Functions of Commercial Banks

What is Commercial Bank

The term commercial bank refers to a financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products like certificates of deposit and savings accounts to individuals and small businesses. A commercial bank is where most people do their banking.

Commercial banks make money by providing and earning interest from loans such as mortgages, business loans, and personal loans.

Customer deposits provide banks with the capital to make these loans.

The general role of commercial banks is to provide financial services to the general public and business, ensuring economic and social stability and sustainable growth of the economy.

In this respect,  credit creation is the most significant function of Commercial Banks.

Example of Commercial bank

  • State Bank of India
  • Industrial Credit and Investment Corporation of India (ICICI) Bank
  • Housing Development Finance Corporation (HDFC) Bank
  • Corporation Bank

Functions of Commercial Banks

Commercial banks perform a variety of functions which can be divided as:

  1. Accepting deposits
  2. Advancing loans
  3. Credit Creation
  4. Financing Foreign trade
  5. Agency services
  6. Miscellaneous services to Customers

1. Accepting Deposits

This is the oldest function of a bank and the banker used to charge a commission for keeping the money in its custody when banking was developing as an institution.

Nowadays a bank accepts three kinds of deposits from its customers. The first is the savings deposits on which the bank pays small interest to the depositors who are usually small savers.

The depositors are allowed to draw their money by cheques up to a limited amount during a week or year.

Businessmen kept their deposits in current accounts. They can withdraw any amount standing to their credit in current deposits by cheques without notice.

The bank does not pay interest on such accounts but instead charges a nominal sum for services rendered to its customers. Current accounts are known as demand deposits.

2. Advancing loans

One of the primary functions of Commercial Banks is to advance loans to their customers. A bank lends a certain percentage of the cash lying in deposits on an only higher interest rate than it pays on such deposits.

This is how it earns profits and carries on its business. The bank advances loans in the following ways:

  • Cash Credit: The bank advances loans to businessmen against certain specified securities. The amount of the loan is credited to the current account of the borrower. In the case of a new customer, a loan account for the sum is opened. The borrower can withdraw money through cheques according to his requirements buy pays interest on the full amount.
  • Calls Loans: These are very short-term loans that advance to the bill brokers for not more than 15 days. They are advance against first-class bills or securities. Such loans can be recalled at very short notice. In normal times they can also be renewed.
  • Overdraft: A Bank often permits a businessman to draw cheques for a sum greater than the balance lying in his current account. This is done by providing the overdraft facility up to a specific amount to the Businessman. But he is charged interest only on the amount by which his current account is actually overdrawn and not by the full amount of the overdraft sanctioned to him by the banks.

3. Credit Creation

Credit creation is one of the most important functions of commercial banks. Like other financial institutions, they aim at earning profits.

For this purpose, they accept deposits and advance Loans by keeping small cash in reserve for day-to-day transactions.

When a bank advances a loan, it opens an account in the name of the customer and does not pay him in cash but allows him to draw the money by cheque according to his needs. By granting a loan, the bank creates credit or deposits.

4. Financing Foreign Trade

A commercial bank finances foreign trade of its customer by accepting foreign bills of exchange and collecting them from foreign banks. It also transacts other foreign exchange business and buys and sells foreign currency.

5. Agency Services

A Bank act as an agent of its customer in collecting and paying cheques, bills of exchange, drafts, dividend etc.

It also buys and sells shares, security debenture, etc. for its customers. It also act as a Trustee and executor of the property and will of its customers.

6. Miscellaneous Services

Besides the above-noted services, the commercial bank performs a number of other services. It acts as the custodian of the value of its customer by providing them lockers where they can keep their jewelry and valuable documents.

It issues various forms of credit instruments such as cheques, drafts, traveler’s cheque, etc. which facilitate the transaction.

The bank also issues a letter of credit and acts as a referee to its clients. It underwrites shares and debentures of companies and helps in the collection of funds from the public.

Types of Commercial Bank

Commercial banks are classified into two categories i.e.  scheduled commercial banks and non scheduled commercial banks.

Scheduled commercial bank are classified into three types:

Private Bank

When the private individuals own more than 51% of the share capital, then that banking company is a private one.

However, these banks are publicly listed companies in a recognized exchange. All private banks are recorded as companies with Limited liability.

Such as Housing Development Finance Corporation Bank(HDFC), Industrial Credit and Investment Corporation of India ( ICICI ) Bank, etc.

Public Bank

Banks set up in a foreign country and operate their branches in the home country are called foreign banks. It is a  type of bank that is Nationalized and the government holds a significant stake.  

For example Bank of Baroda, State Bank of India, etc.

Foreign Bank

Banks set up in foreign countries and operate their branches in the home country are called foreign banks.

For example American Express Bank, Standard & Chartered Bank, etc.

Non- scheduled commercial banks refer to the banks which are not covered in the Reserve Bank of India’s second schedule. The paid-up capital of such a bank is not more than Rs.5 lakhs.

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