Commercial banks are the most important components of the whole banking system. A commercial bank is a profit-based financial institution that grants loans, accepts deposits, and offers other financial services, such as overdraft facilities and electronic transfer of funds.
Commercial banks are financial institutions that accept demand deposits from the general public, transfer funds from the bank to another, and earn a profit.
Commercial banks play a significant role in fulfilling the short-term and medium- term financial requirements of industries. They do not provide, long-term credit, so that liquidity of assets should be maintained. The funds of commercial banks belong to the general public and are withdrawn at a short notice; therefore, commercial banks prefers to provide credit for a short period of time backed by tangible and easily marketable securities.
Functions of Commercial Banks
Primary Functions of Commercial Banks
Below are few very general functions of commercial banks, you must be familiar with all of them. The first two functions of commercial banks are known as primary functions of commercial banks and last two known as secondary functions of commercial banks.
1. Accept Deposits
The most important function of commercial banks is that it collects the surplus money or saving of the people on accepting deposits. These deposits may be created in two ways, such as by direct deposits, when a customer deposits their money in the bank by opening a bank account such as current account, fixed account or saving account and secondly by indirect or derivative deposits, which is credited by giving loans to their customers.
There are two types of deposits, which are discussed as follows :
(a) Demand Deposits :
Refer to kind of deposits that can be easily withdrawn by individuals without any prior notice to the bank. In other words, the owners of these deposits are allowed to withdraw money anytime by simply writing a check. These deposits are the part of money supply as they are used as a means for the payment of goods and services as well as debts. Receiving these deposits is the main function of commercial banks.
(b) Time Deposits :
Refer to deposits that are for certain period of time. Banks pay higher interest on lime deposits. These deposits can be withdrawn only after a specific time period is completed by providing a written notice to the bank.
2. Making Advances
The commercial banks provide loans and advances of various forms. It includes an overdraft facility, cash credit, bill discounting, etc. They also give demand and demand and term loans to all types of clients against proper security.
3. Credit creation
It is the most significant function of the commercial banks. While sanctioning a loan to a customer, a bank does not provide cash to the borrower Instead it opens a deposit account from where the borrower can withdraw. In other words, while sanctioning a loan a bank automatically creates deposits. This is known as a credit creation from the commercial bank.
Commercial banks issue the loan in the form of cash credit, overdraft, and fixed loans and by discounting of the bill of exchange. However, while making or advancing loans; banks always take into consideration the creditworthiness of the applicants, i.e. four “C” of credit. These are the “character”, “capacity”, “capital” and “collateral” which are always guidelines to the bank for advancing loans.
Secondary Functions of Commercial Banks
1. Overdraft Facility
It refers to a facility in which a customer is allowed to overdraw his current account up to an agreed limit. This facility is generally given to respectable and reliable customers for a short period. Customers have to pay interest to the bank on the amount overdrawn by them.
2. Discounting Bills of Exchange
It refers to a facility in which holder of a bill of exchange can get the bill discounted with the bank before the maturity. After deducting the commission, the bank pays the balance to the holder. On maturity, the bank gets its payment from the party which had accepted the bill.
3. Agency Functions
Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients.
Some of the Agency Functions are
(i) Transfer of Funds
Banks provide the facility of economical and easy remittance of funds from place-to-place with the help of instruments like demand drafts, mail transfers, etc.
(ii) Collection and Payment of Various Items
Commercial banks collect cheques, bills,’ interest, dividends, subscriptions, rents and other periodical receipts on behalf of their customers and also make payments of taxes, insurance premium, etc. on standing instructions of their clients.
(iii) Purchase and Sale of Foreign Exchange
Some commercial banks are authorized by the central bank to deal in foreign exchange. They buy and sell foreign exchange on behalf of their customers and help in promoting international trade.
(iv) Purchase and Sale of Securities
Commercial banks buy and sell stocks and shares of private companies as well as government securities on behalf of their customers.
(v) Income Tax Consultancy
They also give advice to their customers on matters relating to income tax and even prepare their income tax returns.
(vi) Trustee and Executor
Commercial banks preserve the wills of their customers as trustees and execute them after their death as executors.
(vii) Letters of Reference
They give information about the economic position of their customers to traders and provide the similar information about other traders to their customers.
General Utility Functions
The general utility functions of the commercial banks include
- To provide safety locker facility to customers.
- To provide money transfer facility.
- To issue traveler’s cheque.
- To act as referees.
- To accept various bills for payment e.g phone bills, gas bills, water bills, etc.
- To provide merchant banking facility.
- To provide various cards such as credit cards, debit cards, Smart cards, etc.
Include the following :
(i) Creating Money :
Refers to one of the important functions of commercial banks that help in increasing the money supply. For instance, a bank lends Rs. 5 lakh to an individual and opens a demand deposit in the name of that individual.
Bank makes a credit entry of Rs. 5 lakh in that account. This leads to the creation of demand deposits in that account. The point to be noted here is that there is no payment in cash. Thus, without printing additional money, the supply of money is increased.
(ii) Electronic Banking :
Include services, such as debit cards, credit cards, and Internet banking.
Hope this article will help you to understand functions of commercial banks in India. Share this article ” Functions of Bank ” to your friends.
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