Functions of Commercial Banks

Introduction

Banks play a pivotal role in aiding the progressive economy of a country as it gives an overview of the country’s economic growth and the performed financial operations i.e. operation of currency and credit system. Back then, when the barter system was prevalent worldwide, there was no concept known as money, hence, goods was exchanged against goods or services. This system reached its nadir during the 18th century as retailers began to abandon bartering by adapting paper currency. The barter system was a failure substantially because of several reasons, such as

• Absence of saving prospect
• Mismatch of demands
• Difficulty in balancing the values

With the advent of currency usage and the lacuna created by the barter system in terms of saving the wealth for future generations, the modern banking system has emerged. In India, the evolution of banking went through three phases, right from 1786 with the foundation laid by the establishment of the Bank of Hindustan at Calcutta by the East India Company under European management. Between 1885 and 1913, many banks had come into existence, but were liquidated due to a lack of governing body. Thus, the Reserve Bank of India (RBI) was established on April 1, 1935, backed by the enactment of the Reserve Bank of India Act, 1934.

As far as commercial banks are concerned, according to RBI, “Commercial Banks refer to both scheduled and non-scheduled commercial banks which are regulated under Banking Regulation Act, 1949”. Primarily, Commercial Banks are profit-based institution that focuses on products and services, which are specially developed and designed for businesses. In a nutshell, a commercial bank is a financial body that performs all processes pertaining to loaning the consumption and investment activities, deposit, and withdrawal of money by/for the public. All major banks are perceived to be commercial in pursuance of the basic structure provided by the Reserve Bank of India Act, 1934.

Meanwhile, it is relevant to note the other types of banks as well, viz. Central Banks, Cooperative Banks, Regional Rural Banks, Local Area Banks, Specialized Banks, Small Finance Banks, and Payment Banks. Among a plethora of banks providing various services, commercial banks are described with two of its characteristics, which is lending and borrowing. Reiteratively, these banks are a profit-making institution that has the core objective of making a profit through receiving deposits and giving money for different projects. It makes a profit by charging interest on different types of loans being provided to the public.

What are Commercial Banks?

• Commercial banks are financial institutions, which accept deposits, grant loans, and offer adequate financial products such as saving accounts, checking accounts, money market account so on.
• It is regulated under the Banking Regulation Act 1949 and by the Reserve Bank of India also known as the Central Bank of India.
• It carries out a business operation of keeping deposits in the form of money and lending loans to the general public, business institutions, and government, as well.
• It enables an individual to hold the safekeeping of obtained income and get a loan when it is needed.
• Though the depositors earn interest from the bank on their deposits, the interest paid to the depositors is considerably less than the interest rate being charged.
• The rate of interest paid to the depositor is called the borrowing rate, and the rate at which the bank lends a loan is called the lending rate.
• Mortgage, personal loans, vehicle loans, and business loans are some of the loans offered by commercial banks.

Types of Commercial Banks

To the common knowledge, Banks in India are divided into two categories viz. Scheduled banks and Non-Scheduled Banks. The former includes banks, which are listed in the 2nd Schedule of the RBI Act, 1934, while the rest falls under the ambit of the latter. Before comprehending the functions of Commercial Banks it is requisite to understand the different types of commercial banks in India. Based on ownership, these banks are categorized into three types,

Private Sector Banks

If the majority of the stakes are held by private individuals, it is a private bank. Like any other commercial bank, it is also a financial institution and as being held by the private businesses or individuals, it has to be registered as a Limited Liability Company. Some examples of private banks are Axis Bank, Federal Bank, HDFC Bank, Indusind Bank, ICICI Bank, etc.

Public Sector Banks

In this kind of commercial bank, the majority of the stakes would be held by the government, and financial guidelines are prescribed by the respective governments. These banks are being called state-owned banks as the government holds more than 50% ownership. Since the ownership is with the government, the credibility is not at stake. As result, naturally, depositors believe that their money is more secured in public sector banks, led to the establishment of a large customer base. Examples of public sector banks are the State Bank of India, the Central Bank of India, the Indian Overseas Bank, the Punjab National Bank, and the Bank of Baroda so on.

Foreign Banks

These banks operate outside the territory of India and within a foreign nation. Banks having the main office outside India are called foreign banks. Some examples of foreign banks are American Express, Citi Bank, FirstRand Bank, etc.

Functions of Commercial Banks

Primary Functions of Commercial Banks

The primary functions of Commercial Banks are as follows,

Accepting Deposit

The most traditional functions of commercial banks are taking deposits from the public in the form of savings, current, and fixed deposits. A saving deposit is when an individual deposits his savings and earns interest on the same, it is payable on demand and can be withdrawn on a cheque. However, the depositors would be incurred administrate fees to maintain the account. Current accounts are usually utilized for business transactions. It is for the people in business who can withdraw their money at any time without any notice. When the customer has money and doesn’t need it anytime before six months can deposit it in a fixed deposit. The interest increase with the length of the deposit and the money can be withdrawn only after the stipulated period.

Credit System 

It is a unique function of a commercial bank. A bank is called a factory of manufacturing of credit, because when a customer is provided with credit or loan, instead of offering liquid cash, a commercial bank creates money by creating a line of credit and transferring the loan all at once.

Providing Loans and advances 

It is a primary source for a commercial bank to make money, where the bank provides loan to individuals or organization and collect interest on the loan amount overdrawn. The bank lends funds to its customers in the form of loans and advances, discounting of bills, overdrafts, etc. the loan would be provided on a suitable mortgage and sometimes even without security at an agreed interest and for a specified period. In pursuance of the cash credit facility, the loan amount would be credited to the customer’s account, and the bank offers him to borrow to an extent with keeping something as a security. Per contra, under overdraft, the customer can overdraw from his current account without any security. Generally, banks hold a small reserve yet an adequate one to meet their expenses while offering the remaining to the customers in various types of short and long-term credits.

Secondary Functions of Commercial Bank

Bank as an agent 

The catchall term that befits to define a bank is the agent. A bank is perceived to be acting as an agent to its customers for the following reasons, as it

• Collect cheques, drafts, bills, etc
• Acts as an administrator, executor, or trustee for the customer’s estate
• Provides a platform for the payment of insurance premiums, loan installments, rent so on
• Assists customers with tax returns, refunds, and so on
• Represent customers in the stock exchange in terms of purchasing and redemption.

General Utility Service

The following are the three utility services that a commercial bank offer,

• Issuance of debit card, credit card, etc.
• Offering locker services.
• Issuance of traveler cheques, gift cheques, credit letters, bank drafts, etc.

Providing Locker Facilities

Locker facilities are provided to customers who want to keep their valuables safe as it obviates the risk of theft or loss of those. For this service, an annual fee would be charged by the banks.

Dealing in Foreign Exchange

In the first place, banks, which are licensed to perform foreign exchange are only eligible for this transaction. The foreign exchange service is provided to the individuals and organizations engaged in exporting and importing businesses.

Exchange of Securities

Commercial banks trade in bonds and securities. It enables customers to purchase or sell from financial institutions.

Discounting Bills of Exchange

Bill of exchange is drawn by the creditor on the debtor, wherein the amount of debt and the date on which the debt amount becomes payable would be specified. Normally, a bill of exchange is issued for 90 days. This amount can also be cleared before the specified time through the discounting method. Bill discounting is considered to be a profitable investment for banks as bills create a steady flow of funds and are perceived as a negotiable instrument.

Therefore, the aforementioned are the notable secondary services of commercial banks.

Conclusion

In extenso, commercial banks are renowned for their function of lending and taking deposits, apart from these banks, there is a central bank that supervises commercial banks and looks into the fixation of interest rates. In banking terms, the central bank is known to be the ‘head honcho’. However, it is pertinent to note that a central bank is not a commercial bank where an individual can open an account and ask for a loan. Thus it is understandable that the central bank does not engage with the general public in terms of providing services.

FAQs on Functions of Commercial Banks