Commercial Banks & Their Functions

In modern economy commercial Banks Play an important role in the financial sector. A Bank is an institution dealing in money and credit. Credit money is the major component of money supply in a modern economy. Commercial banks are the creators of credit. The strength of economy of any country basically depends on a sound and solvent banking system.

A Commercial bank is a profit seeking business firms dealing in money or rather claims to money. It safeguards the savings of the public and give loans and advances.

The Banking Companies Act of 1949, defines banking company as “accepting for the purpose of lending or investment of deposit money from the public, repayable on demand or otherwise and withdrawable by cheque, drafts, order or otherwise”.

Functions of Commercial Banks:

Modern commercial banks perform a variety of functions. They keep the wheels of commerce, trade and industry always revolving. Major functions of a commercial bank are:

Primary or Banking functions and Secondary or Non-Banking functions.

1. Primary Commercial Banking Functions:

Commercial banks have two important banking functions. One is accepting deposits and other is advancing loans.

A) Deposits:

One of the main function of a bank is to accept deposits from the public. Deposits are accepted by the banks in various forms.

i. Current Account Deposits:

Current Accounts are usually opened by businessmen who have a number of regular transactions with the bank, both deposits and withdrawls. There is no restriction on number and amount of deposits. There is also no restriction on withdrawls. No interest is paid on current deposits. Banks may even charge interest for providing this facility. These accounts are also known as demand deposits as amount can be withdrawn on demand.

ii. Saving Account Deposits:

Saving Accounts are opened by salaried and other less income people. There is no restriction on number and amount of deposits. withdrawls are subject to certain restrictions. It earns Interest but less than fixed deposits. It encourages saving habit among salary earners and others. Saving deposits are an important source of funds for banks.

iii. Fixed Account Deposits:

Deposits in fixed account are time deposits. Money under this account is deposited for a certain fixed period of time varying from 15 days to several years. A high rate of interest is paid. If money is withdrawn before expiry date, the depositor receives lower rate of interest. Deposits can be renewed for further period. Many banks sanction loans against security of fixed deposits.

iv. Recurring Account Deposits:

In Recurring deposit, a specified amount is regularly deposited by account holder, at an internal of usually a month. This is to form the habit of small savings among the people. At the end of maturity period, the account holder gets a substantial amount. Interest on this type of deposit is almost equal to fixed deposits.

Thus by creating variety of deposits, banks motivate people in a variety of ways and encourage savings in the economy.

B) Loans And Advances:

Banks not only mobilize money but also lend to its credit worthy customers for maximizing profits. Loans and Advances are granted to:

i. Business And Trade:

Commercial banks grant short-term loans to business and trade activities in following forms:

a. Overdraft:

Commercial banks grant overdraft facility to current account holders Under this system a borrower is allowed to draw more than what is deposited in his account. The borrower is granted to a fixed additional amount against collateral security. Interest is charged for actual amount drawn.

b. Cash Credit:

Cash credit is given by the bank to any businessman to meet regular working capital needs, against the security of goods or personal security. Interest is charged on actual amount drawn by the customer.

c. Discounting Of Bills:

When the holder of the bill is not in a position to wait till the maturity of the bill and requires cash urgently, he sells the bill of exchange to bank. Bank advance credit by discounting bills of exchange, government securities or any other approved financial instruments. The bank purchases the instruments at a discount.

d. Money At Call:

Banks also grant loans for a very short period, generally not exceeding 7 days. Such advances are repayable immediately at a short notice hence they are called as Money at Call or Call money. These loans are given to dealers or brokers in stock market against Collateral Securities.

e. Direct Loans:

Loans are given to customers against the security of moveable properties. Their maturity varies from 1 to 10 years. Interest has to be paid on entire loan amount sanctioned. Loans are of many types like :- personal loans, term loans, call loans, participative loans, collateral loans etc.

ii. Loans to Agriculture:

Banks grant short-term credit to agriculture at a lower rate of interest. Loans are granted for irrigation, purchase of equipments, inputs, cattle etc.

iii. Loans To Industries:

Banks grant secured loans to small and medium scale industries to meet their working capital needs. The time period may be from one to five years. It may be in the form of Overdraft, cash credit or direct loan.

iv. Loans To Foreign Trade:

Loans are granted to export and import in the form of direct loans, discounting of bills, guarantee for deferred payments etc. Here the rate of interest is low.

v. Consumer Credit/Personal loans:

Banks also grant credit to household in a limited amount to buy some durable consumer goods like television sets, refrigerators, washing machine etc. Such consumer credit is repayable in installments. Under 20-point programme, the scope of consumer credit has been extended to cover expenses on marriage, funeral etc., as well.

vi. Miscellaneous Advances:

Banks also gives advances like packing credits to exporters, export bill purchased or discounted, import finance, finance to self-employed, credit to weaker sections of society at concessional rates etc.

2. Secondary/Non-banking Functions:

Banks gives various forms of services to public. Such services are termed as non- banking or secondary functions:

A) Agency Services:

Banks perform certain functions on behalf of their customers. While performing these services, banks act as agents to their customers, hence these are called as agency services. Important agency functions are:

i. Collection:

Commercial banks collect cheques, drafts, bills, promissory notes, dividends, subscriptions, rents and any other receipts which are to be received by the customer. For these services banks charge a nominal amount.

ii. Payment:

Banks also makes payments on behalf of their customers like paying insurance premium, rent, taxes, electricity and telephone bills etc for such services commission is charged.

iii. Income - Tax Consultant:

Commercial banks acts as income-tax consultants. They prepare and finalise the income tax returns of their clients.

iv. Sale And Purchase Of Financial Assets:

As per the customers instruction banks undertake sale and purchase of securities, shares and any other financial assets. Nominal charges are charged by a bank.

v. Trustee, Executor And Attorney:

As a trustee, banks becomes the custodian and manager of customer funds. Bank also acts as executor of deceased customer’s will. As an Attorney the banks sign the documents on behalf of customer.

vi. E-Banking:

Through Electronic Banking, a customer can operate his bank account through internet. He can make payments of various bills. He can even transfer money from one place to another.

B. Utility Services:

Modern Commercial banks also performs certain general utility services for the community, such as

i. Letter Of Credit:

Banks also deal in foreign trade. They issue letter of credit and provide guarantee to foreign traders for the soundness of their customers.

ii. Transfer Of Funds:

Banks arrange transfer of funds cheaply and safely from one place to another. Transfer can be in the form of Demand draft, Mail transfer Travellers cheques etc.

iii. Guarantor:

Banks offer a guarantee of payment on behalf of importer to facilitate imports with deferred payments.

iv. Underwriting:

This facility is provided to Joint Stock Companies and to government to enable them to raise funds. Banks guarantee the purchase of certain proportion of shares, if not sold in the market.

v. Locker Facility:

Safe Lockers are provided to the customers. So that they can deposit their valuables like Jewellary, Securities, Shares and otherdocuments.

vi. Referee:

Banks may act as referee with respect to financial standing, business reputation and respectability of customers.

vii. Credit Cards:

Credit card facility have been introduced by commercial banks. It enables the holder to minimize the use of hard cash. Credit card is a convenient medium of exchange which enables its holder to buy goods and services from member – establishment without using money.

C. Subsidiary Activities:

Many commercial banks also undertakes subsidiary activities such as:

i. Housing Finance:

Housing finance is provided against the security of immoveable property of land and buildings. Many banks such as SBI, Bank of India etc. have set up housing finance subsidiaries.

ii. Mutual Funds:

A Mutual fund is a financial intermediary that pools the savings of investors for collective investment in diversified portfolio securities Many banks like SBI, Indian Bank etc. have set up mutual fund subsidiaries.

iii. Merchant Banking:

A variety of services are offered by merchant banking like:

Management, Marketing and Underwriting of new issues, project promotion, corporate advisory services, investment advisory services etc.

iv. Venture Capital Fund:

Venture capital fund provides start-up share capital to new ventures of little known, unregistered, risky, young and small private business, especially in technology oriented and knowledge intensive business. Many commercial banks like SBI, Canara Bank etc. have set up venture Capital Fund Subsidiaries.

v. Factoring:

Factoring is a continuing arrangement between a financial intermediary (factor) and a business concern (client) where by the factor purchases the clients accounts recieveable. Banks like SBI and Canara Bank have established subsidiaries to provide factoring services.

Thus various services are provided by commercial Banks.