Functions of Commercial Banks

Functions of Commercial Banks

Functions of Commercial Banks– The main functions of commercial banks are accepting deposits from the public and advancing them loans. However, besides these functions, there are many other functions that these banks perform. All these functions can be divided into the following heads:

  • Accepting deposits
  • Giving loans
  • Overdraft
  • Discounting of Bills of Exchange
  • Investment of Funds
  • Agency Functions
  • Miscellaneous Functions

1. Accepting Deposits: The most important function of commercial banks is to accept deposits from the public. Various sections of society, according to their needs and economic condition, deposit their savings with the banks.

(i) Current Deposits: The depositors of such deposits can withdraw and deposit money when­ever they desire. Since banks have to keep the deposited amount of such accounts in cash always, they carry either no interest or a very low rate of interest. These deposits are called Demand Deposits be­cause these can be demanded or withdrawn by the depositors at any time they want.

Such deposit ac­counts are highly useful for traders and big business firms because they have to make payments and accept payments many times in a day.

(ii) Fixed Deposits: These are the deposits that are deposited for a definite period of time. This period is generally not less than one year and, therefore, these are called long term deposits. These deposits cannot be withdrawn before the expiry of the stipulated time and, therefore, these are also called time deposits.

These deposits generally carry a higher rate of interest because banks can use these deposits for a definite time without having the fear of being withdrawn.

(iii) Saving Deposits: In such deposits, money upto a certain limit can be deposited and with­drawn once or twice in a week. On such deposits, the rate of interest is very less. As is evident from the name of such deposits their main objective is to mobilize small savings in the form of deposits. These deposits are generally done by salaried people and the people who have fixed and less income.

2. Giving Loans: The second important function of commercial banks is to advance loans to its customers. Banks charge interest from the borrowers and this is the main source of their income.

Banks advance loans not only on the basis of the deposits of the public rather they also advance loans on the basis of depositing the money in the accounts of borrowers. In other words, they create loans out of deposits and deposits out of loans. This is called as credit creation by commercial banks.

Modern banks give mostly secured loans for productive purposes. In other words, at the time of advancing loans, they demand proper security or collateral. Generally, the value of security or collateral is equal to the amount of loan. This is done mainly with a view to recover the loan money by selling the security in the event of non-refund of the loan.

At limes, banks give loan on the basis of personal security also. Therefore, such loans are called as unsecured loan. Banks generally give following types of loans and advances:

(i) Cash Credit: In this type of credit scheme, banks advance loans to its customers on the basis of bonds, inventories and other approved securities. Under this scheme, banks enter into an agreement with its customers to which money can be withdrawn many times during a year. Under this set up banks open accounts of their customers and deposit the loan money. With this type of loan, credit is created.

(iii) Demand loans: These are such loans that can be recalled on demand by the banks. The entire loan amount is paid in lump sum by crediting it to the loan account of the borrower, and thus entire loan becomes chargeable to interest with immediate effect.

(iv) Short-term loan: These loans may be given as personal loans, loans to finance working capital or as priority sector advances. These are made against some security and entire loan amount is transferred to the loan account of the borrower.

3. Over-Draft: Banks advance loans to its customer’s upto a certain amount through over-drafts, if there are no deposits in the current account. For this banks demand a security from the customers and charge very high rate of interest.

4. Discounting of Bills of Exchange: This is the most prevalent and important method of advancing loans to the traders for short-term purposes. Under this system, banks advance loans to the traders and business firms by discounting their bills. In this way, businessmen get loans on the basis of their bills of exchange before the time of their maturity.

5. Investment of Funds: The banks invest their surplus funds in three types of securities—Government securities, other approved securities and other securities. Government securities include both, central and state govern­ments, such as treasury bills, national savings certificate etc.

Other securities include securities of state associated bodies like electricity boards, housing boards, debentures of Land Development Banks units of UTI, shares of Regional Rural banks etc.

6. Agency Functions: Banks function in the form of agents and representatives of their customers. Customers give their consent for performing such functions. The important functions of these types are as follows:

  • Banks collect cheques, drafts, bills of exchange and dividends of the shares for their custom­ers.
  • Banks make payment for their clients and at times accept the bills of exchange: of their cus­tomers for which payment is made at the fixed time.
  • Banks pay insurance premium of their customers. Besides this, they also deposit loan installments, income-tax, interest etc. as per directions.
  • Banks purchase and sell securities, shares and debentures on behalf of their customers.
  • Banks arrange to send money from one place to another for the convenience of their custom­ers.

7. Miscellaneous Functions: Besides the functions mentioned above, banks perform many other functions of general utility which are as follows:

  • Banks make arrangement of lockers for the safe custody of valuable assets of their custom­ers such as gold, silver, legal documents etc.
  • Banks give reference for their customers.
  • Banks collect necessary and useful statistics relating to trade and industry.
  • For facilitating foreign trade, banks undertake to sell and purchase foreign exchange.
  • Banks advise their clients relating to investment decisions as specialist
  • Bank does the under-writing of shares and debentures also.
  • Banks issue letters of credit.
  • During natural calamities, banks are highly useful in mobilizing funds and donations.

Banks provide loans for consumer durables like cars, Air-conditioner, and Fridge etc.

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