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UNIT 2
COMMERCIAL BANKING
BANK:-
A bank is a financial institution which deals in money. It means that a bank receives
money in the form of deposits from the public and lends money for development of trade &commerce.
BANKER:-
Dr. H.L. Hart (Native of England) defines the term banker as one who is in the
ordinary of his business honours cheques drawn upon him by persons from & for whom he
receives money on current account.
BANKING:-
According to Section 5 (1) (b) of the Banking Regulation Act of 1949, the term
banking is defined as Accepting for the purpose of lending or investment of deposits of
money from the public repayable on demand or otherwise & withdrawable by cheques,drafts, orders or otherwise.
BANKING COMPANY:-
Section 5(1) (c) of the Banking Regulation Act of 1949, defines
the term banking company as Any company which transacts the business of banking inIndia.
COMMERCIAL BANKING:-
It refers to that banking which is concerned with the
acceptance of deposits from the public repayable on demand or after the expiry of certain
period & the granting of mainly short term credit to trade, commerce & industry through anetwork of branches throughtout the country.
FUNCTION OF COOMMERCIAL BANKING:-
The function of commercial banking can be broadly classifiedinto two categories, viz.,
A. Principal/Primary/Basic/Fundamental function.
B. Subsidiary/Secondary/Supplementary/Ancillary function.
A. Primary functions:-
The primary functions of commercial banks are called traditional
functions or core functions. They are the following:-1) Acceptance of deposits from the public.
2) Lending of funds.
3) Investment of funds on securities.4) Creation of credit/money.
5) Use of cheque system.
6) Remittance of funds.
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I. Acceptance of deposits source of funds:-
Accepting deposits is one of primary function of a commercial bank.
Banks receive deposits from individuals, households, & corporate & non-corporatecustomers, government & other agencies & thus, they mobilize the savings in the country
for productive purposes. Commercial banks offer different varieties of deposits to suit to
the requirements of different categories of customers. Deposits serve as the major source ofsupply of funds to the commercial banks. The different sources of supply of funds to the
commercial banks are:-
i) Deposits of various kinds.ii) Borrowings from the Reserve Bank of India.
iii) Borrowings from other financial institutions.
iv) Borrowings from fellow bankers.
v) Borrowings from abroad.
Types of deposits:-
current account deposits/active a/c or running a/c:-
Current accounts form the most important type of bankaccount. They are generally opened by trading & industrial concerns, public authorities,
etc., which have frequent banking transactions involving huge amounts. They can beopened with a minimum of Rs.5000. proper & satisfactory introduction is necessary for
opening current account.
Current accounts are active or running accounts which arecontinuously in operation. In current accounts, customers can deposit any amount of
money & any number of times. Similarly, they can withdraw from current accounts any
amount & as many times as they want, as long as they have funds to their credit.Deposits into current accounts are made by filling in pay-
in-slips & withdrawals from the current accounts are made by issuing cheques. Current
deposits are repayable on demand. It is for this reason, they are also called demand depositsor demand liabilities.So, banks are required to keep the major portion of
current deposits in liquid form. As such; they are not able to earn much income from the
utilization of current deposits. Further they have to incur heavy expenses for themaintenance of current accounts, as a large number of transactions are to br\e recorded in
the account of each customer. For these reasons, generally, no interest is offers on current
deposits; instead incidental charges are claimed by the banks from the customers for thework & expenses involved in the maintenance of current accounts.
Savings Bank Account Deposits:-
Savings bank accounts are opened by middle & lowincome groups who wish to save a part of their current incomes for their future needs &
earn fair interest on their deposits. They can be opened with a minimum of deposit of
Rs.250 when they are to be operated without cheques & with Rs.1000 or more, when theyare to br\e operated by cheques. Proper & satisfactory introduction is necessary for opening
savings bank accounts.
In savings bank accounts, customers can deposits anyamount of money& any number of times. But, as these accounts are intended to promote
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the habit of saving among the depositors, these are restrictions on the number as well as the
amount of withdrawals from these accounts. Money is deposited into these accounts by
filling in pay-in-slips. Withdrawals are made from these accounts either by cheques or byspecial withdrawal forms accompanied by pass books.
As savings bank accounts are opened by customers with
a view to earning interests on their deposits & as there is an opportunity for the banks toutilize the savings bank deposits profitably on account of restrictions on withdrawals, fair
interest is offered by banks on savings bank deposits. At present 3% interest per annum is
allowed by banks in India on savings bank account deposits.
Fixed Deposit Accounts:-
Fixed deposits also form one of the most important types of bankaccounts. They are opened by small investors in order to earn good & steady income. No
introduction is necessary for opening the fixed deposit accounts, as they are not operated
by cheques.In case of fixed deposit accounts, fixed amounts are deposited by
the customers for fixed periods at fixed rate of interest. The period of deposits generallyvaries from three months to five years. The fixed deposits can be withdrawn not on
demand, but only after the expiry of fixed periods. It is for this reason they are also calledTime Deposits.
The fixed deposits are withdrawn by the surrender of Fixed
Deposit Receipt given by the banker at the time of depositing money. The banks canemploy these funds profitably without any fear of withdrawals by the depositors during the
course of fixed periods. That is why, the rate of interest offered by banks on fixed deposit
accounts is higher than that offered on other types of deposits. Generally, the longer theperiod of deposits, the higher the rate of interest & vice versa.
Recurring Deposit Accounts or Cumulative Deposit Accounts:-Recurring deposit accounts are variants of saving bank
accounts. They have become vary popular in recent years. They are meant for people who
have regular monthly incomes. They are intended to encourage the habit of saving among
the depositors on a regular basis.In the case of a recurring deposit account, the depositor
deposits a fixed sum of money every month for an agreed period & at the end of the
specified period, he gets back the amount deposited together with the interest accruedthereon. The amounts that are deposited into recurring deposit accounts every month are in
the multiplies of Rs.5 or 10 with a maximum of Rs.1000. The period for which a recurring
deposit account is opened varies from one year to ten years.
As there is a regular deposit of money into a recurringdeposits account & as there is no withdrawal from the account before the wxpiry of the
fixed period, there is an opportunity for the banker to employ the recurring deposits
profitably. So, he is able to offer high interest on the recurring deposits. The rate of interestoffered by a banker on the recurring deposits is almost equal to that allowed on the fixed
deposits.
In the case of a recurring deposit account, pass book is themeans through which deposits & withdrawals are made. The pass book is to be presented to
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the bank every month when deposit is made so as to enable the banker to record the deposit
therein. Again, at the end of the agreed period, the pas book is to be given to the banker for
obtaining the repayment of the accumulated amount.
II. Lending of funds:-
Lending of funds constitutes the main business of commercial banks.The major portion of the funds of commercial banks is employed by way of advances, as
advances from the primary source of profits for banks. Banks lends funds to the public by
way ofa) Loans.
b) Overdraft.
c) Cash credit.
d) Discounting of bills.
Loans:-
A loan is a financial arrangement under which an advance is granted by a bank to
a borrower on a separate account called the loan account. When a loan is sanctioned to aborrower, the entire amount of loan is debited to the loan account of the borrower at once
in lumpsum, either in cash or by transfer to the credit of his savings bank account or currentaccount or current account if any.
A loan is granted for short term, medium term & long term periods also. The
repayment of loan is made in lumpsum or instalments also. A loan is granted either againstcollateral securities or the personal securities of the borrower.
In the case of a loan interest is charged on the entire amount f loan sanctioned,
irrespective of the amount actually withdrawn by the borrower. Loans are given to against
the personal securities of the borrower. But usually & particularly where the amountinvolved is heavy, tangible securities in the form of government securities, shares,
debentures, fixed deposit receipts. Life insurance policies, documents of title to goods are
taken.
Cash credit:-
A cash credit is a financial arrangement under which a borrower is allowed anadvance under a separate account called cash credit account upto a specified limit called
the cash credit limit.
In the case of a cash credit, the borrower need not withdraw the entire amount
at once in one lumpsum. He can withdraw the amount in instalments as & when he needs.A cash credit is usually more permanent financial arrangement than an
overdraft. It can continue even for years together & is usually granted against the
hypothecation or pledge of agricultural or industrial products.Sometimes, it is given against guarantees. It is rarely given against the
personal securities of the borrower. Interest is charged quarterly or half yearly & is
calculated on the daily debit balance for the actual period of utilization. The cash creditarrangement is the most popular method of borrowing in India & about 70% of the total
bank credit is in the form of cash credits.
The popularity of cash credit is because if two reasons viz.,
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a) The borrower is required to pay interest on the actual amount utilized by him for the
actual period of utilization.
b) It is a permanent financial arrangement.Though cash credit arrangement is popular with the borrowers, it is
disadvantage to the banker, because A) he can charge interest only on the actual amount
withdrawn by the borrower. B) he is required to keep at the disposal of the borrower, theentire amount of cash credit sanctioned.
Therefore, to compensate the banker there is a provision for charging
commitment charge. On the unutilized portion of the cash credit limit.
Overdrafts:-
An overdraft is a financial arrangement under which a current account holder is
permitted by the bank to overdraw his account ie., to draw more than the amount standingto his credit upto an agreed limit against the collateral or personal securities of the
borrower.
In the case of an overdraft, interest is charged quarterly or half yearly & is
calculated on the daily debit balances for the actual period of utilization.It is advantageous to the borrower, as interest is charged only on the amount
actually withdrawn by him. But, it is disadvantageous to the banker because, he can chargeinterest only on the amount actually overdrawn by the customer & he is required to keep at
the disposal of the borrower, the full amount of the overdraft sanctioned.
Therefore, to protect the interest of the banker, generally there is a provision forcharging commitment charge. On the unutilized portion of the credit limit.
Discounting of Bills of exchange:-
It is an arrangement under which a bank takes a bill ofexchange maturing with in a short period of 60 days or 90 days from an approved customer
& pays him or credit his current account immediately with the present value i\of the bill ie.,
the face value of the bill minus discount charges. Then on the due date of the, the bankreceives the face value of the bill from the acceptor of the bill.
The bill discounted may be documentary bill ( ie., a bill
of exchange accompanied by documents of title to goods) or a clean bill (ie., a bill ofexchange not accompanied by documents of title to goods.)
The interest for this financial accommodation is called
the discount & is charge on the face value of the bill for the unexpired period of the bill ie.,
from the date on which the bill is discounted to the date on which the bill matures.
III. Investment of funds on securities:-
Investment of funds on securities is one of theimportant functions of commercial banks. They invest a considerable amount of their funds
in government & industrial securities. In India commercial banks are required by statute to
invest a major portion of their funds in government & other approved securities.While investing its funds on securities, commercial
banks are required to keep in mind certain principles which are called Sound Commercial
Banking Principles or Investment Norms. The various sound commercial banking
principles are:-
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1. Principles of safety or securities:-
A Commercial banks is the custodian of depositary money. So, it is
required to safeguard the money of the depositors entrusted to it. That means whileinvesting the funds of depositors in its hands, a commercial bank should see that the safety
of investments is not sacrificed for the sake of profitability. It has to ensure that the funds
invested will back on time to meet the depositors claims.To ensure safety of funds invested, a bank has to take in to account
the repaying capacity of the borrowers. To assess the repaying capacity, a bank has to take
into account 3 cs i.e., capacity, capital & collateral security offered by the borrowers.
2. Principle of Liquidity:-
The deposits accepted by a commercial bank are repayable either
on demand or after the expiry of a fixed period. That means, to meet the claims of thedepositors on demand or due dates, a commercial bank is required to maintain adequate
liquidity of its funds i.e., keeping sufficient funds in hands or with the central bank. So,
liquidity is another sound commercial banking principle.
3. Principle of profitability:-
Like any other business, commercial banking also is a business.So, like other business enterprise, a commercial bank also must make sufficient profits.
Even public sector commercial banks must aim at reasonable profits. Unless reasonable
profits are earned by a commercial bank to maintain the viability of the banking business,sooner or later it has to become sick & has to even disappear. So, profitability is one of the
sound principles of commercial banking.
4. Principle of Social responsibility or social good:-In a country like India, where there is a socialisation of
credit every commercial bank(public or private) has to take into account a new principle
called the principle of social good. The principle of social good is the outcome of theconcept of social responsibility.
The principle of social good suggest that the commercial
bank which deals in others money are expected to make effective use of public deposits forpromoting maximum social good to the society. In fact, the performance of commercial
banks is judged by their contribution to the achievement of eco-economic objectives & to
the economic development of the country as per the national policies & national priorities
determined by the government.
5. Principle of productivity:-
This is another important principle suggested by bankingexperts. According to them, the bank should invest its funds in such a way as to secure for
itself an adequate & permanent income. The objective of the bank is to earn maximum
profits & its income must accrue from productive investments. If the assets are productivethe income to the bank will also be stable. This principle implies that under no
circumstance, the bank should advance funds for speculative purposes (i.e., antisocial )
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