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| Functions of Commercial Banks |
Banking Awareness Notes - Functions of Commercial
Banks
Commercial
banks have to perform a variety of functions which are common to both developed
and developing countries. These are known as ‘General Banking’ functions of the
commercial banks. The modern banks perform a variety of functions. These can be broadly divided into two
categories: (a) Primary functions and (b) Secondary functions.
A. Primary
Functions
Primary banking
functions of the commercial banks include:
1. Acceptance of deposits
2. Advancing loans
3. Creation of credit
4. Clearing of cheques
5. Financing foreign trade
6. Remittance of funds
1. Acceptance of Deposits: Accepting deposits
is the primary function of a commercial bank mobilise savings of the household
sector. Banks generally accept three types of deposits viz., (a) Current
Deposits (b) Savings Deposits, and (c) Fixed Deposits.
(a)
Current Deposits: These deposits are also known as demand deposits.
These deposits can be withdrawn at any time. Generally, no interest is allowed
on current deposits, and in case, the customer is required to leave a minimum
balance undrawn with the bank. Cheques are used to withdraw the amount. These
deposits are kept by businessmen and industrialists who receive and make large
payments through banks. The bank levies certain incidental charges on the
customer for the services rendered by it.
(b)
Savings Deposits: This is meant mainly for professional men and middle
class people to help them deposit their small savings. It can be opened without
any introduction. Money can be deposited at any time but the maximum cannot go
beyond a certain limit. There is a restriction on the amount that can be
withdrawn at a particular time or during a week. If the customer wishes to
withdraw more than the specified amount at any one time, he has to give prior
notice. Interest is allowed on the credit balance of this account. The rate of
interest is greater than the rate of interest on the current deposits and less
than that on fixed deposit. This system greatly encourages the habit of thrift
or savings.
(c)
Fixed Deposits: These deposits are also known as time deposits. These
deposits cannot be withdrawn before the expiry of the period for which they are
deposited or without giving a prior notice for withdrawal. If the depositor is
in need of money, he has to borrow on the security of this account and pay a
slightly higher rate of interest to the bank. They are attracted by the payment
of interest which is usually higher for longer period. Fixed deposits are liked
by depositors both for their safety and as well as for their interest. In
India, they are accepted between three months and ten years.
2. Advancing Loans: The second primary function of a
commercial bank is to make loans and advances to all types of persons,
particularly to businessmen and entrepreneurs. Loans are made against personal
security, gold and silver, stocks of goods and other assets. The most common
way of lending is by:
(a)
Overdraft Facilities: In this case, the depositor in a current account
is allowed to draw over and above his account up to a previously agreed limit.
Suppose a businessman has only Rs. 30,000/- in his current account in a bank
but requires Rs. 60,000/- to meet his expenses. He may approach his bank and
borrow the additional amount of Rs. 30,000/-. The bank allows the customer to
overdraw his account through cheques. The bank, however, charges interest only
on the amount overdrawn from the account. This type of loan is very popular
with the Indian businessmen.
(b)
Cash Credit: Under this account, the bank gives loans to the borrowers
against certain security. But the entire loan is not given at one particular
time, instead the amount is credited into his account in the bank; but under
emergency cash will be given. The borrower is required to pay interest only on
the amount of credit availed to him. He will be allowed to withdraw small sums
of money according to his requirements through cheques, but he cannot exceed
the credit limit allowed to him. Besides, the bank can also give specified loan
to a person, for a firm against some collateral security. The bank can recall
such loans at its option.
(c)
Discounting Bills of Exchange: This is another type of lending which is
very popular with the modern banks. The holder of a bill can get it discounted
by the bank, when he is in need of money. After deducting its commission, the
bank pays the present price of the bill to the holder. Such bills form good
investment for a bank. They provide a very liquid asset which can be quickly
turned into cash. The commercial banks can rediscount, the discounted bills
with the central banks when they are in need of money. These bills are safe and
secured bills. When the bill matures the bank can secure its payment from the
party which had accepted the bill.
(d)
Money at Call: Bank also grant loans for a very short period, generally
not exceeding 7 days to the borrowers, usually dealers or brokers in stock
exchange markets against collateral securities like stock or equity shares,
debentures, etc., offered by them. Such advances are repayable immediately at
short notice hence, they are described as money at call or call money.
(e)
Term Loans: Banks give term loans to traders, industrialists and now to
agriculturists also against some collateral securities. Term loans are
so-called because their maturity period varies between 1 to 10 years. Term
loans, as such provide intermediate or working capital funds to the borrowers.
Sometimes, two or more banks may jointly provide large term loans to the
borrower against a common security. Such loans are called participation loans
or consortium finance.
(f)
Consumer Credit: Banks also grant credit to households in a limited
amount to buy some durable consumer goods such as television sets,
refrigerators, etc., or to meet some personal needs like payment of hospital
bills etc. Such consumer credit is made in a lump sum and is repayable in
instalments in a short time. Under the 20-point programme, the scope of
consumer credit has been extended to cover expenses on marriage, funeral etc.,
as well.
(g)
Miscellaneous Advances: Among other forms of bank advances there are
packing credits given to exporters for a short duration, export bills
purchased/discounted, import finance-advances against import bills, finance to
the self employed, credit to the public sector, credit to the cooperative
sector and above all, credit to the weaker sections of the community at
concessional rates.
3. Creation of Credit: A unique function of the bank is
to create credit. Banks supply money to traders and manufacturers. They also
create or manufacture money. Bank deposits are regarded as money. They are as
good as cash. The reason is they can be used for the purchase of goods and
services and also in payment of debts. When a bank grants a loan to its
customer, it does not pay cash. It simply credits the account of the borrower.
He can withdraw the amount whenever he wants by a cheque. In this case, bank
has created a deposit without receiving cash. That is, banks are said to have
created credit. Sayers says “banks are not merely purveyors of money, but also
in an important sense, manufacturers of money.”
4. Promote the Use of Cheques: The commercial banks
render an important service by providing to their customers a cheap medium of
exchange like cheques. It is found much more convenient to settle debts through
cheques rather than through the use of cash. The cheque is the most developed
type of credit instrument in the money market.
5. Financing Internal and Foreign Trade: The bank
finances internal and foreign trade through discounting of exchange bills.
Sometimes, the bank gives short-term loans to traders on the security of
commercial papers. This discounting business greatly facilitates the movement
of internal and external trade.
6. Remittance of Funds: Commercial banks, on account of
their network of branches throughout the country, also provide facilities to
remit funds from one place to another for their customers by issuing bank
drafts, mail transfers or telegraphic transfers on nominal commission charges.
As compared to the postal money orders or other instruments, bank drafts have
proved to be a much cheaper mode of transferring money and has helped the
business community considerably.
B. Secondary
Functions
Secondary
banking functions of the commercial banks include:
1. Agency Services
2. General Utility Services
1. Agency Services: Banks also perform
certain agency functions for and on behalf of their customers. The agency
services are of immense value to the people at large.
The various
agency services rendered by banks are as follows:
(a)
Collection and Payment of Credit Instruments: Banks collect and pay
various credit instruments like cheques, bills of exchange, promissory notes etc.,
on behalf of their customers.
(b)
Purchase and Sale of Securities: Banks purchase and sell various
securities like shares, stocks, bonds, debentures on behalf of their customers.
(c)
Collection of Dividends on Shares: Banks collect dividends and interest
on shares and debentures of their customers and credit them to their accounts.
(d)
Acts as Correspondent: Sometimes banks act as representative and
correspondents of their customers. They get passports, traveller’s tickets and
even secure air and sea passages for their customers.
(e)
Income-tax Consultancy: Banks may also employ income tax experts to
prepare income tax returns for their customers and to help them to get refund
of income tax.
(f)
Execution of Standing Orders: Banks execute the standing instructions
of their customers for making various periodic payments. They pay
subscriptions, rents, insurance premia etc., on behalf of their customers.
(g)
Acts as Trustee and Executor: Banks preserve the ‘Wills’ of their
customers and execute them after their death.
2. General Utility Services: In addition to agency
services, the modern banks provide many general utility services for the
community as given.
(a)
Locker Facility: Bank provides locker facility to their customers. The
customers can keep their valuables, such as gold and silver ornaments,
important documents; shares and debentures in these lockers for safe custody.
(b)
Traveller’s Cheques and Credit Cards: Banks issue traveller’s cheques
to help their customers to travel without the fear of theft or loss of money.
With this facility, the customers need not take the risk of carrying cash with
them during their travels.
(c)
Letter of Credit: Letters of credit are issued by the banks to their
customers certifying their credit worthiness. Letters of credit are very useful
in foreign trade.
(d)
Collection of Statistics: Banks collect statistics giving important
information relating to trade, commerce, industries, money and banking. They
also publish valuable journals and bulletins containing articles on economic
and financial matters.
(e)
Acting Referee: Banks may act as referees with respect to the financial
standing, business reputation and respectability of customers.
(f)
Underwriting Securities: Banks underwrite the shares and debentures
issued by the Government, public or private companies.
(g)
Gift Cheques: Some banks issue cheques of various denominations to be
used on auspicious occasions.
(h)
Accepting Bills of Exchange on Behalf of Customers: Sometimes, banks
accept bills of exchange, internal as well as foreign, on behalf of their
customers. It enables customers to import goods.
(i)
Merchant Banking: Some commercial banks have opened merchant banking divisions
to provide merchant banking services.
