of central banks may differ from country to country. In the United States, the Federal Reserve System, often called simply the Fed, is the central bank. The Fed helps regulate and supervise commercial banks. But the Bank of England, the United Kingdom's central bank, does not regulate banks. The Monetary Authority of Singapore carries out most functions of a central bank in that country. However, unlike the Fed and the Bank of England, it does not issue currency.

As a conclusion I have to say that Central and Commercial banks is one of the most important part of economy and all discussions like “Do we still need commercial banks?” are to my mind useless: the banking system may change but not disappear.

5. The banking system of modern Russia. The current banking system overview

Not to go back to the very beginning of banking system of Russian Empire and Soviet era, I would like to start from beginning of 1990 when The Soviet Union collapsed.

The financial system of the Soviet period was a rudimentary mechanism for state control of the economy. There was a mono-bank system with the only one - government owned Bank, which managed the banking system. It was The State Bank (or Gosbank), which acted as the only commercial bank of the country. In its capacity as a Central Bank, Gosbank handled all significant banking transactions, including the issuance and control of currency and credit, the management of gold reserves, and the oversight of transactions among enterprises. Enterprises were issued money and credits in accordance with the government's planned allocation of wages and its management strategy for other expenses.

But in the 1990s, Russia's financial sector, particularly its banking system, has been one of the fastest changing elements of the economy it has developed from the centralized system of the Soviet period (as was mentioned above) to a two-tire system, including a central bank and commercial banks, which is, as we know, the standard structure in most market-based economies.. Although changes have moved clearly in the direction of market principles, in the mid-1990s much additional reform was necessary to achieve stability.

6. The Central Bank of the Russian Federation

On December 20, 1991, the State Bank of the USSR was disbanded and all its assets, liabilities and property in the RSFSR were transferred to the Central Bank of Russia, which several months later was renamed the Central Bank of the Russian Federation.

The Bank of Russia carries out its functions, which were established by the Constitution of the Russian Federation (Article 75) and the Law on the Central Bank of the Russian Federation (Bank of Russia) (Article 22), independently of the federal, regional and local government structures. Central bank of Russia

- elaborates and pursues a single state monetary policy in interaction with the Government of the Russian Federation;

- exercises its exclusive right to issue currency and manages currency circulation;

- acts as the lender of last resort for credit institutions and manages the system of refinancing them;

- sets the rules to effect settlements in the Russian Federation;

- sets the rules to conduct banking operations;

- manages all categories of budget accounts, unless otherwise is stipulated by federal laws, by effecting settlements upon the instruction of authorized bodies of executive power and government extra-budgetary funds responsible for organizing budget execution and executing them;

- efficiently manages Bank of Russia international reserves;

- makes decisions on the state registration of credit institutions, issues banking licenses to credit institutions and suspends and revokes them;

- supervises the activities of credit institutions and banking groups;

- registers the issue of securities by credit institutions in compliance with federal laws;

- conducts on its own or on the instruction of the Russian Government all kinds of banking operations and other transactions necessary for the fulfillment by the Bank of Russia of its functions;

- organizes and implements foreign exchange regulation and foreign exchange control in compliance with federal legislation;

- establishes the procedure for effecting settlements with international organizations, foreign states and also legal entities and private individuals;

- sets the accounting and reporting rules for the Russian banking sector;

- sets and publishes the official exchange rates of foreign currencies against the ruble;

- participates in drafting the Russian balance of payments forecast and organizes the compiling of the balance of payments of the Russian Federation;

- establishes the procedure and terms and conditions for the organization by foreign currency exchanges of operations to buy and sell foreign exchange and issues, suspends and revokes permits granted to currency exchanges to organize operations to buy and sell foreign exchange. (The Bank of Russia will issue, suspend and revoke permits granted to currency exchanges to organize operations to buy and sell foreign exchange once the federal law amending the Federal Law on the Licensing of Individual Kinds of Activity comes into force);

- analyses and makes forecasts on the state of the Russian economy as a whole and by region, especially with regard to monetary, foreign currency, finance and price relationships, and publishes corresponding materials and statistical data;

- performs other functions in pursuance of federal laws.

In its first years The Bank of Russia has had the greatest impact on Russia's economy through its role in monetary policy. The RCB controls the money supply by lending funds to commercial banks and by establishing their reserve requirements. For several years after its establishment, the RCB issued direct credits to enterprises and to the agricultural sector at special rates. Such credits were directed via commercial banks to strategically important sectors of Russian economy: agriculture, the industrial and energy enterprises of the northern regions, the energy sector in general, and other large, state-run enterprises.

The Bank of Russia monetary policy was designed to maintain financial stability and create conditions conducive to sustainable economic growth. The Bank of Russia promptly reacted to any change in the real demand for money and took steps to stimulate positive economic dynamics, cut interest rates, damp down inflationary expectations and slow the inflation rate. As a result, the ruble gained somewhat in real terms and financial market stability increased.

Due to the balanced monetary and exchange-rate policies pursued by the Bank of Russia, the country's gold and foreign exchange reserves have grown for the past 10 years: from 15Bln. USD in 1995 to 138.9 Bln. USD in March 2005:

Source: Association of Russian Banks, 2004

And there have been no extremely sharp fluctuations in the exchange rate. The efforts made by the Bank of Russia with regard to the payment system aimed at increasing its reliability and efficiency in the name of financial and economic stability. To make the Russian payment system more transparent, the Bank of Russia introduced reports on payments by credit institutions and its own regional branches, which took into account international experience, methodology and practice of surveillance over payment systems.

In 2003, the Bank of Russia launched the implementation of a project to improve banking supervision and prudential reporting through the introduction of international financial reporting standards

In December same year the Federal Law "On Insurance of Individual Bank Deposits in the Russian Federation" was adopted. The law stipulates the legal, financial and organizational framework for the system of mandatory insurance of individual bank deposits in the Russian Federation, and also the powers, procedure for the establishment and operation of an institution which performs functions of mandatory deposit insurance, and the procedure of deposit compensation payments. It was absolutely inevitable because most of Russian commercial banks are currently operating on a lopsided playing field, in particular where retail deposits are concerned. Only Sberbank, which monopolizes the retail banking market with about 75 percent of all deposits and a network incomparably larger than its nearest competitor, had by that time a government guarantee for deposits.

Deposit insurance killed two birds with one stone, that is, meet the need for consolidation and for competition on equal grounds.

The quality of reform can be judged by the quality of the set of requirements that are designed.

And finally one of the most significant and important points in Central Bank activity is that it has started to carry out the key function of all central banks - it has become the lender of last resort to commercial banks. Of course at present - with the aim to minimize risk of non-payment of its loan to banks - it lends funds to banks only for very short period of time on collateralized basis which means it takes from the bank extremely reliable and liquid securities (mainly government bonds) as a back-up of the loan.

All the above shows the intentions and ability of the Bank of Russia to control activities of commercial banks in order to optimize risk of their operations in the country.