Economics 12 Notes for Economics Notes

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Functions of commercial banks

Commercial banks act as intermediates between those, who have surplus money and those who need it. To receive deposits and advance loans are the main functions of all commercial banks. In brief, they borrow to lend. They work to earn profit. The main functions of the commercial banks are discussed below:

  1. Accepting Deposits: Bank attracts idle saving of people in the form of deposits. These deposits may be of the following types:
    • Current account/ Demand deposits: These are repayable on demand without any notice. Since, the bank should keep all the money in reserve and can’t make investment; no interest is paid in this account. On the other hand a little commission is charged for the management of the money. Sometimes, however, a small interest is paid for the people who keep large balance.
    • Saving Account: In this account certain percent interest is paid to the depositors. There is given cheque or ATM facilities to withdraw money. Depositors can withdraw only the predetermined amount or to withdraw big amount of money pre-notice should be given to the bank.
    • Fixed/Time Account:  Generally, the deposit in the account will be from 3 months to 5 yrs. The deposit can be withdrawn only after the expiry of the maturity period of the deposit. Higher interest is paid in this account.
  2. Advancing loans and Advances: The deposits received by commercial banks are lent to others for short period only. But in present time, it also provides medium and long term loan to some extent. The banks advance loan in any one of the following ways:
    • Overdraft: Commercial banks provide overdraft facility to its customers by which they are allowed to withdraw more than their deposits. But they have to pay interest on the extra amount, which has to be repaid within a short period.
    • By creating deposit: Under this type of loan, banks advance loan to the borrower against his current assets such as Bonds, Stocks, Debentures, etc or fixed assets like Gold, Silver, Land, House, etc.
    • Discounting bills: It is another way of lending money. The bank purchase bills from bill broker and discount them. These bills provide very liquid form of assets, which can be easily turned into cash. Banks immediately pay cash for the bill after deducting the discount (interest) from its face value.
  3. Remitting funds: Commercial banks remit funds for their customers through bank drafts from one place to another.
  4. Agency function: The commercial bank works as an agent of their customers. The bank receives the rent, dividend, interest of shares and debentures. Similarly, it receives and make payments of insurance premium, income tax, electricity fee, etc on behalf of its customers.
  5. Credit creation: This is an unique function of commercial bank. When a bank advances loan to its customers, it doesn’t lend all cash but opens account on the name of borrower and deposits only the required amount.  Creation of such deposit is called credit creation by which there increases money stock in an economy.
  6. Issue credit instruments: The bank issues the letter of credit, travelers’ cheque, draft, master card to the customers.
  7. General utility functions: In addition to agency services, the modern banks provide many general utility services, which are given below:
    • Purchase and sale of securities
    • Providing valuable advisory service to its customers
    • Exchanging the foreign currency of its customers
    • Providing various economic and statistical information
    • Helps to the central bank to implement various fiscal and monetary policies.

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