Question

Explain the functions of a commercial bank.

State and explain the functions of commercial banks.

Answer 1

Commercial banks act as intermediaries in the country’s financial system by bringing savers and investors together. They are profit-seeking financial institutions. Commercial banks play an important role in mobilizing savings and allocating them to various economic sectors. It includes both scheduled commercial banks and non-scheduled commercial banks. Scheduled commercial banks are those included in the second schedule of the Reserve Bank of India Act of 1934. Based on ownership and function, Indian commercial banks can be classified into four categories: Public sector banks, Private sector banks, regional rural banks, and foreign banks.

The functions of Commercial Banks are as follows:

1. Acceptance of deposits: Accepting deposits is one of the primary functions of commercial banks. Deposits constitute the main source of funds for these banks. Savings lead to the creation of deposits. The deposits are categorised as:
   1. Demand Deposits: These deposits are withdrawable on demand. They are in the form of current account and savings account deposits.
      1. Current accounts are usually opened by business people, corporations, industrial houses, trusts, etc. They are provided with an overdraft facility, i.e. they are allowed to withdraw more than the balance in the account.
      2. Savings accounts are operated mainly by the salaried class, small traders, etc., who wish to save a part of their income with the bank.
   2. Time deposits: These deposits are repayable after a certain period of time. In other words, they can be withdrawn only on maturity. They are in the form of Recurring deposits and Fixed deposits.
      1. Recurring deposit refers to a deposit wherein the customer deposits a fixed amount at regular intervals for a specified period of time.
      2. Fixed deposits refer to the lump sum amount deposited by a customer for a specified period of time. This deposit carries a high rate of interest compared to all other deposits.
2. Providing loans and advances: Commercial banks mobilize savings and lend these funds to institutions and individuals for various purposes.
   1. Loans: Based on tenure, loans can be classified as call loans, short-term, medium-term, and long-term loans. The longer the duration, the greater the rate of interest will be.
   2. Advances: The banks also provide cash credit, overdraft facility, and discount bills of exchange.
3. Ancillary functions: Commercial banks provide a range of ancillary services, such as:
   1. Transfer of funds
   2. Collection of money
   3. Making periodic payments on the customer’s behalf
   4. Merchant banking
   5. Foreign exchange
   6. Safe deposit lockers
   7. Demat facility
   8. Internet banking
   9. Mobile banking
4. Credit creation: Credit creation is an important function of commercial banks. Commercial banks are the creators of credit. Demand and time deposits constitute the primary deposits of banks. After meeting reserve requirements, the balance amount is used for giving loans. Thus, secondary deposits, or derivate deposits, are created out of the loans provided by the banks.