Functions of Commercial Banks

FUNCTIONS OF
COMMERCIAL BANKS
Commercial Bank
A commercial bank is a type of financial
intermediary.
 Commercial banking is also known as business
banking.
 A financial institution that provides services
such as a accepting deposits and giving
business loans.
 Its primary liabilities are deposits and primary
assets are loans and bonds.
Functions of Commercial Bank
 The functions of a commercial banks are divided into

two categories:
 i) Primary functions,
 ii) Secondary functions

Primary Functions
 a) accepting deposits;
 b) granting loans and advances;

Accepting Deposit
 People who have surplus income and

savings find it convenient to deposit the
amounts with banks.
 Depending upon the nature of deposits, funds
deposited with bank also earn interest.
 Ifthe rate of interest is higher, public are
motivated to deposit more funds with the
bank.
Grant of Loans and Advances
 Loans and advances are given to members of the
public and to the business community at a higher rate
of interest than allowed by banks on various deposit
accounts.
 The rate of interest charged on loans and advances
varies depending upon the purpose, period and the
mode of repayment.
 The difference between the rate of interest allowed
on deposits and the rate charged on the Loans is the
main source of a bank’s income.
Loans
 Short term loans as well as long term loans are

given by commercial bank.
 Theborrower may withdraw the entire
amount in lumpsum or in installments.
 Interest is charged on the full amount of loan.
 Loans are generally granted against the
security of certain assets.
Advances
 An advance is a credit facility provided by the

bank to its customers.
 Itdiffers from loan in the sense that loans
may be granted for longer period, but
advances are normally granted for a short
period of time.
 The purpose of granting advances is to meet
the day to day requirements of business.
Mode of Short term Financial
Assistance
Banks grant short-term financial assistance by way of
 cash credit,
 overdraft
 bill discounting.
Cash Credit
 Cash credit is an arrangement whereby the bank

allows the borrower to draw amounts upto a specified
limit.
 Interest is charged on the amount actually withdrawn.
 Cash Credit is granted as per agreed terms and
conditions with the customers.
Overdraft
 A customer who has a current account with the bank
is allowed to withdraw more than the amount of
credit balance in his account.
 Overdraft facility with a specified limit is allowed
either on the security of assets, or on personal
security, or both.
Discounting of Bills
 It is making payment of the amount before the due
date of the bills after deducting a certain rate of
discount.
 The party gets the funds without waiting for the date
of maturity of the bills.
 In case any bill is dishonored on the due date, the
bank can recover the amount from the customer.
SECONDARY FUNCTIONS
 Issuing letters of credit, travellers cheques,
circular notes etc.
 Undertaking safe custody of valuables,
important documents, and securities by
providing safe deposit vaults or lockers;
 Providing customers with facilities of foreign
exchange.
 Transferring money from one place to
another; and from one branch to another
branch of the bank.
 Standing guarantee on behalf of its customers, for
making payments for purchase of goods, machinery,
vehicles etc.
 Collecting and supplying business information;
 Issuing demand drafts and pay orders; and,
 Providing reports on the credit worthiness of
customers.
1. Overdraft Facility:
It refers to a facility in which a customer is allowed to overdraw his
current account upto an agreed limit. This facility is generally given to
respectable and reliable customers for a short period. Customers have to pay
interest to the bank on the amount overdrawn by them.
2. Discounting Bills of Exchange:
It refers to a facility in which holder of a bill of exchange can get the bill
discounted with bank before the maturity. After deducting the commission,
bank pays the balance to the holder. On maturity, bank gets its payment
from the party which had accepted the bill.
3. Agency Functions:
Commercial banks also perform certain agency functions for their
customers. For these services, banks charge some commission from their
clients.
Some of the agency functions are:
(i) Transfer of Funds:
Banks provide the facility of economical and easy remittance of
funds from place-to-place with the help of instruments like demand drafts,
mail transfers, etc.
(ii) Collection and Payment of Various Items:
Commercial banks collect cheques, bills, interest, dividends,
subscriptions, rents and other periodical receipts on behalf of their customers
and also make payments of taxes, insurance premium, etc. on standing
instructions of their clients.
(iii) Purchase and Sale of Foreign Exchange:
Some commercial banks are authorized by the central bank to
deal in foreign exchange. They buy and sell foreign exchange on
behalf of their customers and help in promoting international trade.
(iv) Purchase and Sale of Securities:
Commercial banks buy and sell stocks and shares of private
companies as well as government securities on behalf of their
customers.
(v) Income Tax Consultancy:
They also give advice to their customers on matters relating to
income tax and even prepare their income tax returns.
(vi) Trustee and Executor:
Commercial banks preserve the wills of their customers as
trustees and execute them after their death as executors.
(vii) Letters of Reference:
They give information about the economic position of their
customers to traders and provide the similar information about other
traders to their customers.
 4. General Utility Functions:
(i) Locker Facility:
Commercial banks provide facility of safety vaults
or lockers to keep valuable articles of customers in
safe custody.
(ii) Traveler's Cheques:
Commercial banks issue traveler’s cheques to their
customers to avoid risk of taking cash during their
journey.
(iii) Letter of Credit:
They also issue letters of credit to their customers
to certify their creditworthiness.
(iv) Underwriting Securities:
Commercial banks also undertake the task of
underwriting securities. As public has full faith in the
creditworthiness of banks, public do not hesitate in buying the
securities underwritten by banks.
(v) Collection of Statistics:
Banks collect and publish statistics relating to trade,
commerce and industry. Hence, they advice customers on
financial matters. Commercial banks receive deposits from the
public and use these deposits to give loans. However, loans
offered are many times more than the deposits received by
banks. This function of banks is known as ‘Money Creation’.
THANK YOU

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FUNCTIONS OF

 The functions of a commercial banks are divided into

 ii) Secondary functions

 b) granting loans and advances;

 People who have surplus income and

 Short term loans as well as long term loans are

 An advance is a credit facility provided by the

 Cash credit is an arrangement whereby the bank

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