Functions of Commercial Banks –
The main functions of commercial banks are to receive deposits and advance loans. Banks borrow in form of deposits and lend in form of advances or loans.
# Accepting Deposits
Bank borrows in form of deposits from the public and gives some interest on deposits with them.
Types of deposits –
1. Demand Deposits or Current Account Deposits –
Demand deposits or Current account deposits are a type of deposits with the bank from which money can be withdrawn (full or a part of it) at anytime without notice. Mostly no interest is paid on these types of deposits because bank can’t utilize these short term deposits for lending purposes and it has to keep cent percent reserve against these deposits. But in return for these deposits, the bank provides some facilities to the account holders, for example, cheque facility. On behalf of the account holders of these deposits, banks collects cheques, drafts, dividend warrants, postal orders etc.
2. Fixed Deposits or Time Deposits –
Fixed or time deposits are those types of deposits which are made with the banks for a fixed period of time. In India, this period of time can be from 15 days to few years. These types of deposits can’t be withdrawn before the expiry of that period. But, a loan can be taken from the bank against the security of these deposits within that period. Banks provides higher rate of interest on these types of deposits, so these deposits are a good source of investment for the public who are in a position to save and deposit their money with the banks.
3. Saving Bank Deposits –
Like the demand deposits, saving bank deposits are payable on demand and also can be withdrawn by cheque. But, sometimes there are also restrictions as to the total amount that can be withdrawn at one time and deposited in one deposit. These types of deposits are mostly made by the peoples with fixed salaries for holding their short term savings. These deposits can also be withdrawn through cheques, although there are some restrictions on the number of times of withdrawals through cheques that can be made from these accounts. These deposits have a lower rate of interest than the fixed deposits.
# Advancing Loans
Another important function of the bank is to give loans to others. Banks usually gives loans to the firms and businessmen for the short period of time. Because the bank has to keep itself ready to meet the demands of the people who have deposited money for the short period of time only. The bank makes profits by advancing loans. But the bank uses other people’s money and it has to keep some cash ready to meet the depositors demands. So, the bank must keep a balance between profitability and liquidity. If it keeps its more assets in liquid form, it loses profit and if it tries to make too much profit, it loses its liquidity, means it may not be able to meet the depositors demand. So, the banks have to keep these things in balance.
Ways of advancing loans –
1. By allowing an overdraft –
People makes arrangements with the banks that if a cheque has been drawn by them which is not covered by the deposit, than bank should grant the overdraft and honour the cheque. So, under overdraft arrangements, people can get more than they have deposited but they have to pay interest on the extra amount which has to be paid back within a short period. Overdrafts facilities are mostly granted to the businessmen who can pay off the money after the sale of its products.
2. Cash credit loan –
In the cash credit loan system, borrower has sanctioned a credit limit up to which he can borrow from the bank. Before sanctioning a credit limit bank satisfies itself about the credit worthiness of the borrower. But actual utilization of the credit limit by the borrower depends on his withdrawing power. The withdrawing power of a borrower is determined by his current assets (such as stocks of goods, semi furnished goods, raw material etc.) and payments receivable from others. The borrower has to periodically submit a list of his assets showing his borrowing power to the bank. The interest payable by the borrower to the bank is calculated on the amount of the credit limit actually drawn.
3. Demand loans –
Demand loans are the loans which can be recalled on demand by the bank any time. This loan is paid to the borrower in lump sum (full amount at once) by crediting to his account. So, the interest is payable on the entire amount of demand loan granted. These types of loans usually granted to the stock brokers whose need for credit fluctuates from day to day.
4. Short Term Loans –
Short term loans are given as personal loans against security provided by the borrower. These loans are also given to businessmen to fulfill their financial needs for working capital. This type of loan is also paid in lump sum to borrower by crediting to his account and interest is payable on the entire amount of the loan. Examples – car loans, housing loans etc.
# Discounting Bills of Exchange –
Bank has another important function of discounting bills of businessmen.
A businessman buys goods and is granted credit, say, for a month. The seller of the goods draws a bill of exchange which the purchaser is asked to sign. The bill orders the purchaser to pay a certain sum after the expiry of one month. If seller goes on selling this way, his all stock of goods will be sold and he will only have these bills in his cash box. Unless he changes these bills into cash, his business will come to a standstill. So, he does not keep these bills with him till they mature for payment. But he takes these bills to the bank and gets the present worth of the bills in the form cash, leaving the bank to realize them when the date of payment comes. This is called discounting of a bill.
Discounting bill is a good investment for bank. Bills are certain to be paid on maturity. They set up a regular flow of incoming and outgoing of cash. These bills are negotiable instruments, so, they do not create any difficulty at the time of payment and do not involve the bank in any litigation. These bill suits the banks for short term investment.
# Transfer of Money –
Bank transfers funds for their clients or customers from one place to another. This is cheap as well as safe to transfer funds or money from one place or person to another place or person.
# Miscellaneous Functions –
Bank provides lockers or safe deposit box or vaults to their clients.
Bank collects interest on behalf of its clients and also pays dividends on behalf of the joint-stock companies.
It pays insurance premium on behalf of its clients from their deposits.
It executes the wills of deceased clients and acts for them as a trustee.
Banks creates money through credit creation.
Aim Institute of Economics 