Saturday, August 22, 2009

Functions of Commercial Banks

Commercial Banks act as intermediaries between those who have surplus money and those who need it. To receive deposits and advance loans are thus two main functions of all commercial banks. In short they borrow to lend. They borrow in the form of deposits and lend in the form of advances. Besides there are other incidental functions which have developed according to the needs of society. We discuss all of them below.
Banks attract the idle savings of people in the form of deposits. These deposits may be of any of the following types.
(a) Demand Deposits or Current Accounts: There are repayable on demand without any notice. Usually no interest is paid on them; because the banks cannot utilize short term deposits and must keep almost cent percent reserve against them. On the other hand a little commission is charged for the service rendered. Occasionally, however a small interest is paid to the people who keep large balances.
(b) Fixed deposits or time deposits: These deposits can only be withdrawn after the expiry of the period for which these deposits are made. Higher interest is paid on them, the rate rising with the length of the period and the amount of deposit.
(c) Savings Bank Deposits: These deposits stand midway between current and fixed accounts. One or two withdraws up to a limit of one fourth of the deposit is allowed in a weak. The rate of interest is less than on fixed deposits.
Receiving of deposits is not the whole story about a bank’s function. It that were so, how could a bank pay interest? Hence after collecting money, 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 demand of the depositors who have deposited money for short periods. Money is advanced by banks in any one of the following ways.
(a) By allowing an Overdraft: Customers are given the right to over-draw their accounts. In other words they can get more than they have deposited, but they have to pay interest on extra amount which has to be repaid within a short period. The amount of permisable over draft varies with the financial position of the borrower.
(b) By Creating a Deposit: Cash-credit is another way of lending by banks. When a person want a loan from a bank, he has to satisfy the manager about his ability to repay, the soundness of his venture and his honesty of purpose. After that the bank may require a tangible security, or it may be satisfied with borrower’s personal security. Usually such security is accepted as can be easily disposed of in the market e.g. government securities or shares of approved concerns. The details of 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 in bank, if he has already 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 loan creates a deposit”.
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.
(c) Discounting Bills: Discounting of bills is another way of lending money. The banks purchase these bills through bill brokers and discount companies or discount them directly for the merchants. These bills period a very liquid asset (i.e. asset which can easily be turned into cash). The banks immediately pay cash for the bill after deducting the discount (interest) and wait for the bill to mature when they got back their full value.
The investment in the bills is quite safe, because a bill bears the security of two businessmen the drawer as well as drawer, so that if one proves dishonest or fails, the bank can claim money from other. This is regarded as the best investment by the banks. It is liquid, lucrative and safe. This is why it is said that a good bank manager knows the difference between a bill and mortgage.
Banks remit funds for their customers through bank drafts 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.
Beside these main functions, the banks perform several other functions as given below.
(a) 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 risk of theft is avoided.
(b) Agency Functions: The banks 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 the customers. They pass bills of lading or railway receipts to the purchasers of goods when they pay for them. The amount is passed on to the suppliers.
Banks also collects the amount of utility bills from customers of different utility agencies.
(c) References: They give 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 out side the country.
(d) Letters of Credit: In order to help the travellers, the banks issue letters of credit. A man who is going abroad takes with him a letter of credit from his bank. It is mentioned these that he can be paid sum up to a certain limit. He shows this letter to banks in other countries which make the payment to him and debt the bank which has issued the letter of credit.
(e) Collection of Statistics: The modern bank collects statistics about money, banking, trade and commerce and publishes them in the form of pamphlets and hand outs. This helps the banks customer in acquiring knowledge about the latest economic situation on the basis of which they can formulate their business policy.
(f) Under writing Services: Some time private companies issue debentures for public sale. But the public may hesitate in buying these debentures unless they are under written by the banks. The public has full confidence in the banks. If debentures carry the signatures of a bank, the public would not hesitate in buying them. For under writing these debentures, the bankers charge a small underwriting commission from the companies.
(g) Advice of Financial Letters: Since the bank is fully acquainted with the economic situation in the county, it is in a position to render useful advice to its customers on financial matters.
An efficient banking system is absolutely necessary for a country. It is to prosper commercially the services that an efficient banking system can render a county cannot be exaggerated. The banking system can be useful in the following ways in addition to what has been mentioned above in the functions of banks.
1. The banks create instruments of credit: The banks create instruments of credit which serve as very convenient substitutes for money. This means a great saving.
2. The Banks increase the mobility of capital: They bring the borrowers and the lenders together. They collect money from those who can not use it and give it to those who can. They thus help the movement of funds from place to place and form person to person in a very convenient and inexpensive manner.
3. The bank encourage the habbit of thrift: One of the requisite conditions of saving is that there should be channels of investment so long as money is kept in one pocket, the chances are that it will be spent and not saved. But if it is put in the bank, it is out of sight and to be out of sight is to be out of mind. The chances are that it will remain in the bank.
4. Accumulation of Capital: By encouraging savings, the banks bring about accumulation of large amounts of capital in the country from small individual savings. In this way they add to productivity of the resources of the country and contribute to the general prosperity and welfare.
In a word banks are indispensable not only to maintain economic activity i.e. consumption, production, exchange distribution but also for promoting economic development.


5 Responses to “Functions of Commercial Banks”

Anonymous said...
July 24, 2011 at 11:14 PM

this article proved very useful for me. thank u

Arsalan Wahid said...
August 4, 2011 at 12:57 AM

No doubt, i found it very helpful. thanks. Arsalan Wahid

Anonymous said...
December 31, 2011 at 6:12 AM

really useful may u b happy

Anonymous said...
March 31, 2012 at 9:51 PM

Lot of the things are clear here about the commercial banks but still some points are missing . . . . . .

Anonymous said...
September 14, 2013 at 12:52 AM


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