Banking > Functions of Commercial Bank

“Ordinary banking business consists of changing cash for bank deposit and bank deposit for cash, transferring bank deposit from one person to another, giving bank deposit in exchange for government bonds, the recurring promises of businessmen to repay and so forth.” — Prof. Sayer’s

The primary function of a commercial bank is to accept deposits from individuals, businesses, and institutions. Deposits are the main source of funds for banks.
Deposits are broadly classified into two categories:

Demand Deposits

Time Deposits

The second primary function of a bank is to lend money. Banks charge a higher interest rate on loans than they pay on deposits — this difference (called the spread) is the bank's profit. Banks provide loans in the following ways:

(a) Cash Credit

• The bank sanctions a loan limit against security (shares, stock, bonds).
• The borrower does not receive the full amount at once — he withdraws as needed.
• Interest is charged only on the amount actually withdrawn, not the total sanctioned amount.
• Very popular with Indian businessmen.

Example: A textile factory owner gets a ₹10 lakh Cash Credit limit. He withdraws ₹3 lakh in January and ₹4 lakh in March. He pays interest only on the amounts withdrawn.

(b) Overdraft Facility

• Allowed to current account holders only.
• The customer can withdraw more than the balance in his account up to a pre-approved limit.
• Interest is charged only on the amount overdrawn.

Example: A shopkeeper has ₹20,000 in his account. The bank gives him an overdraft of ₹50,000. He can write cheques up to ₹70,000 (₹20,000 + ₹50,000 overdraft).

(c) Term Loans (Short, Medium, Long-Term)

• The bank credits the entire loan amount to the borrower's account at once.
• Interest is charged on the entire amount, regardless of usage.
• Longer duration = higher interest rate.

(d) Discounting Bills of Exchange

• A bill of exchange is a written promise by a debtor to pay a creditor a fixed amount after a certain period (usually 90 days).
• If the creditor needs money before the 90 days, the bank buys the bill at a discount (deducts its commission).
• On maturity, the bank collects the full amount from the debtor.

Example: Ram sells goods worth ₹10,000 to Shyam on 90-day credit. Ram needs money now, so he gets the bill discounted at the bank for ₹9,800. The bank earns ₹200 as commission and collects ₹10,000 from Shyam after 90 days.

Commercial banks provide the cheque system, which is the most convenient, safe, and widely used mode of payment in business.

• Cheques can be used to make and receive payments without carrying cash.
• Banks also facilitate fund transfers through: Demand Drafts (DD), Pay Orders, NEFT, RTGS, IMPS, Mail Transfers, and Electronic Transfers.

Example: Instead of carrying ₹5 lakh in cash, a businessman issues a cheque. The bank debits his account and credits the recipient's account — safe and instant.

Banks act as agents of their customers and charge a commission or service fee for the following:

• Collection services: Collecting payments on cheques, bills, dividends, pensions, and interest on shares/debentures on behalf of customers.
• Payment services: Paying insurance premiums, electricity bills, taxes, etc., automatically from the customer's account.
• Investment services: Buying and selling stocks, shares, mutual funds, NSCs, and UTI units on behalf of customers.
• Foreign exchange: Some banks are authorised to deal in foreign currency — they issue Letters of Credit and discount foreign bills for exporters/importers.
• Trustee and Executor: Banks safely store customers' wills and execute them upon the customers' deaths.

Modern commercial banks are called "Departmental Store Banks" because they offer a wide range of services under one roof:

• Safe Deposit Lockers – for jewellery, documents, and valuables
• Traveller's Cheques and Gift Cheques – for safe travel and gifting
• Credit and Debit Cards – for digital cashless transactions
• Demat Account Facility – for holding shares in electronic form
• Internet Banking and Mobile Banking – for 24/7 banking access
• Investment and Tax Advice – financial planning assistance
• Merchant Banking – services to companies issuing new securities

Credit creation is the most important and unique function of commercial banks. It means banks can create more money than the original deposits through repeated lending.

How Does Credit Creation Work?
When a bank receives a deposit, it holds a fraction of it as reserves (called the Cash Reserve Ratio / CRR) and lends the rest. The borrower spends the money, which is re-deposited in another bank. That bank again keeps its reserve and lends the rest. This chain continues — multiplying the original deposit many times over.
Real-Life Analogy: Imagine you lend your ₹1,000 to a friend, who lends ₹900 to another friend, who lends ₹810 further — each time a bit less is passed on. Now imagine this across thousands of banks — that's how the entire banking system multiplies money.

"Banks help in the remittance or transfer of funds expeditiously and safely from one place to another through the use of various credit instruments like cheques, drafts, pay orders, mail transfers, telegraphic transfers, e-mail, etc."
Simple Translation: Banks make it super easy and safe to send money from Mumbai to Delhi (or anywhere else) using various tools.

"This function is of great significance these days in view of the tremendous commerce."
Real Example:

• 1990s: Mumbai trader sends ₹5 lakh to Delhi supplier via Demand Draft
• 2026: Same trader sends ₹5 lakh via UPI in 2 seconds

Banks help traders buy/sell goods within India (internal) and outside India (external).
How banks help (2 ways):

• Bill Discounting = Trader waits 90 days for payment → Bank gives cash NOW (minus small fee)
• Short-term loans = Quick cash against invoices/receipts

Real Example: Mumbai cloth merchant sells to Delhi → Gets 90-day bill → Bank pays immediately → Merchant buys more cloth!

Banks convert ₹ → $ → ₹ for exporters/importers/tourists.

Examples:

• Exporter gets $10,000 → Bank converts to ₹8.3 lakhs
• Importer pays supplier $5,000 → Bank sells dollars
• Student going to the USA → Buys dollars for studies

Banks = One-stop finance shop! Here's what else they do:

• Accept Deposits – Main source of funds: Demand Deposits (Current/Savings Accounts) & Time Deposits (Fixed/Recurring Deposits)
• Grant Loans & Advances – Cash Credit, Overdraft, Term Loans, Bill Discounting (banks profit from interest spread)
• Cheque System – Safe payment method using cheques (principal business payment tool)
• Transfer of Funds – Fast/safe money transfer via drafts, pay orders, mail/telegraphic transfers (essential for commerce)
• Credit Creation – Banks multiply money: loans create new deposits (Initial Deposit × 1/CRR formula)
• Financing Trade – Bill discounting + short-term trade loans (facilitates internal/external trade)
• Foreign Exchange & Utility Services – Currency exchange + lockers, travel cheques, mobile banking, agency functions