Commercial Banks and Functions of Commercial Banks

Commercial Banks

A commercial bank is an institution that operates for profit. The traditional functions of a commercial bank relate to the acceptance of deposits from the public and provision of credit to different sectors of the economy. However, with the evolution of modern banking and growth of banking system as an integral part of the national economy, there has been a perceptible change in the attitude and outlook of the commercial banks. These banks have started providing a host of banking services to their customers. Nevertheless, the basic character of commercial banking remains unchanged. In the early days, commercial banks are organized as a joint stock company to earn profit. They cater to the needs of short-term, medium term credit and provide capital to businessmen and industrialists. In the recent days, the banks lend long term funds to businessmen and industrialists.

Functions of Commercial Banks

The various functions performed by commercial banks can be classified as follows:

1. Accepting or attracting deposits

Commercial banks accept deposits by mobilizing the savings of the people. These deposits can be of three forms.

Savings deposits: It is a kind of safety vault for the people with idle cash. These deposits are kept under savings account. Deposits in this account earn interest at nominal rates and the banks are entitled to release deposits on demand by the deposit holder. In practice, the bank imposes a limit on the number and amount of withdrawals during a period. Cheque facilities are also given to the deposit holder.

Demand deposits: Demand deposits are kept under current account. The depositor can withdraw the money on demand. But, the account holder should specify the amount and the number of withdrawals. Banks do not pay any interest on these accounts. On the contrary, bank imposes service charges on maintaining these accounts.

Fixed deposits: These are also known as time deposits. The amount deposited cannot be withdrawn before the maturity period for which they have contracted. These deposits carry interest at higher rates varying with the length of the contract.

2) Advancing of loans

Banks adopt several ways for granting loans and advances. These operations take different forms.

a) Cash credit: The bank sanctions loans to individuals or firms against some collateral security. The loan money is credited in the account of the borrower and he can withdraw the amount as and when it is required. The ceiling of the loan amount is determined by the bank on the basis of the stock value of the borrower which in turn becomes Banker's possession. The borrower can withdraw the cash within or upto the credit limit. The bank charges interest for the amount withdrawn only.

b) Provision of overdraft facilities

The respectable and reliable customers enjoy these facilities. The customer can issue cheques and overdraw the money in times of need, even if there is no adequate balance in his account. The customer will pay the interest to the bank for the amount overdrawn.

c) Discounting bills of exchange

This operation is done through discounting of commercial papers, promissory notes and bills of exchange, usually for three months. The banks after deducting interest charges and collection charges from the face value of the bills, give the balance amount to the customer. When the exchange bill matures, the banks collect the payment from the party.

3) Creation of money or credit

Every loan sanctioned by the banker creates a deposit. Because, when a bank sanctions loan to a customer, an account is opened in his name and the loan amount is credited into his account. The borrower withdraws money whenever the amount is required. The creation of such deposits leads to increase in the money stock of the economy and through its circulation creates new money.

4) Other functions

Some of the other important functions performed by these banks are as follows:

 a) a) Transfer of funds

In the complexity of trade and commerce in the modern days, the transfer of funds from one place to another becomes difficult. Banks help in eliminating this difficulty through the use of various credit instruments like cheques, bank drafts and pay orders, traveller cheques, etc. This process is called 'clearing' and it is efficiently done by bank operations.

b) Agency functions

Commercial banks are increasingly acting as financial agents for their clients. They make all sorts of payments on behalf of their clients like insurance premium, pension claims, dividend claims or capital demands etc. Likewise, they buy and sell gold, silver and securities on behalf of their clients.

c) General utility services

A commercial bank performs general utility services such as providing safety lockers for the safer custody of valuables of the customers.

Issuing of letter of credit to the customers.

Under-writing loans to be raised by public bodies and corporations.

Compiling statistics and information relating to trade, commerce and industry.

Thus, commercial banks render valuable services to the community. Developed banking system ensures industrial and economic progress. It constitutes the lifeblood of an advanced economic society. In developing countries like India, commercial banking may be described as 'development banking'. It plays a critical developmental role in making their funds available to the priority sectors, weaker sections and employment-oriented schemes.