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Friday 1 June 2012

What is Commercial Bank and Its Functions


A bank is a financial institution which deals with money and credit it is organized on a joint stock company system primarily for the earning of profit. Commercial bank accepts deposits from individuals, firms and companies at a lower rate of interest and gives at higher rate of interest to those who need them. The difference between the terms at which it borrows and at which it lends forms the source of its profit.

Functions of a commercial bank

The early role of the banking was to keep and safe the money and other deposits of the citizens and was charging very low fee for it. After a sometime bankers realize to expand operations by lending money to those who required it. That was the foundation of ‘loan and deposit’. The functions of the banks are divided into two broad categories are described below.   

Basic functions

The basic functions of a commercial bank are accepting of deposits and advancing of money.

Accepting of deposits

The first important function of a bank is to deposits from these who can save but cannot make profitable use of their savings themselves. In order to attract the savings from different persons and institutions, the bank maintains the following three types of accounts.

  • Current account

The businesses and trades usually maintain their funds in current account. Current account is one where money is constantly being drawn out and put in. Since the money is withdraw at anytime by the customer, therefore the banks usually do not pay interest on current deposits. Current account holders receive a cheque book and regular statements containing details of money paid in and paid out.

  • Fixed deposit account

Fixed deposits are kept with the banks for a specified period of time. The rates of interest on fixed deposits (also known as term deposits) are fairly high. The longer the period of deposit, the higher is the rate of interest.

  • Saving account

The aim of this account is to encourage and mobilize savings of the people. Saving account is generally opened by persons of small income. The banks pay interest on this type of deposits. However, the banks normally place restrictions on their frequent withdrawal.

Making loans

The other major function of a commercial bank is to make loans to businessmen, traders, households etc. These loans are made against documents of title to goods, personal securities of the borrowers, marketable securities etc. All the functions of modern bank, advancing or lending is by far the most important. The advances comprise a very large portion of a bank’s total assets. The strength of a bank is primarily judged by the soundness of its advances. The lending of money may be in following forms.

  • Cash credit

It is a very common form of borrowing by business concerns. The banks advance long term loans to the commercial and industrial units against the security of goods. The borrower is permitted to draw within the cash credit limit sanctioned by the bank. The interest is charged only on the amount of money withdrawn by the borrower.

  • Discount of bills

The bank also makes loans to their customers by discounting bills of exchange. Discounting of bills refers to making the payment of bill before its maturity. The discount charged is the earning of the bank. The premature payment made is a loan to the holder of the bill. Discounting of bills by bank is considered a safe, certain and liquid form of bank lending.

  • Overdraft

It is a convenient from of short term financing by a bank. Under this facility a customer may arrange with his bank to permit him over-draw o his current account known as an overdraft (O/D). The bank allows customer to overdraw his account upto a certain limit on providing security of shares, insurance policies, deposit receipts etc. Whenever the customer has surplus funds, he may pay such funds into his current account to reduce the loan or even to settle the overdraft balance. Interest is charged on daily balance on the overdrawn amount.  

  • Loans

The commercial banks grant short and long term loans to individuals, firms and companies mostly against securities. The amount of loan is credited to the borrower’s account who withdraws it as per his requirements.    

Secondary functions

The secondary functions of a commercial bank are classified as special financial services and agency functions.

Special financial services

The business of today is highly competitive. It is not enough for the banks to accept deposits and make loans. Banks are now offering international services such as currency exchange, issue of letters of credit, banker’s acceptances; most of the commercial banks are also offering ATMs and EFT.

Agency functions

Banks act as agents of their customers in various ways as:

  • Acting as trustee or executor

It is client directs his bank to act as trustee or executor in the administration of a will or in any business settlement requiring a technical knowledge, the bank will take this responsibility also for the benefit of its customer and charge a small fee for providing this essential services.

  • Collection of cheques

It acts agents to its customers in the collection and payment of cheques, bills and promissory notes.

  • Collection of dividends

The bank provides a very useful service in the collection of dividends or interest earned on shares held by its customers.

  • Execution of standing instructions

The customer may order in writing to his bank to make payment of regularly recurring nature to an individual or firm by debiting them to its account. The bank will make payments and charge a small commission. The payments will be stopped on written instructions of the customer only.

  • Purchase or sale of securities

The bank, if authorized by the customer, purchases or sells securities on his behalf and thus adds another benefit to its portfolio.

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