Functions of Commercial Banks | Meaning, Structure, Agency function & Utility

Functions of Commercial Banks | All you need to know

This article will take you through to the functions of commercial banks in India. To develop a better understanding of the topic we have included the meaning of commercial banks as well.

Explore the different functions of commercial banks of India which involve primary, secondary, general utility, agency, and modern functions.

The banking system in India serves as the principal mechanism of the network of institutions. The system controls the financial or monetary services of the economy.

One of the money creating elements of the banking system in India is commercial banks.

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What are Commercial Banks?

Commercial banks are referred to financial institutions which accept deposits or money from the public.

commercial banks functions

The money is withdrawable by cheque or otherwise. The banks use the money they collect for lending purposes to households, firms, and the government.

The definition of activity of bank as per the India Banking Regulation Act, 1949 is “Accepting for the purpose of lending or investing of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise.”

There are three important points to note in the definition of a commercial bank. All these functions are essential for making a financial institution a bank.

Moreover, none of these functions alone is enough to make a financial institution a bank.

Commercial banks need to perform the following functions to be regarded as a bank:-

  • The bank should accept cheque able deposits from the public at large. These deposits are repayable on demand and can be withdrawn by cheque or otherwise.
  • The next essential function is that the banks should use the deposits for lending to others and undertaking investments in securities.
  • A unique characteristic of commercial banks is the creation of money. The debts by the commercial banks circulate as money in the economy. They have the power to ‘create’ and ‘destroy’ money through their lending functions or activities.

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What are the functions of commercial banks?

Commercial banks have a wide range of functions to perform. The functions are categorised on several bases.

They are divided into the primary, secondary, agency, general utility, and modern functions.

Explore in details about each of the function of commercial banks.

What are the primary functions of commercial banks?

Accepting deposits

primary functions of commercial banks

Accepting deposits from the public is the primary function of the commercial bank.

A Bank receives deposits from individuals (households), firms, and other institutions. These deposits act as the major resources for a bank.

The deposits are further classified into the following categories:

Savings bank account

A savings bank account is the one where the deposits are payable on demand and money can be withdrawn by cheques.

The banks impose certain restrictions on the depositors or account holders.

There is a limit on the number and amount of withdrawal made from the account during a particular time frame.

Usually, individuals, the general public, salaried individuals and retired persons hold these accounts.

Also, the bank provides interest on the deposits at nominal rates.

Current account

In current accounts, also known as demand deposits, the deposits are payable on demand.

There is no restriction on the amount or number of withdrawals made by cheque through these accounts.

Generally, businessmen and traders hold these accounts to use them for making and receiving business payment through cheque.

Banks do not provide any interest on the deposits in current accounts.

Various services are provided to the current account holders in place of a certain service charge.

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Fixed or time deposit account

An account where the money is deposited for a fixed period is known as fixed deposit accounts. Usually, the period ranges from 6 months to 5 years or more.

The deposits are not payable on demand and do not enjoy any cheque or withdrawal facility.

They are also known as time deposits as the money cannot be withdrawn before the maturity period for which the deposit is made.

A higher interest rate is offered to the account holders on these deposits.

The rate of interest depends on the length of time for which the deposit has been made.

Recurring deposit account

Recurring or cumulative deposit accounts are a type of fixed deposits.

A certain amount of money has to be deposited at regular intervals for a specified period.

The banks provide interest in recurring deposits as well.

The primary motive of recurring deposits is to motivate individuals to save a particular amount regularly over a specified period.

Granting loans and advances

loans approval

The second primary function of the commercial bank is to grant loans and advances.

Lending acts as the most profitable business for a bank as they charge interest from the borrowers.

The rate of interest charged is much higher than the interest paid to the depositors.

Banks provide loans and advances to their customers in the following ways:

Cash Credit

The type of loan given to the borrower against his or her current asset is termed as cash credit. The asset can be a stock of goods, shares, bonds and more.

Under cash credit, the entire amount is not given to the borrower at once. Instead, the bank opens an account in the name of the borrower and allows the person to withdraw the borrowed amount as and when required.

The bank charges interest only on the amount which the person withdraws from the bank.

Outright Loans or Short-term loans

Outright or short term loans are provided by the banks for a fixed period.

The complete amount of the sanctioned loan is credited in a lump sum to the borrower’s current account.

The borrower pays interest on the entire amount regardless of the amount s/he uses.

Overdraft Facilities

Banks provide an overdraft facility to the customers. Under this, the person is allowed to draw cheques for the amount over the bank balance available in his credit.

The excess amount which a person can withdraw is to the extent of the amount of authorized overdraft only.

The commercial banks charge interest only on the amount overdrawn.

Discounting Bills of exchange

Banks can lend through discounting or purchasing the bills of exchange.

Bills of exchange is an instrument which a creditor draws on the debtor specifying the amount of debt and date on which it becomes payable. Such bills are normally issued for 90 days.

The bill cannot be encashed from the debtor before the expiry of the period.

Discounting bills of exchange mean that the bank enchases the bill after deducting its commission before the expiry of 90 days period.

When the bill matures, the bank gets the payment from the banker of the debtor who has accepted the bill.

A bill can be discounted only when the bill is due for payment.

What are the secondary functions of commercial banks?

The commercial banks perform certain secondary functions as well. They are as follows:-

Buying and selling of securities

The banks buy and sell securities like shares, debentures, bonds, stocks and more on behalf of their customers.

Locker facilities

locker

Banks offer locker facilities to their customers for the safety of valuables.

Bank allots a locker to the customer in that they can safely keep their money, jewelry, documents, or other valuables.

A nominal fee is charged from the customers for this facility.

Paying and gathering credit

Banks perform the function of paying and gathering credit from several sources.

They have to follow the central bank’s guidelines in the process. This regulates the credit in the economy and functioning of the bank.

What are the agency functions of commercial banks?

Banks offer several agency functions to their customers. They charge commission or service charge in place of the services or functions they perform.

Collecting cheques, bills etc.

The banks collect funds in the form of cheques, drafts, bills of exchange, hundies and other financial instruments.

They do it on behalf of their customers. The customers have to request the banks to perform this function for them.

Making and collecting payments

On behalf of their customers, banks collect various types of payments such as taxes, pensions, insurance premiums, dividends, interests and more.

Remittance facilities

For the facility of their customers, banks offer remittance of money from place to another.

Reference letters

Banks provide information about the financial standing of their customers to companies or businessmen in India or abroad.

Likewise, banks give information about businessmen or companies to their customers. This is done upon due acceptance from both sides.

Act as trustees, executor or attorney

Banks can act as trustees, executors and attorneys of funds, wills, financial or important documents, properties, task and many more.

The banks have to be authorized as one to execute their functions by the customers.

Prepare income tax returns

Banks can prepare and file the income tax return on their customer’s behalf.

Agent to the customers

Commercial banks act as agents to and for their customers in the sale and purchase of securities or other financial transactions or investments.

Also, they offer instrument services of firms and companies by acting as underwriters and bankers for the new issue of securities to the public.

What are the general utility functions of commercial banks?

Besides primary, secondary and agency services, banks perform general utility functions as well which are as follows:

  • Certain commercial banks deal in foreign exchange transactions. RBI authorizes these banks and they are the authorized dealers. These banks purchase and sell foreign currency at prescribed rates.
  • Banks issue letter of credit on behalf of the importer which enables foreign trade. It acts as a letter of guarantee enabling the importer to purchase goods.
  • They issue traveler’s cheque to help their customers by avoiding carrying money while traveling anywhere in the world.
  • Banks act as underwriters and bankers for companies and promote the capital market. They encourage the issues of shares in the primary and secondary markets and receive a commission from companies.
  • Acting as referees, banks offer information on the financial standing, business reputation, and respectability of their customers. This is done when a third-party enquires. This is done upon the acceptance of the customers only.
  • Banks provide trade information and help companies in mobilizing their funds in the foreign markets by the sale of global deposit receipts.
  • Banks give advice on financial matters to individuals, firms, or companies on several financial matters when they seek their services.

What are the modern functions of commercial banks?

The modern functions of commercial banks refer to the functions which the banks have been offering lately. Banks perform these functions with the advancement in technology and modern banking practices. These were not possible earlier due to lack of technology.

  • Banks issue credit and debit cards to the account holder of the banks.
  • ATM facility is offered to the customers. It allows withdrawing money through credit or debit card from an authorized ATM anytime.
  • Banks offer phone and net banking services to its customers. This makes making and receiving payments easy and simple via phone or the internet. The customers do not have to visit the banks physically.
  • Banks offer SMS alerts of any activity relating to their accounts. Deposit, withdrawal, changes, or updates, all information is conveyed to customers via SMS alert.
  • NEFT or National Electronic fund transfer is a one-to-one nationwide fund transfer. Individuals can transfer funds electronically from any bank branch to any person holding a bank account in India participating in NEFT.
  • RTGS or Real Time Gross Settlement is an electronic mode of fund transfer. The transfer takes place on a real-time basis and is done for high-value transactions. The minimum amount for RTGS is 2 lakh.
  • Bancassurance means offering insurance products or benefits to the customers of the banks. The bank staff and tellers are the points of sale and contact for the customers.

What is the structure of commercial banks in India?

Commercial Banks act as the most important source of institutional credit in India. The origination of banking in India can be traced to the last decade of the 19th century.

The oldest banks in India were the Bank of Bengal, the Bank of Bombay, and the Bank of Madras which, after the merger, later came to be known as the State Bank of India in 1955 after the nationalization of the bank.

Before independence, commercial banks were entirely private banks in India. However, during the time of independence, the banking sector and system in India was small and there were only a few scheduled banks available.

Above all, these banks were confined to the urban areas only while granting loans to industrial and trading sectors prominently.

In July 1969, 14 major commercial banks were nationalized. This marked the major structural transformation of the banking sector in India.

The nationalization was followed by 6 more banks in April 1980.

The objective of nationalization was to improve the reach of commercial banks to the rural areas and offer cheap financial assistance to priority sector alongside preventing the concentration of banking capital in the hands of big business houses.

Being a part of economic reforms since 1990, various financial institutions and industrial houses working in the private sector and foreign banks have been started their banking operations in India.

At present, there are 89 scheduled commercial banks and they can be classified into the following broad categories:

Public Sector Banks

Public sectors banks are those where more than 50% of the stake is held by the government.

The shares of public sector banks are listed on stock exchanges and the remaining shares are held privately by bodies or individuals.

Private Sector Banks

The banks which have the majority or more than 50% of the stake held by private shareholders and not the government are private sector banks.

Foreign Banks

Foreign banks are those which have their head offices or headquarters located in countries other than India.

Examples of foreign banks are Chartered Bank, HSBC, Deutsche Bank, bank or America, and more.

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