Functions of Commercial Banks

Commercial Banks not only deal in money and credit but they also perform various functions, viz., agency functions, credit creation, and other agency functions and general utility services. The various functions of commercial banks include:

A.    Primary Functions: These functions are performed by commercial banks from their very existence. They are classified into two categories, namely,

(1) Accepting Deposits and

(2) Advancing Loans

(1)    Accepting Deposits: Being advancing loans as the primary function, banks require money to fulfill this objective. Hence they accept deposits from individuals and institutions and make payment for deposits as interest. For this purpose banks operate various types of accounts in which the deposits are attracted. Generally commercial banks operate following types of accounts.

(i)                 Savings Deposits: The savings deposit promotes thrift habit among people. Small savings are collected and deposited in such accounts which are used for capital formation in the country. The rate of interest paid on savings deposits is comparatively lower. Even though there are restrictions on making withdrawal, liquidity of such accounts is higher in comparison with time deposits. Corporate business houses and firms are generally not allowed to open Savings Bank accounts. Those customers, who maintain a minimum balance as directed by the bank, can avail cheque facility with their accounts. Recently, most of the commercial banks provide ATM (Automated Teller Machine) cards to their customers with an additional feature as International Debit Card as per the terms and conditions of the bank.

(ii)               Current Account Deposits: This account is generally opened by traders, businessmen and industrialists, which offers high liquidity. No interest is paid on such deposits and there is no restriction on number of withdrawals. However, some charges are levied by the bank on such accounts. Customers are also given overdraft facility as per their credit.

(iii)             Fixed Deposits: It is also called time deposit account. In such accounts money is deposited for a fixed period. After the maturity of the account the bank repays the principal plus interest for that given period. The interest on such accounts is pre-decided. The rate of interest is comparatively high and it varies as per the duration of the account. Interest rates are fixed as per the RBI rules and regulations. In times of urgent need for money, the bank allows premature closure of fixed deposits by paying interest at reduced rate. Depositors can also avail of loans against Fixed Deposits.

(iv)             Recurring Deposits: In Recurring Deposit account, the customer opens an account and deposit a certain sum of money every month and is deposited for a given period. After the maturity the accumulated amount along with the interest rate is paid to the customer. The rate of interest generally is higher than the saving deposit account and lower than the fixed deposit account.

(v)               Cash Certificates: Cash Certificates are issued to the public for a longer period of time. It attracts the people because its maturity value is in multiples of the sum invested. It is an attractive and high yielding investment of those who can keep the funds for a long time.

(2)    Advancing Loans: The commercial banks provide loans and advances in various forms. Interest rate charged by banks on loans is higher than the interest rate paid by banks on deposits and thereby banks earn profit. Generally, commercial banks advance loans in following forms.

(i)     Overdraft: When a bank allows its customers having current account to withdraw the amount more than the deposits in the account is called Overdraft. This facility of overdrawing his account is generally pre-arranged with the bank up to a certain limit. It is short-term temporary fund facility from bank and the bank will charge interest over the amount withdrawn. This facility is generally available to business firms and companies.

(ii)   Cash Credit: Under this form of advancing credit, the customer opens an account and the sanctioned amount is credited with that account. The customer can operate that account within the sanctioned limit as and when required. It is made against security of movable and immovable properties, shares and debentures, personal security etc. On the basis of operation, the period of credit facility may be extended further. The bank charges interest only on the amount actually withdrawn from the account. Central Bank discourages this type of advances as it imposes uncertainty on money supply. Hence this form of lending is slowly phased out from banks and replaced by loan accounts. Cash Credit system is not in use in developed countries.

(iii) Discounting Bills of Exchange: Under this method of lending, bank provides credit against the dated bill of exchange before its maturity at discounted values, i.e., values a little lower than the face values. The bank can discount genuine commercial bills, i.e., those drawn against sale of goods on Credit. The banker’s discount is generally the interest on the full amount for the unexpired period of the bill.  If the buyer does not make the payment of the bill then the bank gets the payment from the seller of the bill.

(iv) Loans and Advances: Banks provide loans and advances to its customers against adequate collaterals. The loan amount is paid in cash or by credit to customer account which the customer can draw at any time. The interest is charged for the full amount whether the customer withdraws the money from the account or not. The loan is sanctioned for a given period time. As per the terms and conditions, the customer has to repay the loaned amount with the interest rate within the stipulated time. On default, the bank can attach the collaterals to recover the amount advanced by the bank.

(v)   Other Advances: Nowadays commercial banks have extended their traditional function of making loans and advances by starting many innovative schemes in giving advances to their customers. They provide housing finance facilities to their customers in order to participate in the working of achieving the goal of increase in better housing facilities in the country and thereby a better standard of living for the people. Government of India also encourages banks to provide housing finance. Borrowers of housing finance get tax exemption benefits on interest paid.

B.     Secondary Functions

The secondary functions of the banks consist of agency functions and general utility functions.

(1)   Agency Functions: Commercial banks act as agent of their customers and render services. Some charges are levied by the banks on such services. However some of the services are rendered free of charges as its commitment to maintain a better customer friendly relationship. Agency functions include the following:

(i)        Collection of cheques, dividends, interests etc: Bank collects cheques, drafts, promissory notes, interest, dividends etc., on behalf of its customers and credits the amounts to their accounts.

(ii)      Payment of rent, insurance premiums: The bank makes the payments such as rent, insurance premiums, subscriptions etc. on instructions by the customer. Till the order is revoked, the bank will continue to make such payments regularly by debiting the customer’s account.

(iii)    Underwriting functions: Large industrial and business units raise capital from the market. Debentures are underwritten by the banks. It helps the companies to collect the minimum capital on their guarantee. If the shares and debentures are not purchased in adequate quantum, the bank itself purchases all these shares and debentures. It increases the trust of the public in the company concerned.

(iv)    Purchase and sale of securities: Commercial banks undertake the purchase and sale of different securities such as shares, debentures, bonds etc., on behalf of their customers.

(v)      Act as trustee, executor, attorney, etc.: The banks act as executors of Will, trustees and attorneys. It is safe to appoint a bank as a trustee than to appoint an individual.

(vi)    Preparation of Income-Tax returns: Banks prepare income-tax returns and provide advices on tax matters for their customers. For this purpose they employ tax experts and make their services available to their customers.

(vii)  Act as correspondent: Banks also do correspondence on behalf of customers relating to booking vehicles, travel tickets, passport etc.

(viii)          Dealing in foreign exchange: As an agent, commercial bank purchase and sell foreign exchange as per CBN guidelines.

(2) General Utility Services:

                                            i.            Safety locker facility: Safekeeping of important documents, valuables like jewels is one of the important service other than banking provided by commercial banks. These lockers are available on half-yearly or annual rental basis.

                                          ii.            Money transfer: Transfer of funds is another service provided by banks. Apart from traditional instruments/mechanisms such as cheques, Demand Draft (DD), Mail Transfer (MT), Telegraphic Transfer (MT), banks nowadays make use of credit cards, debit cards, internet banking, ATM facility etc. to transfer funds from one place to another. By taking advantage of the communication development, money can be transferred from one place to another even without bank charges/commission.

                                        iii.            Travellers cheque and Letters of credit: Banks issue travellers cheques and letters of credit to help carry money safely while travelling within the country or abroad. Traveller’s cheque is a medium of exchange that can be used in place of hard currency. Travellers' cheques are often used by individuals who are travelling on vacation to foreign countries. The cheques were first introduced by American Express back in 1891. The cheque can then be used virtually anywhere in the world once it has been countersigned with the same signature. The advantage to the traveller is that the traveller’s cheque cannot be used by someone else if it is lost or stolen, and can be replaced usually anywhere in the world.

Letter of credit is a letter by which one banker requests another, to whom the said letter is addressed, to hold a certain sum at the disposal of the third person who is the holder of that letter, and to pay him such amount as he requires against either cheques on the banker giving the letter or on the banker to whom the letter is addressed, but not exceeding in total the whole amount covered by the said letter.

                                        iv.            Acts as referees: The banks act as referees and supply information about the business transactions and financial standing of their customers on enquiries made by third parties. This is done on the acceptance of the customers and help to increase the business activities in general.

                                          v.            Information relating to trade and economic position: Large commercial banks collect information relating to economic and business activities and provide in published form in annual reports or in new letters to help its customers to take business decisions easily and quickly.

                                        vi.            Credit/Debit cards: Banks have introduced credit/debit card system. These plastic cards enable a customer to purchase goods and services from certain specified retail and service establishments up to a limit without making direct payment. In the case of credit card, the amount is paid to these establishments by the bank. The bank subsequently collects the dues from the customers by means of cheque or by transferring money from the customer’s bank account though internet banking. In the case of debit card, the amount is paid to the merchant establishments by debiting funds to the customer’s bank account and credits it to the account of the concerned establishment.

                                      vii.            ATM facility: Under this system the customers can do banking transactions like withdrawal of money, cash deposit, money transfer, submit request for stop payment of cheques, submit request for new cheque book etc. at any time from any ATM centres provided/directed by the bank.

                                    viii.            Management of public debt: Commercial banks manage public debts on behalf of central bank when central and state governments raise loans through debentures of bonds.

                                        ix.            Others: Apart from the above said services provided by the banks, there are whole lot of services are rendered by commercial banks, which differ from banks to bank. They provided services with regard to share market function, merchant banking, factoring services etc.