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Top 14 Functions of Commercial Banks – Discussed!

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Banks act as intermediaries between those who have surplus money and those who need it.

To receive deposits and to advance loans are thus the two main functions of all commercial banks. In short, they borrow to lend.

They borrow in the form of deposits and lend in various forms of advances. Besides, there are other incidental functions which have developed according to the needs of society. Some of the most essential functions of commercial banks are as follows:

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We discus all of them below:

1. Accepting Deposits:

Banks attract the idle savings of people in the form of deposits.

These deposits may be of any of the following types:

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2. Demand deposits, also known as current accounts:

These are repayable on demand without any notice. Usually no interest is paid on them, because the bank cannot utilize short-term deposits, and must, therefore, keep almost cent per cent reserve against them. On the other hand, a little commission is charged for the services rendered. Occasionally, however, a small interest is paid to people who keep large balances.

3. Fixed Deposits or Time Deposits:

These deposits can be withdrawn only after the expiry of the period for which these deposits have been made. Higher interest is paid on them—the rate rising with the length of the period and the amount of deposit. The usual rate in India today varies between 6 per cent and 110 per cent, depending upon the time-period for which deposits are made.

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4. Savings Bank Deposits:

These deposits stand midway between current and fixed accounts. These deposits are not as freely withdraw-able as current accounts. One or two withdrawals up to a limit of one-fourth of the deposit but not more than Rs. 1,000 are generally allowed in a week. The rate of interest is less than that on the Fixed Deposits.

5. Giving Loans:

But receiving of deposits is not the whole story about a bank’s functions. If that were so, how could a bank pay interest? Hence, after collecting money by way of deposits, a bank invests it or lends it out. Money is lent to businessmen and traders usually for short periods only. This is so because the bank must keep itself ready to meet the demands of the depositors, who have deposited money for short periods.

Money is advanced by the banks in any one of the following ways:

6. By allowing an Overdraft:

Customers of standing are given the right to overdraw their accounts. In other words, they can get more than they have deposited, but they have to pay interest on the extra amount which has to repaid within a short period. The amount of permissible over-draft varies with the financial position of the borrower.

7. By Creating a Deposit:

Cash credit is another way of lending by the banks. When a person wants a loan from a bank, he has to satisfy the .manager about his ability to repay, the soundness of the venture and his honesty of purpose. In addition, the bank may require a tangible security, or it may be satisfied with the borrower’s personal security.

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Usually such security is accepted as can be easily disposed of in the market, e.g., government securities or shares of approved concerns. Then details about time and rate of interest are settled and the loan is advanced. A borrower rarely wants to draw the whole amount of his loan in cash. Usually he opens a current account with that amount the bank, if he already has not got an account with this bank.

Now it is exactly as if that sum had been deposited by him. This is how a deposit is ‘created’ by a bank. That is why it is said “every loans creates a deposit.” A cheque book is given to the borrower with the right to draw cheques up to the full amount of the loan, but interest is charged on the whole sum even though only a part is withdrawn. After the period, for which the money has been borrowed, is over, the borrower returns the amount with interest to the bank. Banks make most of their profits thus by giving loans.

8. Discounting Bills:

The discounting of bills by a bank is another way of lending money. The banks purchase these bills through bill-brokers and discount; companies of discount them directly for the merchants. These bills provide a very liquid asset (i.e., an asset which can be easily turned into cash). The banks immediately any cash for the bill after deducting the, discount (interest), and wait for the bill to mature when they get back its full value.

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The investment in bills is considered quite safe, because a bill beats the security of two businessmen, the drawer as well as the drawer, so that if one proves dishonest or fails, the bank can claim the money from the other. This is regarded as the best investment by the banks. It is liquid, lucrative and safe. That is why it is said that a good bank manager knows the difference between a bill and a mortgage.

9. Remitting Funds:

Banks remit funds-for their customers through bank draft to any place where they have branches or agencies. This is the cheapest way of sending money. It is also quite safe. Funds can also be remitted to foreign countries.

10. Miscellaneous Functions:

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Besides these main functions, the banks perform several others as given below:

11. Safe Custody:

Ornaments and valuable documents can be kept in safe deposit with a bank, in its strong room fitted with lockers, on payment of a small sum per year. Thus the risk of theft is avoided.

12. Agency Functions:

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The bank works as an agent of their constituents. They receive payments on their behalf. They collect rents, dividends on shares, etc. They pay insurance premia and make other payments as instructed by their depositors. They accept bills of exchange on behalf of their customers. They pass bills of lading or railway receipts to the purchasers of goods when they pay for them. This amount is passed on to the suppliers of goods.

13. References:

They provide references about the financial position of their customers when required. They supply this information confidentially. This is done when their customers want to establish business connections with some new firms within or outside the country.

14. Letters of Credit:

In order to help the travelers, the banks issue letters of credit travelers’ cheques. A man going on a tour takes with him a letter of credit from his bank. It is mentioned there that he can be paid sums up to a certain limit. He shows this letter to banks in other places which make the payment to him and debit the bank which has issued the letter of credit.

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