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Functions of Commercial Banks: Ultimate banking Guideline

Hello, This plays an important role in the growth and development of the economy in general and the enterprise sector in particular. Commercial Bank in India comprises the State Bank of India (SBI) and its subsidiaries, nationalized Banks, foreign banks, and other scheduled commercial banks, regional rural banks, and non-scheduled commercial banks.

The period for which loan is granted varies from 7 to 10 years. These loans are repayable in half-yearly or yearly installments. Most commercial banks have got specialized units in their administrative structure to take care of the financial needs of the small scale industrial units.

The fixed capital needs or the long and medium-term needs of the small scale industrial units are presently being taken care of by the banks under their integrated scheme of credit for the small entrepreneurs. The rate of interest charged normally from the small scale industrial units is between 12% and 15% against 18% from the large scale units.

We will give you the Ultimate Banking Guideline about Commercial Banks in full detail in this article. So let’s move forward.

Functions of Commercial Banks: Ultimate banking Guideline

The Commercial Banks perform a variety of functions which can be divided into the following three categories:

  1.      Basic Functions
  2.      Agency Functions
  3.      General Utility Functions

1. Basic Functions

The basic functions of a bank are those functions without performing which an institution cannot be called a banking institution at all. That is why these functions are also called primary or acid test functions of a bank. The basic/primary/acid test function of a bank are:-

  1.      Accepting Deposits
  2.      Advancing of Loans
  3.      Credit Creation

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1. Accepting Deposits

The first and the most important function of a bank is to accept deposits from those people who can save and spare for safe custody with the bankers. It serves two purposes for the customers.

On the one hand, their money is safe with the bank without any fear of theft and on the other hand, they also earn interest as per the kind of saving they have made. For this purpose the banks have different kinds of deposit accounts to attract the people which are as under;-

  1.      Saving Deposit Account
  2.      Fixed Deposit Account
  3.      Current Deposit Account
  4.      Recurring Deposit Account
  5.      Home Loan Account

1. Saving Deposit Account

The Saving Bank Account is the most common bank account being utilized by the general public. The basic purpose of this account is to mobilize the small savings of the general public.

Certain restrictions are imposed on the depositors regarding the number of withdrawals and amount to be withdrawn in a given period of time. Generally, the rate of interest paid by the bank on these deposits is low as compared to a recurring or fixed deposit account.

Cheque facility is also provided to the depositors with certain extra restrictions on the depositors. One of the conditions is that the depositor shall have to maintain a minimum balance in the account say Rs.500 which is otherwise very low in the case of an account without the facility of the checkbook, say Rs.20 only. Some service charges are also imposed if the depositor uses the cheque facility at large levels.

2. Fixed Deposit Account

This is an account where money can be deposited for a fixed period of time say one year or two years or three years of five years and so on. Once the money is deposited for a fixed period of time, the depositor is prohibited from the withdrawal of money from the bank before the expiry of the stipulated period of time.

The basic advantage to be a customer is that he is offered interest at a higher rate of interest and the banker is free to utilize the money for that fixed period. But where a customer is in need of money in any contingency or emergency, the bank also has the facility to provide loans against the fixed deposit receipt at liberal terms and conditions.

Even if a customer insists on the withdrawal of his money the fixed deposit receipt can also be encashed before the expiry of the stipulated period of time with the condition that the customer shall not be entitled to a higher rate of interest, but the customer is allowed that rate of interest which is applicable on the saving deposit account as if the amount was deposited in the savings account.

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3. Current Deposit Account

In the savings bank account, there are restrictions on the number of withdrawals that can be made in a day or a week or a month. Therefore it does not suit the needs of traders and businessmen who have to make several payments daily and deposits money in a similar manner.

Therefore, there is a facility for them in the shape of another account called Current Deposit Account. These accounts are generally maintained by the traders and businessmen who have to make a number of payments every day. Money from this account can be withdrawn by the account holder as many times as desired by the customer.

Normally bank does not pay any interest on these current accounts, rather some incidental charges are charged by the banker as service charges. These accounts are also called demand deposits or demand liabilities.

The facility of Over Drafts is provided to the traders through these current accounts for which the banks charge interest on the outstanding balance of the customers. A limit is fixed by the bankers for withdrawal of overdrafts and the customer is not allowed to withdraw more than that limit from his O/D current account.

Say if a trader has an O/D limit of Rs.1,00,000 with a bank, he can withdraw money up to Rs.1,00,000 from the bank without depositing any money with the bank. But he cannot withdraw more than Rs.1,00,000. He shall have to pay interest on such withdrawals.

4. Recurring Deposit Account

To encourage regular savings by the general public, another account is opened in the banks called Recurring Deposit Account. This account is preferred by the fixed income group because a particular amount fixed at the time of opening the account has to be deposited in the account every month for a stipulated period of time.

Say Rs.500 per month for a period of three years. In this case, the customer is bound to deposit Rs.500 per month regularly for a period of three years. Generally, the bank pays a rate of interest higher than that of a savings account and just equal to the fixed deposit account on such recurring deposit accounts.

The withdrawal of money is allowed only after the stipulated period of time along with the interest. Rather the account stands closed at the end of the stipulated period of time. In this case, also the bank provides a facility to withdraw the money before the stipulated period of time in the case of any emergency.

The bank shall allow the rate of interest which is applicable to saving the bank account in case the customer wants to close the account before then stipulated period of time.

5. Home Loan Account

The home loan account facility has been introduced in some scheduled commercial banks to encourage savings for the purchasing of or construction of a house to live. In this account, the customer is required to deposit a particular amount per month or half-yearly or even years for a period of five years.

After the stipulated period bank provides three to five times the deposited amount a loan to the subscribers to purchase or construct a house. The rate of interest is also very attractive on this account nearly equal to that of the fixed deposit account.

Even the rebate of Income Tax is also available on the amount contributed in this account under Section 88 of the Income Tax Act, 1961. The facility to close the account after the stipulated period of time is also allowed.

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Advancing of Loans

Advancing of loans is the second acid test function of the commercial banks. After keeping certain cash reserves, the banks lend their deposits to the needy borrowers. It is one of the primary functions without which an institution can not be called a bank.

The bank lends a certain percentage of the cash lying in the deposits on a higher rate of interest than it pays on such deposits. The longer the period for which the loan is required the higher is the rate of interest. Similarly higher the amount of loan, the higher shall be the rate of interest. Before advancing the loans the bank satisfies themselves about the creditworthiness of the borrowers.

This is how a bank earns profits and carries on its banking business. There are various types of loans that are provided by the banks to the borrowers. Some of the important ways of advancing loans are as under:-

Call Money Advances

  1.      Cash Credits
  2.      Overdrafts
  3.      Discounting Bills of Exchange
  4.      Term Loans

1. Call Money Advances

The Call Money Market which is also known as inter-bank call money market deals with very short period loans called call loans. The Call Money Market is a very important constituent of the organized money market which functions as an immediate source of very short term loans.

The major suppliers of the funds in the call money market are All Commercial Banks, State Bank of India (SBI), Life Insurance Corporation of India (LIC), General Insurance Corporation (GIC), Unit Trust of India (UTI) and Industrial Development Bank of India (IDBI) and the major borrowers are the scheduled Commercial Banks. No collateral securities are required against these call money market loans.

As the participants are mostly banks, it is also called the inter-bank call money market. The Scheduled Commercial Banks use their surplus funds to lend for a very short period to the bill brokers. The bill brokers and dealers in the stock exchanges generally borrow money at a call from the commercial banks.

The bill brokers in turn use them to discount or purchase the bills. Such funds are borrowed at the call rate which varies with the volume of funds lent by the commercial banks. When the brokers are asked to pay off the loans immediately, then they borrow from SBI, LIC, GIC, and UTI, etc.

These loans are granted by the commercial banks for a very short period, not exceeding seven days in any case. The borrowers have to repay the loan immediately whenever the lender bank calls them back.

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2. Cash Credits

This is a type of loan which is provided to thy businessmen against their current assets such as shares, stocks, bonds, etc. These loans are not based on creditworthiness or personal security of the customers.

The bank provides this loan through opening an account in the name of the customer and allows them to withdraw the borrowed amounts of loans from time to time up to the limit fixed by the bank which is determined by the value of the security provided by the borrowers.

Interest is charged only on the amount of money actually withdrawn from the banks and not on the amount of the sanctioned amount of loan.

In some other cases, certain banks follow a different procedure for cash credits. The whole amount of the loan is credited to the current account of the borrower. In the case of a new customer, a separate account is opened and the amount of loan is transferred to it.

The borrower is free to withdraw the money through cheques as and when required by the borrower. But in this case, the borrower has to pay the interest on the whole amount credited in their accounts.

3. Overdrafts

The facility of Over Drafts is provided to the traders and businessmen through current accounts for which the banks charge interest on the outstanding balance of the customers. A limit is fixed by the bankers for withdrawal of overdrafts and the customer is not allowed to withdraw more than that limit from his Over Draft Current Account.

This facility is required by the traders and businessmen because they issue several cheques in a day and similarly deposits so many cheques daily in their current accounts. They may not be known at a particular day that whether there is a balance in the account or not and their issued cheques are not dishonored so they are provided with the facility of overdrafts.

Say it a trader has an Over the Draft limit of Rs.2,00,000 with a bank, he can withdraw money up to Rs.2,00,000 from the bank without depositing any money with the bank. But he cannot withdraw more than Rs.2,00,000. He shall have to pay interest on such withdrawals.

4. Discounting Bills of Exchange

This is another popular type of lending by commercial banks. A holder of a bill of exchange can get it discounted with a commercial bank. Bills of Exchange are also called the Commercial Bills and the market dealing with these bills is also called commercial bill market.

Bills of exchange are those bills that are issued by the businessmen or firms in exchange for goods sold or purchased. The bill of exchange is a written unconditional order signed by the drawer (seller) requiring the drawee (buyer) to pay on demand or at a fixed future date, (usually three months after the date written on the bill of exchange), a definite sum of money.

After the bill has been drawn by the drawer (seller), it is accepted by the drawee (buyer) by countersigning the bill. Once the buyer puts his acceptance on the bill by signing it, it becomes a legal document. They are like post-dated cheques issued by the buyers of goods for the goods received.

The bill holder can get this bill discounted in the bill market if he wants the amount of the bill before its actual maturity. These bills of exchange are discounted and pre-discounted by the commercial banks for lending credibility to the bill brokers or for borrowing from the central bank. The bill of exchange market is not properly developed in India.

The Reserve Bank of India introduced the bill market scheme in 1952. Its main aim was to provide finance against bills of exchange for 90 days. The scheduled commercial banks were allowed to convert a part of their advances into promissory notes for 90 days for lodging as collateral security for advances from Reserve Bank of India.

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5. Term Loan

Earlier the commercial banks were advancing only short term loans. The commercial banks have also started advancing medium term and long term loans. Now the maturity period of term loans is more than one year. The amount of the loan sanctioned is either paid to the borrower or it is credited to the account of the borrower in the bank.

The interest is charged on the whole amount of loan sanctioned irrespective of the amount withdrawn by the borrower from his account. The repayment of the loan is accepted in a lump sum or in the installments.

Credit Creation

Credit Creation is one of the basic functions of a commercial bank. A bank differs from the other financial institutions because it can create credit. Like other financial institutions, commercial banks also aim at earning profits.

For this purpose, they accept deposits and advance loans by keeping small cash in reserve for day-to-day transactions. In layman’s language when a bank advances a loan, the bank creates credit or deposit. Every bank loan creates an equivalent deposit in the bank.

Therefore the credit creation means multiple expansion of bank deposits. The word creation refers to the ability of the bank to expand deposits as a multiple of its reserves.

The credit creation refers to the unique power of the banks to multiply loans and advances, the hence deposits. With a little cash in hand, the banks can create additional purchasing power to a considerable extent. It is because of this multiple credit creation power that the commercial banks have been named the “factories of creating credit” or manufacturers of money.

1. Agency Functions

The commercial banks also perform certain agency functions for and on behalf of their customers. The bank acts as the agent of the customer while performing these functions. Such services of the banks are called agency services. Some of the important agency services are as under:-

  1.      Remittance of funds
  2.      Collection and Payment of Credit Instruments
  3.      Execution of Standing Orders
  4.      Purchase and Sale of Securities
  5.      Collection of dividends on shares and interest on debentures
  6.      Trustees and Executors of wills
  7.      Representation and Correspondence

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1. Remittance of funds

Commercial banks provide a safe remittance of funds of their customers from one place to another through cheques, bank drafts, telephone transfers, etc.

2.Collection and Payment of Credit Instruments

The commercial banks used to collect and pay various negotiable instruments like cheques, bills of exchange, promissory notes, hundreds, etc.

3.Execution of Standing Orders

The commercial banks also execute the standing orders and instruments of their customers for making various periodic payments like subscriptions, rents, insurance premiums, and fees on behalf of the customers out of the accounts of their customers.

4.Purchase and Sale of Securities

The commercial banks also undertake the sale and purchase of securities like shares, stocks, bonds, debentures, etc., on behalf of their customers performing the function as a broker agent.

5. Collection of dividends on shares and interest on debentures

Commercial banks also make a collection of dividends announces by the companies of which the customer of the bank is a shareholder and also collects the interest on the debentures which becomes due on particular dates generally half-yearly or annually.

6.Trustees and Executors of wills

The commercial banks preserve the wills of their customers as their trustees and execute the wills after the death of the customer as per the will as the executors.

7. Representation and Correspondence

The commercial banks also act as the representative and correspondents of their customers and get passports, traveler’s tickets, book vehicles, and plots for their customers on the directions of the customers.

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General Utility Functions of Commercial Banks

General Utility Functions

In addition to basic functions and agency functions the commercial banks also provide general utility services for their customers which are needed in the various walks of life and the commercial banks provide a helping hand in solving the general problems of the customers, like safety from loss or theft and so many other facilities some them are as under:-

  1.      Locker Facility
  2.      Raveler’s Cheque Facility
  3.      Gift Cheque Facility
  4.      Letter of Credit
  5.      Underwriting Contract
  6.      Provides Statistical Data
  7.      Foreign Exchange Facilities
  8.      Merchant Banking Services
  9.      Acting as Referee

1. Locker Facility

The commercial banks provide locker facilities to their customers at very reasonable charges which are not possible at the premises of the customers. The customers can avail the facility of lockers in different sizes according to the needs of the customers.

The locker charges also vary with the size of the lockers. The customers can keep their valuables in the and important documents in these lockers for safety. Lockers can be operated in the usual business hour of the bank on all working days.

2. Raveler’s Cheque Facility

Where customers want to visit long distant places and also need money, they need not carry the money with them which is not safe during long-distance journeys and there is always a fear of loss or theft during the journey. The commercial banks provide a unique facility through a traveler’s cheque.

The customers can get traveler’s cheques from the banks and travel without the fear of theft or loss of money. Wherever they need money they can approach the branch of the bank in that city and encash the Raveler’s cheque according to the need.

3. Gift Cheque Facility

Some commercial banks also provide the facility of issuing gift cheques in the denomination of different amounts according to the needs of the customers, say Rs.11, 21, 51, 101, 501, and so on. This facility is provided for special occasions for the customers and normally the banks do not charge anything for issuing these gift cheques.

4. Letter of Credit

The commercial banks also help their customers by providing another unique service by providing the letter of credit in which the bank certifies the creditworthiness of the customers. These letters of credit are used in the long-distance trade and especially in foreign trade where the parties do not know each other and it is a bank that provides the safety to them regarding their creditworthiness by issuing a letter of credit.

5. Underwriting Contract

The commercial banks underwrite the securities issued by the public or private companies and Government securities. It is the reputation of the bank which matters in the underwriting contracts. Where the bank is a very reputed one, the investors shall not have any hesitation in investing the money in which their banker is the underwriter.

In case the public does not purchase the securities, it is the underwriting bank that has to purchase the securities up to the amount of which the bank has underwritten.

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6. Provides Statistical Data

Commercial banks also help their customers by providing them important information through statistical data. Commercial banks collect statistical data in which important information relating to industry, trade, commerce, money, and banking is collected and published in their journals and bulletins containing research articles on the economic and financial matters. Such statistical data are maybe useful for the customers in dealing with their own business, trade, or commerce.

7. Foreign Exchange Facilities

The commercial banks also deal in the business of foreign currencies. These banks provide foreign exchange and also discount the foreign bills of exchange. Some commercial banks have also opened special branches for foreign exchange services to the non-resident Indians settled abroad.

8. Merchant Banking Services

The commercial banks have also started providing merchant banking facilities. The Banking Commission Report, 1972 emphasized the need of creating specialized institutions to cater financial requirements of different sectors exclusively and examined the need of setting up merchant banking institutions.

Commission recommended the setting up of merchant banking institutions. Consequently, in 1972 itself, State Bank of India started its merchant banking division. Since then a number of other commercial banks and financial institutions started their merchant banking divisions.

Now the merchant banking firms in the private sector have started gearing up to meet the challenge posed by commercial banks and financial institutions in the field of merchant banking in India.

9. Acting as Referee

Commercial banks are the best source of seeking information about the creditworthiness of the customers. Banks may be referred for seeking information regarding creditworthiness, financial position, business reputation, and respectability of their customers.

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Keywords

     1. Bank: A bank collects money from those who have it to spare or who are saving it out of their incomes, and it lends this money to those who acquire it.

    2. Scheduled Bank: All those banks which are included in the list of Schedule Second of the Reserve Bank of India are called Scheduled Bank.

     3. Public Sector Bank: The bank which is owned or controlled by the Government is known as a public sector bank.

     4. Commercial Bank: Commercial bank is that bank which performs all kinds of banking business and functions like accepting deposits, advancing loans, credit creation and agency functions for their customers

     5. Cash Credit: It is a type of loan which is provided to the businessman against their current assets.

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