What are the functions of Commercial Banks?



In the modern world, banks perform such a variety of functions that it is not possible to make an all-inclusive list of their functions and services. However, some basic functions performed by the banks are discussed below.

1. Accepting Deposits

The first important function of a bank is to accept deposits from those who can save but cannot profitably utilize this saving themselves. People consider it more rational to deposit their savings in a bank because by doing so they, on the one hand, earn interest, and on the other, avoid the danger of theft. To attract savings from all sorts of individuals, the banks maintain different types of accounts:

(i) Fixed Deposit Account:

Money in these accounts is deposited for fixed period of time (say one, two, or five years) and cannot be withdrawn before the expiry of that period. The rate of interest on this account is higher than that on other types of deposits. The longer the period, the higher will be the rate of interest. Fixed deposits arc also called time deposits or time liabilities.

(ii) 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 Money from these accounts can be withdrawn in as many times and in as much amount as desired by the depositors. Normally, no interest is paid on these accounts; rather, the depositors have to pay certain incidental charges to the bank for the services rendered by it. Current deposits are also called demand deposits or demand liabilities.

(iii) Saving Deposit Account:

The aim of these accounts is to encourage and mobilise small savings of the public. Certain restrictions are imposed on the depositors regarding the number of withdrawals and the amount to be withdrawn in a given period. Cheque facility is provided to the depositors. Rate of interest paid on these deposits is low as compared to that on fixed deposits.

(iv) Recurring Deposit Account:

The purpose of these accounts is to encourage regular savings by the public, particularly by the fixed income group. Generally money in these accounts is deposited in monthly installments for a fixed period and is repaid to the depositors along with interest on maturity. The rate of interest on these deposits is nearly the same 3s on fixed deposits.

(v) Home Safe Account:

Home safe account is another scheme aiming at promoting saving habits among the people. Under this scheme, a safe is supplied to the depositor to keep it at home and to put his small savings in it. Periodically, the safe is taken to the bank where the amount of safe is credited to his account.

2. Advancing of loans

The second important function of a bank is advancing of loans to the public. After keeping certain cash reserves, the banks lend their deposits to the needy borrowers. Before advancing loans, the banks satisfy themselves about the credits worthness of the borrowers. Various types of loans granted by the banks are discussed below:

(i) Money at Call:

Such loans are very short period loans and can be called back by the bank at a very short notice of say one day to fourteen days. These loans are generally made to other banks or financial institutions.

(ii) Cash Credit:

It is a type of loan, which is given to the borrower against his current assets, such as shares, stocks, bonds, etc. Such loans are not based on personal security. The bank opens the account in the name of the borrowers and allows him to withdraw borrowed money from time to time up to a certain limit as determined by the value of his current assets. Interest is charged only on the amount actually withdrawn from the account.

(iii) Overdraft:

Sometimes, the bank provides overdraft facilities to its customers though which they are allowed to withdraw more than their deposits. Interest is charged from the customers on the overdrawn amount.

(iv) Discounting of Bills of Exchange:

This is another popular type of lending by the modern banks. Through this method, a holder of a bill of exchange can get it discounted by the bank. In a bill of exchange, the debtor accepts the bill drawn upon him by the creditor (i.e, holder of the bill) and agrees to pay the amount mentioned on maturity. After making some marginal deductions (in the form of commission), the bank pays the value of the bill to the holder. When the bill of exchange matures, the bank gets its payment from the party, which had accepted the bill. Thus, such a loan is self-liquidating.

(v) Term Loans:

The banks have also started advancing medium-term and long-term loans. The maturity period for such loans is more than one year. The amount sanctioned is either paid or credited to the account of the borrower. The interest is charged on the entire amount of the loan and the loan is repaid either on maturity or in installments.

3. Credit Creation

A unique function of the bank is to create credit. In fact, credit creation is the natural outcome of the process of advancing loan as adopted by the banks. When a bank advances a loan to its customer, it does not lend cash but opens an account in the borrower's name and credits the amount of loan to this account. Thus, whenever a bank grants a loan, it creates an equal amount of bank deposit. Creation of such deposits is called credit creation which results in a net increase in the money stock of the economy. Banks have the ability to create credit many times more than their deposits and this ability of multiple credit creation depends upon the cash-reserve ratio of the banks.

4. Promoting Cheque System:

Banks also render a very useful medium of exchange in the form of cheques. Through a cheque, the depositor directs the bankers to make payment to the payee. Cheque is the most developed credit instrument in the money market. In the modern business transactions, cheques have become much more convenient method of settling debts than the use of cash.

5. Agency Functions:

Banks also perform certain agency functions for and on behalf of their customers:

(i) Remittance of Funds:

Banks help their customers in transferring funds from one place to another through cheques, drafts, etc.

(ii) Collection and Payment of Credit Instruments:

Banks collect and pay various credit instruments like cheques, bills of exchange, promissory notes, etc.

(iii) Execution of Standing Orders:

Banks execute the standing instructions of their customers for making various periodic payments. They pay subscriptions, rents, insurance premium, etc. on behalf of their customers.

(iv) Purchasing and Sale of Securities:

Banks undertake purchase and sale of various securities like shares, stocks, bonds, debentures etc. on behalf of their customers. Banks neither give any advice to their customers regarding these investments nor levy any charge on them for their service, but simply perform the function of a broker.

(v) Collection of Dividends on Shares:

Banks collect dividends, interest on shares and debentures of their customers.

(vi) Income Tax Consultancy:

Banks may also employ income-tax experts lo prepare income-tax returns for their customers and to help them to get refund of income-tax.

(vii) Acting as Trustee and Executor:

Banks preserve the wills of their customers and execute them after their death.

(viii) Acting as Representative and Correspondent:

Sometimes the banks act as representatives and correspondents of their customers. They get passports, travelers tickets, book vehicles, plots for their customers and receive letters on their behalf.

6. General Utility Function:

In addition to agency services, the modern banks provide many general utility services as given below:

(i) Locker Facility:

Banks provide locker facility to their customers. The customers can keep their valuables and important documents in these lockers for safe custody.

(ii) Traveller's Cheques:

Banks issue traveller's cheques to help their customers lo travel without the fear of theft or loss of money. With this facility, the customers need not take the risk of carrying cash with them during their travels.

(iii) Letter of Credit:

Letters of credit are issued by the banks to their customers certifying their creditworthiness. Letters of credit are very useful in foreign trade.

(iv) Collection of Statistics:

Banks collect statistics giving important information relating to industry, trade and commerce, money and banking. They also publish journals and bulletins containing research articles on economic and financial matters.

(v) Underwriting Securities:

Banks underwrite the securities issued by the government, public or private bodies. Because of its full faith in banks, the public will not hesitate in buying securities carrying the signatures of a bank.

(vi) Gift Cheques:

Some banks issue cheques of various denominations (say of Rs. 11, 21, 31, 51.101, etc.) to be used on auspicious occasions.

(vii) Acting as Referee:

Banks may be referred for seeking information regarding the financial position, business reputation and respectability of their customers.

(viii) Foreign Exchange Business:

Banks also deal in the business of foreign currencies. Again, they may finance foreign trade by discounting foreign bills of exchange.