Functions of Commercial Banks
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Transcript of Functions of Commercial Banks
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Functions of Commercial BanksThe functions of a commercial banks are divided into two categories:i) Primary functions, andii) Secondary functions including agency functions.i) Primary functions:The primary functions of a commercial bank include:a) accepting deposits; andb) granting loans and advances;a) Accepting depositsThe most important activity of a commercial bank is to mobilisedeposits from the public. People who have surplus income andsavings find it convenient to deposit the amounts with banks.Depending upon the nature of deposits, funds deposited withbank also earn interest. Thus, deposits with the bank grow alongwith the interest earned. If the rate of interest is higher, publicare motivated to deposit more funds with the bank. There is alsosafety of funds deposited with the bank.b) Grant of loans and advancesThe second important function of a commercial bank is to grantloans and advances. Such loans and advances are given tomembers of the public and to the business community at a higherrate of interest than allowed by banks on various deposit accounts.The rate of interest charged on loans and advances variesdepending upon the purpose, period and the mode of repayment.The difference between the rate of interest allowed on depositsand the rate charged on the Loans is the main source of a bank’sincome.i) LoansA loan is granted for a specific time period. Generally,commercial banks grant short-term loans. But term loans,Functions of Commercial Banks :: 23that is, loan for more than a year, may also be granted.The borrower may withdraw the entire amount in lumpsumor in instalments. However, interest is charged on the fullamount of loan. Loans are generally granted against thesecurity of certain assets. A loan may be repaid either inlumpsum or in instalments.ii) AdvancesAn advance is a credit facility provided by the bank to itscustomers. It differs from loan in the sense that loans maybe granted for longer period, but advances are normallygranted for a short period of time. Further the purpose ofgranting advances is to meet the day to day requirementsof business. The rate of interest charged on advances variesfrom bank to bank. Interest is charged only on the amount
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withdrawn and not on the sanctioned amount.Modes of short-term financial assistanceBanks grant short-term financial assistance by way of cash credit,overdraft and bill discounting.a) Cash CreditCash credit is an arrangement whereby the bank allows theborrower to draw amounts upto a specified limit. The amount iscredited to the account of the customer. The customer canwithdraw this amount as and when he requires. Interest is chargedon the amount actually withdrawn. Cash Credit is granted as peragreed terms and conditions with the customers.b) OverdraftOverdraft is also a credit facility granted by bank. A customerwho has a current account with the bank is allowed to withdrawmore than the amount of credit balance in his account. It is atemporary arrangement. Overdraft facility with a specified limitis allowed either on the security of assets, or on personal security,or both.24 :: Business Studiesc) Discounting of BillsBanks provide short-term finance by discounting bills, that is,making payment of the amount before the due date of the billsafter deducting a certain rate of discount. The party gets thefunds without waiting for the date of maturity of the bills. Incase any bill is dishonoured on the due date, the bank can recoverthe amount from the customer.ii) Secondary functionsBesides the primary functions of accepting deposits and lending money,banks perform a number of other functions which are called secondaryfunctions. These are as follows -a) Issuing letters of credit, travellers cheques, circular notes etc.b) Undertaking safe custody of valuables, important documents, andsecurities by providing safe deposit vaults or lockers;c) Providing customers with facilities of foreign exchange.d) Transferring money from one place to another; and from onebranch to another branch of the bank.e) Standing guarantee on behalf of its customers, for makingpayments for purchase of goods, machinery, vehicles etc.f) Collecting and supplying business information;g) Issuing demand drafts and pay orders; and,h) Providing reports on the credit worthiness of customers.
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Primary Functions of Commercial Banks
Commercial Banks performs various primary functions some of them are given below
1. Accepting Deposits : Commercial bank accepts various types of deposits from public especially from its
clients. It includes saving account deposits, recurring account deposits, fixed deposits, etc. These deposits are
payable after a certain time period.
2. Making Advances : The commercial banks provide loans and advances of various forms. It includes an over
draft facility, cash credit, bill discounting, etc. They also give demand and demand and term loans to all types
of clients against proper security.
3. Credit creation : It is most significant function of the commercial banks. While sanctioning a loan to a
customer, a bank does not provide cash to the borrower Instead it opens a deposit account from where the
borrower can withdraw. In other words while sanctioning a loan a bank automatically creates deposits. This is
known as a credit creation from commercial bank.
Secondary Functions of Commercial Banks
Along with the primary functions each commercial bank has to perform several secondary functions too. It
includes many agency functions or general utility functions. The secondary functions of commercial banks can be
divided into agency functions and utility functions.
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1. Agency Functions : Various agency functions of commercial banks are
1. To collect and clear cheque, dividends and interest warrant.
2. To make payment of rent, insurance premium, etc.
3. To deal in foreign exchange transactions.
4. To purchase and sell securities.
5. To act as trusty, attorney, correspondent and executor.
6. To accept tax proceeds and tax returns.
2. General Utility Functions : The general utility functions of the commercial banks include
1. To provide safety locker facility to customers.
2. To provide money transfer facility.
3. To issue traveller's cheque.
4. To act as referees.
5. To accept various bills for payment e.g phone bills, gas bills, water bills, etc.
6. To provide merchant banking facility.
7. To provide various cards such as credit cards, debit cards, Smart cards, etc.