Primary Funtions of Commercial Banks

Primary Funtions of Commercial Banks

The primary functions of a commercial bank are of three types. They are:

I. Accepting Deposits

II. Granting Loans and Advances.

III.Creation of Credit

I. Accepting Deposits

The basic deposit accounts offered by commercial banks are listed below. In these days banks compete with each other to attract customers by adding facilities to these deposit accounts. Broadly deposit accounts can be classified into demand deposits and time deposits.

A. Demand Deposits

These deposits are repayable on demand on any day. This consists of savings deposits and current deposits.

a. Savings Deposits

General public deposit their savings into this account. This account can be opened in one individual’s name or more than one name. Section 25 companies also can open savings accounts. Business firms are not permitted to open savings account. The rate of interest allowed on this deposit is lower than fixed deposits. Interest is paid on  the basis of  the amount and number  of days the amount remains credited  in the account. The bank provides facilities like cheque book, ATM  (Automated Teller Machine) card etc. There is limit on number of ATM card  withdrawals from other bank ATMs only. A minimum balance should be maintained in this deposit account. Otherwise penal interest is charged. Beyond a number (20 or 60 leaves) cheque book is available for a fee. Nomination can be registered. Salary account is a type of savings account offered to salaried employees in which zero balance is permitted. Some banks offer overdraft facility. An account  inactive  for a long period will become dormant account.

b. Current Deposits

This account is suitable for business institutions. Individuals too can open this account. A higher minimum balance should be kept in this account. If not penal interest is charged. No interest is paid for the balance in this account. Some banks have started offering interest on these account balances. Banks may collect bank charges on this account. Overdraft (short term unsecured loan) facility is available to current account customers. There is no limitation on deposit of cheques or withdrawals from this account. Credit worthiness of current account business customers are shared among banks.

B. Time Deposits

They include fixed deposits and recurring deposits which are repayable after a period.

a. Fixed Deposits (FD)

Certain amount is deposited for a fixed period for a fixed rate of interest. FDR (fixed depositreceipt) is giventothedepositor. 

Rate of interest is higher than savings account. On the date of maturity the principal along with interest for  the fixed period is paid.   A customer can obtain loan by depositing FDR. Pre-mature withdrawal of cash is also allowed for payment of penal charges and it carries no interest. Partial withdrawal also allowed. Fixed deposit period can be  1 month to 10 years. FD is also called term deposit

b. Recurring Deposits (RD)

Certain sum is deposited into the account every month for one year or five years or the agreed period. Interest rate is  more  than savings deposits and almost equal to fixed deposits. At the end of the period the deposited amounts along with interest are returned to the customer. Premature closing is allowed with a charge or deduction. It is ideal for persons having regular income to save and receive a lump sum. Any institution can open RD account. Minors or students also can open this account. Loan against this deposit is also provided by some banks.

II. Granting Loans and Advances

The second primary function of commercial banks is lending money in order to earn interest income. Banks provide specific sums as loans which are repayable along with interest. Demand loans should be repaid whenever demanded. Term loans can be repaid after the agreed period. Advances are credit facilities provided for short period (within a year) to business community. But both terms are used interchangeably.

A. Advances

a. Overdraft

It  is  a  credit  facility  extended  mostly   to current account holding business community customers. It is an arrangement reached between the banker and the credit worthy customers. Such customers are allowed to overdraw (when there is no balance money in the account) up to a certain amount usually for 3 months period. It may be extended for further periods. Only on the withdrawn amount of credit interest is charged and not on the maximum limit allowed. It is an unsecured credit. Secured overdraft against the security of financial instruments is also provided by some banks. It is repayable on demand.

b. Cash Credit

It is a secured credit facility given mostly to business institutions. Stock in  hand,  raw materials, other tangible assets,  etc. are provided as collateral. A certain sum is allowed as credit for a short period. Interest is payable on the actual amount withdrawn and not on the entire credit facility. . It is repayable on demand.

c. Discounting of Bills

Business customers approach banks to discount the commercial bills of exchanges and provide money. It is a short term credit instrument. Banks deduct the discount (interest) for the period mentioned in the bill and release the balance amount to the traders. If the bill is dishonoured, the bank can recover the amount from the customer. It is a form of unsecured credit.

B. Loans

Short term and medium term loans are provided by commercial banks against eligible collaterals to business concerns. It is a definite sum of money lent for a definite period. It is repayable in one lump sum or in instalments. Interest is payable on the entire loan amount. Every bank in these days design new methods of advancing loans to find more ways of learning income. Generally commercial banks provide the following loans.

a. Housing Loan

Taking the title deeds of the house as collateral security, based on the monthly income of the borrowing customer, banks advance medium and long term loans. The customer repay the loan in equated monthly instalments (EMI consists of principal and interest). This is a boon to the middle class salaried employees who cannot afford to pay the full price of a house in a lump sum.

b. Consumer Loans

Consumer durables like refrigerator, air conditioner, laptop, washing machine, television, etc. can be purchased by customers with consumer loans from banks. The product purchased is hypothecated (secured loan arrangement where the movable asset remains with the borrower) as security for the consumer loan amount. The customer pays in equated monthly instalments for a specified period.

c. Vehicle Loans

Two wheelers, cars, buses and other vehicles can be purchased by individuals as well as institutions obtaining vehicle loans from the banks. Vehicles are hypothecated to the bank until the entire loan amount is repaid. Vehicle registration book is deposited with the bank andonfull paymentof loanamount it will be handed over to the customer.

d. Educational Loan

Loan is provided by banks to students for studying undergraduate, post graduate or professional courses. Loan may be received in instalments to pay the educational fees every year. After completion of the course one year is allowed for the student to get employed. Afterwards, the student should repay the loan with interest for the entire period. Interest is charged from the date of first instalment of loan amount payment.

e. Jewel Loan

Customers pledge their gold jewels and obtain loans from banks. The margin (percentage of value per gram that can be given as credit) requirement is fixed by the RBI. Interest should be paid every month. Otherwise interest on interest is charged. Within 12 months the customer can redeem or else can re-pledge. Jewels not redeemed even after reminders are sold in auction by banks to recover their dues.

III. Creation of Credit

Apart from the currency money issued by the RBI, the credit money in circulation created by commercial banks influence economic activities of a country to a large extent. Credit money of commercial banks is far greater in volume than the currency money. The volume, the purposes and the sector to which this credit money is to be channelised - all these are implemented by commercial banks under the guidance of the RBI.