What is the meaning of commercial bank ?What is the definition of commercial bank ? and What are the important functions of a commercial bank ? Meaning and definition of commercial bank, Important functions of commercial banks. Primary and secondary functions of commercial banks.
Introduction
Commercial banks are a part and parcel of modern economy. By giving loans and advances to agriculture, industry, trade and commerce, they help in economic development of the country. Now bank deposits (bank money) form a large part of the total supply of money and banks power to regulate the volume of money has made them economically significant.
Meaning of Commercial Bank
A commercial bank is a financial institution which by accepting deposits, advancing on the basis of these deposits and in the process by creating money facilitates the trade and business of the country.
Functions of Commercial Banks
While discussing the function of commercial banks, it reminds us the functions of the predecessors of modern banking. First, the merchant bankers accepted money for safe keeping and began to issue documents which were taken as titles of money. Second, the goldsmiths of England accepted precious metallic coins from the people for safe keeping and charged a commission for the purpose. Finally the goldsmith became the money lender and charged interest thereon. The modem commercial banks have combined all the functions of their ancestors in addition to a number of contingent functions which are discussed below.
1. Acceptance of Deposits;
The first important function of commercial banks is to accept deposits from the individuals and business firms. The people deposit their surplus money in the bank mainly due to two reasons — security of deposits and interest on deposits. Banks accept deposits mainly in the following ways:
(i) Current or Demand Deposit — It refers to that kind of deposits which can be withdrawn at any time during the banking hours without giving a prior notice. Demand deposit is like the cash in hand. Since money can be withdrawn on demand at any time, this is called demand deposits. Banks pay a very little interest or no interest on this account. This is because bank cannot invest these money in profitable channels. Generally traders and business men prefer this account because they keep hug? amount of their sale proceeds in this account daily and pay through cheques to discharge their business obligations.
(ii) Time or Fixed Deposit — It refers that kind of deposit which be withdrawn before the expiry of the period for which the deposit is made. Bank gets an opportunity to utilise this money in profitable channels. The rate of interest is higher than other deposits. Longer the period for which the deposit is made, higher would be the rate of interest.
(iii) Savings Bank Deposit — It refers to that kind of deposit which can be withdrawn at any time without giving any prior notice; but the bank may Impose certain restrictions on the number of withdrawals. If the amount of withdrawal is high, then a prior notice may be needed. The rate of interest is higher than demand deposits and lower than fixed deposits. The aim of this type of deposit is to encourage small savings in the economy. This account can be operated with or without cheque facilities.
(iv) Recurring Deposit — In this deposit account, a certain amount of money on regular instalments is deposited for a fixed period of time. On maturity, the depositor gets back his deposit with interest. If a customer has opened a 5-year recurring deposit account with monthly instalment of ₹200/-, then he cannot withdraw money before 5 years. In every month, he has to deposit 000 on a regular basis. On default (of instalments), penalty is charged by the bank. The rate of interest on this deposit is nearer to fixed deposit.
2. Advancement of Loans;
Next to deposit mobilisation, another important function of the commercial bank is to advance loans for short period. It gives loans and advances to farmers, businessmen and traders. The bank from its long experience knows that all depositors do not come at a time to withdraw all of their deposits. During the business hour of the bank, a fraction Of the total deposits are demanded daily. Hence a wise banker keeps that fraction in the form of ready cash and the rest is offered as loans and advances. Generally the bank gives loans against some form of security. The commercial bank gives loans in the following ways.
(i) Cash Credit — This type of loan is generally preferred by the businessmen. It is a system of lending money against the promissory note of the borrower guaranteed at least by two sureties. It is sometimes backed by merchandise goods. Once the loan is sanctioned, payment is not made in the form of cash. The sanctioned amount is credited to the borrower's account. The borrower can withdraw money according to his requirements. The peculiarity of this loan is that the bank can withdraw or reduce the accommodation whenever it likes. The borrower pays the interest only on the amount of loan actually utilised.
(ii) Overdraft system — Overdraft is a special privilege granted to the reliable and responsible customers. It is a system of lending money over and above the actual deposit of the customer. The amount of excess money to be granted as loans must be agreed upon by the depositor and the banker. The borrower pays the interest on the excess money drawn. If amount of overdraft is large, the bank may demand collateral security for the purpose.
(iii) Direct Loan — It is a type of loan granted to individuals and businessmen against the mortgage of immovable property like land, building, gold etc. Once the loan is sanctioned, an account is opened in the name of the borrower and the sanctioned amount is credited to his account. The borrower can withdraw the amount through cheques.
(iv) Discounting Bills of Exchange — Bank gives loans by discounting the bills of exchange. If the holder of the bill (creditor) needs money before the date Of maturity, he can present the bill before a commercial bank. The bank while discounting the bill deducts Something as commission from the face value of the bill. After the maturity, the bank collects the full value of the bill from the debtor stated in the bill.
For example the retail dealer in medicine at purl Mr. Harilal purchases medicine worth ₹1000/- from Mr. Parilal, the wholesaler at Bombay on credit. Mr. Parilal sends a bill of exchange to Mr. Harilal at Puri. If the rate of interest is 20% per annum and the bill matures after six months, then the full value of the bill, on maturity will be ₹1000 + ₹100 = ₹1100/-. After receiving the bill, Mr. Parilal writes 'accepted' on the face of the bill and puts his signature. The bill is endorsed by his commercial bank. The bill now becomes a negotiable instrument and can be purchased and sold in the market. The bill is returned to the wholesaler (creditor) at Bombay who will get the full value of the bill ₹1100/- after six months. If the creditor needs money before the maturity date, he will present the bill before a bank who will give money to the holder of the bill by deducting something (say ₹50) as commission. After maturity, the bank gets the full value from the debtor at Puri. Through this process the bank gets a profit of Rs.50/- and helps in promotion of trade and commerce. Actually, this is a system of lending money. The bank gives a loan to the person in whose favour the bill has been drawn and collects the amount with interest on maturity.
3. Creation of Credit;
Creation bank money is the most significant function of a modern commercial bank money works as good as legal tender money. When we deposit money in the bank, the bank gives us a cheque book to withdraw money according to our convenience. This is called primary deposits. But bank does not keep all the deposits in the form of ready cash as all deposits are not withdrawn at a time. A fraction of the total is demanded daily. After keeping this minimum reserve, the bank lends the excess reserve. When a loan is sanctioned payment is not made in terms of cash. An account is opened in the name of the borrower and the sanctioned amount is deposited to his account. This is called derivative deposits. Therefore it is said that every loan creates a deposit. The borrower is provided with a cheque book. He can use this cheque as a means of payment. This is called creation of bank money. The depositors are provided with a cheque book and a major part of depositor's money is utilised by the bank as loans and the loanees are provided with a cheque book. Thus additional Purchasing power is created in the economy which greatly affects the economic activities of the country.
4. Agency Services;
In addition to the above traditional functions, commercial banks now-as days perform a number of agency services to attract the customers. Here the bank works as the agent or representative of the customers. The following discussion outlines of the important agency functions of a modem commercial bank.
(i) Remittance of Funds — On behalf of customers, the bank sends money from one place to the other. When huge amount of money is to be sent from one place to the other, it is very expensive to send by post. Therefore funds can be remitted through bank draft or money transfer system which is very cheap in comparison to other methods of sending money.
(ii) Collection of cheques, bills and dividends — The bank collects cheques, bills, dividends, etc. on behalf of the customer and credits the amount to his account. For all these functions, the bank is paid a commission.
(iii) Arrangement for Payment — The bank pays insurance premium, telephone bill, income tax, electricity charges, rent to the persons, institutions stated by the customer. For all these services, the bank charges a commission.
(iv) Safe custody — The bank keeps the valuables like gold, jewellery and important documents of the customer in the safe custody. The bank maintains them in strong vaults and charges a commission for the purpose.
(v) Sale and purchase of securities — The bank, on behalf of its customers purchases and sells securities and charges a commission for the same.
(vi) Trusteeship — The bank acts as the trustee and executer of the property of the customers. Sometimes as per orders of the customers, the bank acts as the attorney or lawyer of the customers.
5. General Utility Services;
In addition to agency functions, the bank performs a large number of general utility services for the public. Banks issue letters of credit to their customers certifying their credit worthiness. They issue travellers' cheque to their customers to make the travel riskless. Banks collect statistics relating to trade industry and finance and publish bulletins containing research articles on economic and financial matters. By analysing the Govt.'s economic and monetary policies, they give valuable suggestions and constructive objections thereby help in moulding the Govt. policies. Banks underwrite the securities issued by the Govt., public and private bodies.
6. Developmental Functions;
In under-developed countries like India, commercial banks have an additional function to Perform. They help in economic development of the country. In our country, major commercial banks were nationalised in 1969. After that the developmental function of the commercial bank has come to the forefront. Banks provide concessional lending to the priority sectors like agriculture, small scale and cottage industries, exports etc. They also provide loans to weaker sections at a concessional rate of interest under different poverty alleviation programme of the Govt. Under the lead bank scheme, one commercial is to lead a particular district and to take steps for overall economic development of the district. The commercial bank Sponsors the gramya banks in a particular area, provides them funds, expertise and guides them in conducting banking business in rural areas.
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