Functions Of Commercial Banks

Introduction

Banks not only let us manage our wealth but they also guide us to invest money in various resources. Commercial banks are those banks that interact mainly with the public and so knowing about commercial banks is an important part of everyone’s knowledge.

What are Commercial Banks?

Commercial banks are financial institutions that deal in deposits and withdrawals of money for the general public. These organizations also provide loans for investment and other such activities. Commercial banks are profit-making institutions and they do business only in order to make a profit.

Commercial banks are regulated by the central bank or the Reserve Bank of India. The commercial banks also avail loans from the Reserve bank at lower rates which they distribute among their customers at higher rates to earn a profit. Therefore, commercial banks are the ones that deal with both the central bank and the general public through their operations.

Therefore, there are two primary characteristics of a commercial bank - lending and borrowing. The bank also receives money as deposits from the public and provides money to various projects to earn interest (profit). The rate of interest that a bank offers to the depositors is known as the borrowing rate, while the rate at which a bank lends money is known as the lending rate.

Functions of a Commercial Bank

The functions of commercial banks depend on the nature of the task as most of the required financial tasks for the general public as well as the businesses are done by these banks. Starting from the deposit, to offering the services as an agent of the insurance firm, the commercial banks now do all such tasks.

The banks usually offer services to other financial organizations in return for a commission. Therefore, it can be stated that commercial banks engage in all kinds of financial functions that offer them a profit in return.

The functions of commercial banks are divided into two categories - Primary and Secondary functions.

Primary Functions

• Accepting deposits − Commercial banks take deposits of money from the general public. These deposits are divided into three types.

• Savings Deposit − Savings deposits allow the general public to credit funds towards their accounts. However, there is a certain limit on deposits in the case of savings deposits. Savings deposits are ideal for individuals with a fixed income and are utilized to create savings over time.

• Current Deposits − Current deposits are usually meant for business accounts and they allow the account holder to withdraw and deposit money whenever needed. In some cases, current accounts also offer overdrafts until a pre-specified limit to individuals and businesses.

• Fixed deposit − Fixed deposits are deposits of the lump sum amount and they come with a predetermined lock-in period. The funds are deposited for a specific duration in the case of fixed deposits.

• Providing loans and advances −Providing loans and advances is one of the main functions of commercial banks. Loans are provided to both organizations and individuals, and profit is earned from the interest on the loans.

  Generally, banks retain a small reserve of all the money they have as deposits for their expenses and offer the remaining funds to customers as various types of short and long-term loans.

• Credit Cash − When loans are sanctioned, the customers are not provided with liquid cash. First, a bank account is created for the customer, and then the money is transferred to that account. This process allows the bank to create money through a line of credit.

Secondary Functions

• Exchange of securities − This is another function of commercial banks where it trades bonds and securities. Customers can buy or sell the securities from the bank itself, which offers more convenience to individual traders.

• Providing locker facilities − Commercial banks provide locker facilities to store valuables safely. Locker facilities eliminate the impending risk of theft, harm, or loss of valuables, which are prevalent at home.

• Dealing in Foreign Exchange − Commercial banks offer help to provide foreign exchange to individuals and organizations. Foreign exchanges are used to export or import goods from overseas. However, banks need a license to deal in foreign exchange.

• Discounting Bills of Exchange − One of the main secondary functions of a commercial bank in modern times is to discount the bills of businesses. Bill discounting is usually considered to be a profitable investment for banks. Bills not only create a steady flow of funds, but they are also not a risky venture during payment as they are considered negotiable instruments. These exchanges also do not engage the banks in any litigation.

• Bank as an Agent − Commercial Banks also provide various finance-related services to customers, fulfilling the role of an agent. These services generally include –

Serves as a platform for other institutions to pay premiums, repay loan installments, etc.

Assists customers with tax refunds, tax returns, and other similar tasks.

Acts as a trustee, administrator, or executor of a customer-owned estate.

Offers a legal platform for electronic transfers of funds, and processing of cheques, drafts, bills, etc.

Types of Commercial Banks

There are three different types of commercial banks.

Private Commercial Bank

Private commercial banks are financial institutions where private individuals and businesses have a majority of the share capital. All private banks are considered to be companies with limited liability.

Banks, such as Industrial Credit and Investment Corporation of India (ICICI) Bank, Housing Development Finance Corporation (HDFC) Bank, Yes Bank, etc. are private commercial banks.

Public Commercial Bank

Public commercial bank is a type of nationalized bank where the government holds a significant stake. Examples of public commercial banks include the State Bank of India (SBI), Bank of Baroda, Dena Bank, Punjab National Bank, etc.

Foreign Commercial Banks

These banks have their headquarters in foreign countries and have branches in other countries, such as India.

For example, Hong Kong and Shanghai Banking Corporation (HSBC), American Express Bank, Standard & Chartered Bank, Citibank, etc. are foreign commercial banks that also operate in India.

Conclusion

Commercial banks play a key role in maintaining the fluidity of commerce as well as personal endeavors in today’s life. Without the existence of commercial banks, the whole civilization will be on the verge of extinction.

As mentioned previously, commercial banks not only manage their businesses by earning interest, but they also offer many other services that are necessary for living day-to-day life.

Commercial banks keep the liquidity of economies intact and run the whole game of finance. Hence, they are very important institutions that cannot be ignored by anyone.

FAQs

Q1. What are the three types of commercial banks? Illustrate shortly and give an example of each.

Ans. The three types of commercial banks are the following −

• Private commercial bank − Private commercial banks are financial institutions where private individuals and businesses have a majority of the share capital. For example, HDFC Bank.

• Public commercial bank − It is a type of nationalized bank where the government holds a significant stake. Examples of public commercial banks include the State Bank of India (SBI).

• Foreign commercial banks − These banks have their headquarters in foreign countries and have branches in other countries, such as India. Citibank is a foreign commercial bank.

Q2. What are the two main functions of commercial banks?

Ans. The two main functions of commercial banks are accepting deposits and offering loans and advances.

Q3. Do commercial banks need a license to deal in foreign exchange?

Ans. Yes. Commercial banks need a license to deal in foreign exchange.