Question

What are the primary functions of commercial bank?

Answer 1

The primary functions of commercial banks are termed as banking functions.
(I) Accepting Depostis:
The most significant and traditional function of commercial bank is accepting deposits from public. A commercial bank acts as the custodian of public deposits. This function is very important because it helps in the mobilisation of funds from households to businessman for production purposes and provides necessary funds to the bank to create bank money. Commercial banks act as an intermediary by accepting deposits and paying interest on them and giving loans and charging the borrowers interest at a high rate. The difference between the two is the profit of the bank. Commercial bank accepts the following types of deposits:
(a) Demand Deposits (b) Time Deposists
(a) Demand Deposits: The deposits which can be withdrawn on demand, are known as demand deposits. They are of two types - (1) Current Account Deposits (2) Saving Account Deposits.
(1) Current Account Deposits : Current account deposits are usually held by businessmen, industrial enterprises, public bodes for business transactions. Money deposited in current account can be withdrawn in part or full at any time and any number of times by the depositors without any prior notice. Overdraft facilities and agency service are provided by the bank to the current account holders, very low or no interest is paid on these accounts as the banks cannot utilise these short term deposits. Banks may charge certain amount of service charges on account holders.
(2) Saving Account Deposits: Saving account deposits are opened by salaried class or people with fixed income for holding their short term savings, Money deposited in these accounts retain high degree of liquidity. At the same time it earns nominal interest. It is a kind of demand deposits which is generally kept by people for sake of safety.
(b) Time Deposits: These are deposits, which are repayable after a certain period of time. They are of two types - (1) Recurring Deposits (2) Fixed Deposits
(1) Recurring Deposits: These are deposits under which people deposit a fixed amount at regular interval for specified period of time. These deposits encourage savings and carry high rate of interest.
(2) Fixed Deposits: Fixed deposits are time deposits or term deposits, which attract fund for a specific period. It is a time abound deposit as the amount deposited cannot be withdrawn before the maturity of the period. However, loans can be taken from the bank against the security of this deposit, within that period. These deposits earn a higher rate of interest as the bank uses this money for giving loans where the bank earns high interest, so they can also pay high interest to depositors.
(II) Advancing/ Granting Loans:
The second major function of a commercial bank is to make loans and advances out of the money, which comes to it from the public by way of deposits. Direct loans and advances are given to all types of persons particularly to businessmen and investors against personal security, gold, silver and other assets. The profit earning capacity of commercial banks depends on this function of lending. Generally banks grant loans and advances to the borrowers in the following forms:
(1) Loans (2) Cash Credit (3) Overdraft facility (4) Discounting of bills
(1) Loans: Various types of loans and advances are provided by commercial banks, on the basis of time period. They are as follows:
(a) Call loans or Money at call (b) Short Term Loans
(c) Medium Term Loans (d) Long Term Loans
(a) Call loans or Money at Call: Inter-bank loans provided by commercial banks for a period of $7$ to $15$ are known as call loans.
(b) Short Term Loans: These are provided by commercial bank for a period of not more than two years. The rate of interest is higher than call loans. They are given to businessmen to fulfill their working capital requirement.
(c) Medium Term Loans: The loans are sanctioned for a period of two to five year period. The rate of interest charged for this type of loan is more than the short term loans. Such loans are useful to industries for introducing innovations or for introduction of new methods of production.
(d) Long Term Loans: Loans which are sanctioned for five and more years are known as long term loans. The rate of interest charged is higher than other loans. Such loans help businessmen to introduce permanent changes in the methods of production.
(2) Cash Credit : Cash credit are allowed to any customer. Under this facility, the commercial banks allow the borrowers to withdraw cash to a certain limit in the form of cash credit. This facility is available against personal security or security of goods pledged to the bank. Interest is charged on the amount withdrawn.
(3) Overdraft: It is given to current account holders. Overdraft facility enables, companies, firms and businessmen to withdraw amount over and above their actual balance in their current account. The extra amount withdrawn is treated as loan and interest is charged on it. Such facility is granted against collateral security. There overdraft facility help businessmen to serve transaction purpose or meet their working capital.
(4) Discounting Bills of Exchange or Hundies: This type of lending is very popular with the banks. A Bill of Exchange is a written promise by the debtor to a creditor to pay a specified sum of money after one or three months. If the creditor is in urgent need of money he can present this bill of exchange to the bank for discounting. After discounting or deducting its commission, the bank pays the present price of the bill to the holder. When the bill of exchange matures the bank can recover its payment from the party who signed the bill.