Commercial Bank: Meaning and Functions of Commercial Banks

Commercial Bank: A commercial bank is a financial institution authorized to provide a variety of financial services, including consumer and business loans, savings accounts etc. Earlier commercial banks were limited

Raju Choudhary

Commercial Bank

Commercial Bank: A commercial bank is a financial institution authorized to provide a variety of financial services, including consumer and business loans, savings accounts etc. Earlier commercial banks were limited to accepting deposits of money or valuables for safekeeping and verifying coinage or exchanging one jurisdiction’s coins for another’s. By the 17th century, most of the essentials of modern banking, including foreign exchange, the payment of interest, and the granting of loans, were in place.

Commercial Bank Functions

Commercial Banks play a very prominent role in the financial system of an economy. They perform a variety of functions as discussed below:

1. Acceptance of deposits: One of the primary functions of a commercial bank is to accept deposits from the public. The deposits accepted by the banks are of the following types.

  • (a) Current deposits: These are the deposits made into the current account of a bank. They are most convenient to businessmen, public authorities and joint stock companies because there are no restrictions on the number and the number of withdrawals.
  • (b) Savings deposits: These deposits are made into a savings bank account of the bank. They are most convenient to the small businessman, salaried employees, artisans and people belonging to the low and middle income groups. The interest paid on these deposits is comparatively low and is around 4% per annum.
  • (c) Term deposits: They are also called fixed deposits because the money is deposited with the bank for a fixed period of time. The deposit can be withdrawn after the expiry of the maturity period. The minimum period of deposit is 15 days. The rate of interest varies from 6% per annum to 12% per annum.
  • (d) Recurring or cumulative deposits: These are the variants of fixed deposits. These deposits are very convenient for those who cannot save huge amounts at a time. These deposits carry interest at a rate more than that of a savings bank and less than that of a term deposit.

2. Payment of loans and advances:

Another primary function if the commercial bank is to give loans and advances to different sections of the public like traders, industrialists, farmers, artisans etc.

(a) Demand loans/call loans: A demand loan is a loan that should be repaid on demand by the bank. It does not have a specified maturity period. This loan is a kind of advance made with or without security. These are also called call loans. Normally call loans are given to other banks or financial institutions for a day or a few days.

(b) Short term loans: These loans are given for a specified short period. They are sanctioned to businessmen and farmers etc. to finance working capital. Individuals may also receive such loans as personal loans. They are given against security.

(c) Cash credits: A cash credit refers to an arrangement by which the bank allows its customer to borrow money upto a specified limit from an account opened for the purpose. The customer need not withdraw the entire amount in one installment.

(d) Overdraft: This is a facility allowed by the bank to the current account holders. They are allowed to withdraw money with or without security in excess of the balance available in their account up to a limit. Interest is charged on the amount of actual withdrawal.

(e) Discounting of bills of exchange: Bills of exchange are undertakings written by the buyers and given to sellers when the transaction is made on credit basis. The buyer undertakes to make payment after a specified period or on a specified future date. The traders who posses such bills of exchange with them may approach the banks for discounting of the bills of exchange when they need money.

d) Credit cards: Now-a-days, the banks have devised new methods of giving loans to the customers. One such popular method is issuance of the credit card. A credit cardholder can use his card to purchase goods on credit from specified firms and shops and also withdraw cash subjects to certain regulations.

3. Creation of Credit:

The commercial banks create credit. This is a unique function of commercial banks. Credit is created from out of the primary deposits of money the customers received from the public. Part of the total amount of these deposits is given as loans and advances to its customers.

4. Agency Functions:

Commercial banks perform certain agency functions also:

  • (a) Collection of cheques, drafts, bills of exchange etc. of their customers from other banks.
  • (b) Collection of dividends and interest from business and industrial firms.
  • (c) Purchase and sale of securities, shares, debentures, government securities on behalf of the customers.
  • (d) Acting as trustees and keeping their funds in safe custody, acting as executors and executing the will of the customers after their death.
  • (e) Making payments such as insurance premium, income-tax, subscriptions etc. on behalf of their customers as per their advice.

5. General Utility Functions:

Besides the above agency functions, the commercial banks provide certain general utility services to their customers.

  • (a) Provide locker facility for the safe custody of the silver, gold ornaments, important and valuable documents.
  • (b) Transfer money of the customers from one bank to the other by way of demand drafts, mail transfer.
  • (c) With the use of computers and internet facility, now-a-days the banks are facilitating on-line transfer of money from one bank to the other.
  • (d) Issue letters of credit to enable the customers to purchase commodities on the basis of credit.
  • (e) Endorse and provide guarantee to the shares issued by the joint stock companies and help them in rising capital.
  • (f) Traveler’s cheques are issued by the commercial banks to avoid the risk of carrying of cash.
  • (g) Provide foreign exchange to the customers for exports and imports in connection with their business.
  • (h) Convey information on behalf of their customers to the businessmen operating in other places and also collect information of such businessmen and provide it to the customers.
  • (i) Recently the commercial banks have been establishing ATMs (Automated Teller Machines) at different locations so as to enable their customers to withdraw cash from their accounts at any ATM at any time in a day.

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