FUNCTIONS OF COMMERCIAL BANKS

An institution that provides services like accepting the deposits, providing business
loans, and offering basic investment products is known as the commercial banks. It
is largely a division of a large bank which deals with loan and deposit services
provided to large and small size businesses. Thus, there are many functions of
commercial banks in India. Mainly there are two functions, primary and
secondary.

Functions of Commercial Bank

Commercial Banks perform various functions which can be categorised into

two broad categories; viz., Primary Functions and Secondary Functions.
A. Primary Functions
Accepting Deposits and Advancing of Loans are the two primary functions
performed by commercial banks.
1. Accepting Deposits
One of the most essential functions of commercial banks is accepting deposits.
Commercial banks accept deposits from their customers in different forms
based on the requirements of different sections of society. The main types of
deposits include:
 Demand Deposits or Current Account Deposits:
The deposits which are repayable on demand by the banks are known as
demand deposits or current account deposits. In general, these kinds of
deposits are maintained by businessmen to make transactions with these
deposits. One can get the amount deposited as demand deposits by a cheque
without any restriction. Besides, commercial banks do not pay any interest to
the depositors on these accounts; instead, they charge some amount as a
service charge for running these accounts.
 Fixed Deposits or Time Deposits :
The deposits in which the depositor, deposits money with the bank for a fixed
time period are known as fixed deposits or time deposits. These deposits do
not enjoy a cheque facility and carry a high interest rate.
 Saving Deposits:
The deposits, which include combined features of demand deposits and fixed
deposits are known as saving deposits. The depositors have the cheque facility
to withdraw money from their accounts, but there are some restrictions on the
number and amount of withdrawals. The restrictions are imposed to discourage
the frequent use of saving deposits. Besides, the interest rate on saving
deposits is less than the interest rate on fixed deposits.
2. Advancing of Loans
The banks are not allowed to keep the amount deposited with them, idle.
Therefore, commercial banks have to keep some amount of the total deposits
as cash reserves and lend the rest of the balance to needy borrowers and charge
interest from them. The interest received by commercial banks from advancing
loans is the main source of their income. Some of the different types of loans
and advances made by commercial banks are:
 Cash Credit:
The loan given to the borrowers against their current assets like stocks, bonds,
shares, etc., is known as cash credit. For this, a credit limit is sanctioned to the
borrower, and money is credited to this account. The borrower can now
withdraw any amount at any time within his credit limit. Interest is charged
from the borrower on the amount actually withdrawn by him.
 Demand Loans:
The loans given by the banks which they can recall at any time on demand are
known as demand loans. The entire amount of the demand loan is credited to
the borrower’s account, and interest is charged on that amount.
 Short-term Loans:
Personal loans given to borrowers against some collateral security are known
as short-term loans. The amount taken as a loan is credited to the account of
the borrower, and he can withdraw that money from his account. Interest is
charged on the entire sum of the loan granted.
B. Secondary Functions
Besides primary functions, commercial banks also perform some secondary
functions.
1. Overdraft Facility
A facility that allows the customer to overdraw from the amount of his current
account upto an agreed limit is known as an overdraft facility. In general, an
overdraft facility is given to respectable and reliable customers for a short
period. Besides, the customers have to pay interest on the amount overdrawn
by them.
2. Discounting Bills of Exchange
A facility in which the holder of a bill of exchange, before its maturity date
can get the bill discounted with the bank. The bank pays the amount to the
holder after deducting some amount as commission. Now, on the date of
maturity, the party which has accepted the bill pays back the money to the
bank.
3. Agency Functions
There are some agency functions performed by commercial banks for which
they charge some commission from their clients. Some of these functions are:
 Transfer of Funds:
With the help of instruments like mail transfers, demand drafts, etc.,
commercial banks provide their customers with the facility of easy and
economical remittance of funds from one place to another.
 Collection and Payment of Various Items:
Commercial banks provide their customers with the service of collecting bills,
interest, subscriptions, rents, and other periodical receipts on their behalf.
They also make payments for insurance premiums, taxes, etc., on their
customer’s standing instructions.
 Purchase and Sale of Foreign Exchange:
The central bank gives authority to commercial banks to deal in foreign
exchange. Commercial banks, on the behalf of their customers, buy and sell
foreign exchange and also helps in promoting international trade.
 Purchase and Sale of the Securities:
Commercial banks on behalf of their customers, purchase and sell government
securities and stocks and shares of private companies.
 Income Tax Consultancy:
Commercial banks provide advice to their customers related to income tax.
They also help them in the preparation of their income tax returns.
 Trustee and Executor :
Commercial banks play the role of a trustee and preserve the will of their
customers and as an executor, execute the will after their death.
 Letters of Reference:
Commercial banks provide information about the economic position of their
customers to the traders and vice-versa.

4. General Utility Functions

Some of the general utility functions performed by commercial banks are:
 Locker Facility: Commercial banks provide their customers with the
facility of lockers or safety vaults so they can keep their valuable things in
safe custody.
 Traveller’s Cheques:
To avoid the risk of taking cash on their journey, commercial banks provide
their customers with the facility of traveller’s cheques.
 Letter of Credit:
Sometimes people need to show their creditworthiness for various reasons.
Commercial banks certify the creditworthiness of their customers whenever
required.
 Underwriting Securities:
Commercial banks also performs the function of underwriting securities. And
as the public has full faith in the bank’s creditworthiness, they do not hesitate
in purchasing the securities which are underwritten by banks.
 Collection of Statistics:
Commercial banks advice their customers on financial matters by collecting
and publishing statistics related to commerce, trade, and industry.
Importance of Commercial Banks
Commercial banks play a crucial role in the economic development of a
country. The banks help in the acceleration of a country’s economic growth in
the following ways:
1. Help Consumers:
Commercial banks help consumers in purchasing durable consumer goods like
Air Conditioners, Refrigerators, T.V., etc., which are out of their paying
capacity limit, by advancing credit to them. By doing so, commercial banks
create demand for these consumer goods.
2. Provision of Finance and Credit:
Commercial banks play an essential role as a source of finance and credit for
industry and trade. These banks not only perform activities that are confined
to domestic trade and commerce but are also extended to foreign trade.
3. Accelerating the Rate of Capital Formation:
Commercial banks encourage people’s habit of thrifting and mobilise their
savings which are then allocated effectively among the ultimate users of funds;
i.e., the investors for productive investment. Therefore, savings made by
people result in capital formation forming the basis of economic development.
4. Promoting Balanced Regional Development:
Commercial banks play an essential role by providing credit facilities to rural
people by opening up their branches in backward areas. These banks use the
funds collected in the developed regions to channelise investment in the under
developed regions of the country. By doing so, commercial banks bring out
more balanced regional development.
5. Developing Entrepreneurship:
Commercial banks promote entrepreneurship by way of underwriting shares of
new and existing companies and also, grant assistance for the promotion of
new ventures or for financing promotional activities. These banks provide
finance to the loss-making/sick industries to make them viable units.

Types of Commercial Banks

Commercial banks are of three types i.e., Public sector banks, Private sector banks
and Foreign banks.

Public Sector Banks:

These are banks where majority stake is held by the Government of India or
Reserve Bank of India. Examples of public sector banks are State Bank of India,
Corporation Bank, Bank of Baroda and Dena Bank, etc.

Private Sectors Banks:

In case of private sector banks majority of the share capital of the bank is held by
private individuals. These banks are registered as companies with limited liability.
For example The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd.,
Development Credit Bank Ltd, Lord Krishna Bank Ltd., Bharat Overseas Bank
Ltd., Global Trust Bank, Vysya Bank, etc.

Foreign Banks:

These banks are registered and have their headquarters in a foreign country but
operate their branches in our country. Some of the foreign banks operating in our
country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank,
American Express Bank, Standard & Chartered Bank, Grindlay’s Bank, etc. The
number of foreign banks operating in our country has increased since the financial
sector reforms of 1991.
Development Banks

Business often requires medium and long-term capital for the purchase of
machinery and equipment, for using the latest technology, or for expansion and
modernization. Such financial assistance is provided by Development Banks.
They also undertake other development measures like subscribing to the shares
and debentures issued by companies, in case of under subscription of the issue by
the public. Industrial Finance Corporation of India (IFCI) and State Financial
Corporations (SFCs) are examples of development banks in India.

Co-operative Banks

People who come together to jointly serve their common interest often form a co-
operative society under the Cooperative Societies Act. When a co-operative
society engages itself in banking business it is called a Co-operative Bank. The
society has to obtain a licence from the Reserve Bank of India before starting
banking business. Any cooperative bank as a society is to function under the
overall supervision of the Registrar, Co-operative Societies of the State. As
regards banking business, the society must follow the guidelines set and issued by
the Reserve Bank of India.

Types of Co-operative Banks

Here are three types of co-operative banks operating in our country. They are
primary credit societies, central cooperative banks and state co-operative banks.
These banks are organized at three levels, village or town level, district level and
state level.

Primary Credit Societies:

These are formed at the village or town level with the borrower and non-borrower
members residing in one locality. The operations of each society are restricted to a
small area so that the members know each other and are able to watch over the
activities of all members to prevent frauds.

Central Cooperative Banks:

These banks operate at the district level having some of the primary credit
societies belonging to the same district as their members. These banks provide
loans to their members (i.e., primary credit societies) and function as a link
between the primary credit societies and state co-operative banks.

State Co-operative Banks:

These are the apex (highest level) co-operative banks in all the states of the
country. They mobilise funds and help in its proper channelisation among various
sectors. The money reaches the individual borrowers from the state cooperative
banks through the central co-operative banks and the primary credit societies.

Specialised Banks

There are some banks, which cater to the requirements and provide overall
support for setting up business in specific areas of activity. EXIM Bank, SIDBI
and NABARD are examples of such banks. They engage themselves in some
specific area or activity and thus, are called specialised banks. Let us know about
them.

Export-Import Bank of India (EXIM Bank):

If you want to set up a business for exporting products abroad or importing

products from foreign countries for sale in our country, EXIM bank can provide
you with the required support and assistance. The bank grants loans to exporters
and importers and also provides information about the international market. It
gives guidance about the opportunities for export or import, the risks involved in it
and the competition to be faced, etc.

Small Industries Development Bank of India (SIDBI):

If you want to establish a small-scale business unit or industry, loan on easy terms
can be available through SIDBI. It also finances the modernisation of small-scale
industrial units, use of new technology and market activities. The aim and focus of
SIDBI are to promote, finance and develop small-scale industries.

National Bank for Agricultural and Rural Development (NABARD):

It is a central or apex institution for financing agricultural and rural sectors. If a

person is engaged in agriculture or other activities like handloom weaving,
fishing, etc. NABARD can provide credit, both short-term and long-term, through
regional rural banks. It provides financial assistance, especially, to co-operative
credit, in the field of agriculture, small-scale industries, cottage and village
industries handicrafts and allied economic activities in rural areas.

Banking System

The structure of banking system differs from country to country depending upon
their economic conditions, political structure, and financial system. Banks can be
classified on the basis of the volume of operations, business pattern and areas of
operations. They are termed as a system of banking. The commonly identified
systems are:

Unit Banking

Unit banking is originated and developed in the U.S.A. In this system, small
independent banks are functioning in a limited area or in a single town . It has its
own board of directors and stockholders. It is also called as “localized Banking”.

Branch Banking

The Banking system of England originally offered an example of the branch

banking system, where each commercial bank has a network of branches spread
throughout the country.

Correspondent Banking

The correspondent banking system is developed to remove the difficulties in the

unit banking system. The smaller banks deposit their cash reserve with bigger
banks.

Therefore, correspondent banks are intermediaries through which all unit banks
are linked with bigger banks in financial centers. Through correspondent banking,
a bank can carry-out business transactions in another place where it does not have
a branch.
Group Banking

Group Banking is the system in which two or more independently incorporated

banks are brought under the control of a holding company. The holding company
may or may not be a banking company. Under group banking, the individual
banks may be unit banks, or banks operating branches or a combination of the
two.

Pure Banking and Mixed Banking

On the basis of lending operations of the bank, banking is classified into:

(a) Pure Banking

(b) Mixed Banking

(a) Pure Banking:

Under pure Banking, the commercial banks give only short-term loans to industry,
trade, and commerce. They specialize in short-term finance only. This type Of
banking is popular in U.K.

(b) Mixed Banking:

Mixed banking is that system of banking under which the commercial ban s
perform the dual function of commercial banking and investment banking.
Commercial banks usually offer both short-term as well as medium-term loans.
The German banking system is the best example of mixed Banking.
Relationship Banking

It refers to the efforts of a bank to promote personal contacts and to keep

continuous touch with customers who are very valuable to the bank. In order to
retain such profitable accounts with the bank or to attract new accounts, it is
necessary for the bank to serve their needs by maintaining a close relationship
with such customers.

Narrow Banking

A bank may be concentrating only on the collection of deposits and lend or invest
the money within a particular region or certain chosen activity like investing the
funds only in Government Securities. This type of restricted minimum banking
activity is referred to as ‘Narrow Banking’.

Universal Banking

As Narrow Banking refers to restricted and limited banking activity Universal

Banking refers to broad-based and comprehensive banking activities.

Regional Banking

In order to provide adequate and timely credits to small borrowers in rural and
semi-urban areas, Central Government set up Regional Banks, known as Regional
Rural Banks all over India jointly with State Governments and some Commercial
Banks.

Local Area Banks

With a view to bringing about a competitive environment and to overcome the
deficiencies of Regional Banks, Government has permitted the establishment of
one type of regional banks in rural and semi-urban centers under private sector
known as “Local Area Banks”.

Wholesale Banking

Wholesale or corporate banking refers to dealing with limited large-sized

customers. Instead of maintaining thousands of small accounts and incurring huge
transaction costs, under wholesale banking, the banks deal with large customers
and keep only large accounts. These are mainly corporate customer.

Private Banking

Private or Personal Banking is banking with people — rich individuals instead of

banking with corporate clients. It attends to the need of individual customers, their
preferences and the products or services needed by them. This may include all-
around personal services like maintaining accounts, loans, foreign currency
requirements, investment guidance, etc.

Retail Banking

Retail banking is a major form of commercial banking but mainly targeted to

consumers rather than corporate clients. It is the method of banks’ approach to the
customers for sale of their products.
Banking Practice Questions

A banking system is referred to as a system that provides cash management and

other financial services.

History of Banking in India

Q1: Which of the following banks can be included in the Scheduled Commercial
Banking System of India?

A) Private Sector Banks B) Regional Rural Banks (R R B) C)

The Foreign Banks in India D) All of the above E) None of the
above

Q2: Which of the Public Sector Bank’s emblem figures a dog and the words
‘faithful friendly’ in it?

A) State Bank Of India B) Central Bank of India C)

Syndicate Bank D) Punjab National Bank E) Oriental Bank
of India F) I D B I Bank
Q3: In India, the first bank of limited liabilities managed by Indians and founded
in 1881 was?

A) Oudh Commercial Bank B) Punjab and Sindh Bank C)

Hindustan Commercial Bank D) The Reserve Bank of the Imperial flag
E) Punjab National Bank

Q4: When was the second phase of nationalisation done?

A) 23rd April, 1978 B) 15th April, 1980 C) 27th July, 1991

D) 23rd June, 1979 E) None of the above

Q5: Who will act as the banker to the Governor of India?

A) State Bank of India B) N A B A R D C) The Finance Minister

of India D) Reserve Bank of India (R B I) E) None of these

Q6: The headquarters of the Reserve Bank of India is located in which of the
following cities?

A) Kolkata B) Chennai C) Delhi D) Mumbai

E) Allahabad

Q7: Who regulates the money circulation in India?

A) The Reserve Bank of India (R B I) B) State Bank of India

C) N A B A R D D) Commercial Banks
E) None of the above
Q8: Which bank came into existence in the year 1921 when three banks namely,
Bank of Bengal (1806), Bank of Bombay (1840) and Bank of Madras (1843) were
reorganised and amalgamated to form a single banking entity?

A) Punjab National Bank B) Imperial Bank of India

C) State Bank of India D) Reserve Bank of India (R B I) E)
None of the above

Find Your Answers Here

Q1: A), Q2: C), Q3: ), Q4: B), Q5: D), Q6: D), Q7: A), Q8: B)