No Kidding


new internationalist
issue 168 - February 1987

You’re probably helping finance everything from cruise missiles to luxury apartments in Mexico City! For the money we have in banks or insurance companies can be borrowed by almost anyone else. Once it enters the financial system we have very little say in what happens next. On this page we show some of the routes it can follow.


[image, unknown] People save on average around 20 per cent of their earnings - for future purchases, for emergencies or just for long-term security.

Money can be saved in many different ways. Some people put it into banks, others buy shares in companies, others keep their money with large institutions like pension funds or life assurance companies. What you as an individual save then becomes available for spending or investing by someone else. This might be another individual or a company.

In the UK many people also invest in 'building societies' which specifically lend the money out to individuals to buy houses.


[image, unknown] A banking company is established when a group of people, the 'shareholders', get together to contribute a sum of money which will form the bank's capital'. The bank, once it has been registered with the central bank, can then start borrowing and lending money.

People who keep their money in a bank expect to be rewarded for this - to be paid 'interest'. Those who borrow this money, on the other hand, will be charged interest. Since banks charge higher rates of interest than they pay, they earn money from which they can pay their employees, build up some reserves and also distribute profit to the shareholders

Should any borrowers fail to repay, the bank must draw on its reserves or shareholder capital so that the savers do not lose their money.

Banks open to the public are called commercial or 'clearing' banks to distinguish them from investment banks.


[image, unknown] Pension funds or insurance companies cannot simply keep their clients' cash in a safe. For one thing inflation is - likely to reduce its value. But the Institutions would also be losing the opportunity to increase the value of the money they are holding. They can do this by investing in businesses through buying shares and receiving some of the profits. So when the pension or insurance policy is paid out the client can look forward to receiving a sum greater than she or he has paid in. Because they have such vast sums of money at their disposal institutions play a very important part in financial activity - they own 70 per cent of all traded shares.


[image, unknown] People who run a business, like a shop, could start out by using their own savings to buy the premises and the goods to sell. And any money the business earns can be saved and used to purchase extra equipment.

In practice, however, a business is unlikely to find sufficient funds in this way, so it has to borrow money. There are many ways this can be done. The simplest is to use a bank. This is relatively straightforward if the bank considers the business a good investment. But the owners of the business will have to set aside some of their future earnings to repay the loan.

Other ways to get money for investment include selling shares in the company or selling bonds.


[image, unknown] Shares (also called 'equities' - and ' stock' in the US) are pieces of paper which certify that the holder owns a part of a business. A shareholder then has certain rights. These may include the right to vote at general meetings of the Company as well as to receive a 'dividend' - a proportion of any profits which the business makes.

For the owner of the business, obtaining money in this way has the advantage that the money does not need to be repaid. But it has the advantage that control of the company can now rest with the shareholders. And they also expect to be paid dividends.

If the shareholder want to get their money back they cannot generally get it from the company. The shares will have to be sold to someone else - usually through a stock exchange.


[image, unknown] A bond is a piece of paper given in exchange for a borrowed sum of money. It is a written promise to repay the money on a certain date in the future and in the meantime to pay the bondholder a dividend, called a 'coupon'. This will usually be a fixed percentage of the original sum paid on a set date annually.

Buyers of bonds need to trust the sellers of the bonds. So only well-known companies can issue bonds in their name. If the buyer of a bond wishes to be repaid before it is due they can sell it in a stock exchange.

Governments, local and national, sell bonds when they want to raise money. When governments issue bonds there is very little risk of non-payment so such bonds are called 'gilt-edged' investments.

Both shares and bonds come under the general category of securities. And both are usually issued with the help of an investment bank.


[image, unknown] This is where companies can issue shares and bonds - it serves as a 'primary market' for them. But a stock exchange's major function is to act as a 'secondary market', where the reselling or 'exchange' of securities takes place. Access to exchanges is increasingly available through networks of computer terminals.

The resale value of a share will depend on the dividend it is likely to put in the future and therefore on the financial health of the company. It is this resale value the 'share price', which can fluctuate and is published daily in financial papers.

The value of the bond will fluctuate for a different set of reasons: it will be heavily influenced by bank interest rates. The 'interest' from a $100 bond with a coupon of 12 per cent will always be $12. If banks at the time of issue are also paying 12 per cent interest on money deposited with them there would be little to choose between buying a bond or saving the money in a bank. But if bank interest rates fall then a bond previously bought with a 12 per cent coupon will then be worth more. Conversely, bond values fall when interest rates rise.


[image, unknown] Like normal banks these are intermediaries between savers and lenders. But unlike commercial banks they are not open to the public. They provide a variety of services, usually dealing with very large sums of money. This might merely mean acting as a go-between - putting large investors like institutions, as well as wealthy individuals, in touch with companies which need money.

They can also act as advisors to companies when they want to issue shares, judging how many shares to issue and what the price would be. They can also (for a fee) 'underwrite' the issue; this commits them to buying up any shares left unsold.

Like normal banks they must be backed up with share capital from which they can draw if anything goes wrong. Investment banks are also called 'merchant banks' in the UK.


[image, unknown] This is the means by which a government regulates the national financial system. The central bank has many functions. One is to decide how many banknotes should be in circulation and have them printed. The government can get them into circulation by using them to pay its bills.

Another is to supervise the activities of the commercial banks. If a commercial bank gets into trouble because a number of lenders cannot repay their loans the central bank may step in to save it from collapse. It can do this by lending the commercial bank money - and printing more if necessary to do so. In this way it serves as a 'lender of last resort' and helps stabilize the banking system.

Yet another function is to serve as a way in which the government can control interest rates. The central bank can, for example, offer to lend money to the commercial banks at less than the present market rate. This 'competition' from the government would have the effect of driving the market rate down.


[image, unknown] Most official international aid agencies like those of the United Nations are financed directly by governments. But there are other agencies, like the World Bank, which are essentially investment banks which borrow money from financial institutions - by selling World Bank bonds to them for example. The World Bank can then use this money to lend to developing countries. If you consider the projects they finance to be dangerous or harmful to local populations the most direct line of protest is through your political representative: the world's governments are the shareholders in the World Bank.

[image, unknown]
Photo: Camera Press


[image, unknown] You may not consider that you are investing in the stock exchange or elsewhere. But a significant proportion of all our savings is being directed through the financial system and towards things of which we might well disapprove.

Your life insurance policy may be financing US government arms expenditure - even if you are not a US citizen. Your pension may also be invested in countries with repressive regimes which practise torture. Your holiday savings may well be financing companies which manufacture dangerous products like cigarettes.

People concerned about such possibilities are increasingly trying to pressurize banks and financial institutions into investing ethically. And even some of the more obstinate of them are changing their behaviour. The British bank Barclays, for example, has recently withdrawn from investment in South Africa.

Money is very difficult to keep track of once it has left our hands. But if we are persistent and watchful it is possible to exercise some control

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