Role and Functions of Commercial Banks

Role and Functions of Commercial Banks

From ancient days indigenous banking had been organised into the form of family or individual business. The indigenous bankers have been variously called as Shroffs, Seths, Shahukars, Mahajans, Chettis, etc. This activity is confined to certain castes such as Jains, Maruaries, Vaishyas, etc. They lend moneys to various categories of borrowers with varying conditions. This type of activity is predominant in villages where villagers themselves conduct agriculture, trade and retail business. The interest rates charged are very high.
This form of traditional indigenous banking undertakes banking operation and makes remittances, discounting hundis, receiving deposits, giving loans against stock in trade and keeping their funds as deposits for fixed terms with mills. It provides funds generally to agriculturists, small producers, etc., for various purposes, including consumption.
With the passing of time banks have moved on from traditional banking to the modern day financial intermediary. They cater to the financial needs of different sectors. However, the basic functions of the commercial banks comprise of transfer of funds, acceptance of deposits and then offering those deposits as loans for different purposes and to different sectors. But now the expanding business activities of the banks have changed the banks orientation from passive funds mobiliser to the active financial intermediary. So, the relationship between the bankers and the customers is not the same like before. The market has undergone a sea change. The customers have become more demanding today. The transition from sellers market to buyers market has compelled the bankers to understand the pulse and needs of the customers.
It may not be incorrect to say that the banking products and services today are designed by the customers. The luxury of discretion to design the products and services by the bankers is not any more available to the bankers.
Bankers today have no choice except to alter their product mix, delivery channels and corporate structure to serve their functional role. Some of the products which were shunned by the bankers and were treated as inflationary 20 years ago in nature like Housing Loan, consumer durables finance which otherwise were the prerogative of the bank employees have become targets of bank business and area of fierce competition and business mantra. Banks are vying with each other to sell across their ideas and products in the compelling hours of competition and the unexpected quarters say co-operative banks too have joined the fray.

Role

Commercial banks play an important role in every economy.
Escalate the economic development: The commercial banks play the leading role in economic development of a country. Economic development involves investment in various sectors of economy. The banks are not simply collecting funds but also serve as a guide to the customer investment of their funds. The banks collect savings from the people and mobilize saving for investment in industrial project. To escalate the process further, the banks can develop medium and long term savings instruments by issue of pre-printed deposit receipts
Increase in saving: The people deposit there savings into the banks and the bank pays reasonable profit on these savings.
Increase in investment: The money which is collected by the bank is lent to businessmen and industrialists. The investors borrow from banks to finance the projects and promote the growth rate through the reorientation of loan policy. The policy of banks is an instrument in wide dispersal of credit in country. Special funds are provided to the investors for the completion of projects. The banks provide a guarantee for industrial loan from international agencies. The foreign capital flows to developing countries for investment in projects.
Increase in employment: The increase in the investment increases the level of employment. The banks advance loan to the investors. As a result; the industrial units are setup in different parts of the country. Hence the level of employment is increased.
Transfer of money: When the people want to transfer their money from one place to another place, they get travellers cheque and the bank draft from the bank.
Capital formation: The process of the capital formation cannot be completed without the financial role play of commercial banks. So banks increase capital formation.
Agency role: Besides normal banking the banks perform agency services for the client. The banks buy and sell securities, make rent payments, receive subscription funds and collect utility bills for the Government departments. Thus these banks save time and energy of busy peoples.
Facilitation of foreign exchange: Commercial banks also arrange foreign exchange for the business transaction with other countries. The facility of foreign currency account has resulted in an increase of foreign exchange reserves. By opening a letter of credit these banks promote foreign trade.

Functions

The functions of commercial banks are divided into two categories:
Primary functions, and
Secondary functions
Let us understand each of them one by one.

Primary Functions

The primary functions of a commercial bank include the following:
Accepting deposits: The most important activity of a commercial bank is to mobilize deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank.
Grant of loans and advances: The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies depending upon the purpose, period and the mode of repayment. The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of a bank’s income.
Loans: A loan is granted for a specific time period. Generally, commercial banks grant short-term loans. But term loans (loan for more than a year) may also be granted. The borrower may withdraw the entire amount in lumpsum or in installments. However, interest is charged on the full amount of loan. Loans are generally granted against the security of certain assets. A loan may be repaid either in lumpsum or in instalments.
The primary functions of a commercial bank include the following:
Accepting deposits: The most important activity of a commercial bank is to mobilize deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank.
Grant of loans and advances: The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies depending upon the purpose, period and the mode of repayment. The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of a bank’s income.
Loans: A loan is granted for a specific time period. Generally, commercial banks grant short-term loans. But term loans (loan for more than a year) may also be granted. The borrower may withdraw the entire amount in lumpsum or in installments. However, interest is charged on the full amount of loan. Loans are generally granted against the security of certain assets. A loan may be repaid either in lumpsum or in instalments.
The primary functions of a commercial bank include the following:
Accepting deposits: The most important activity of a commercial bank is to mobilize deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank.
Grant of loans and advances: The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies depending upon the purpose, period and the mode of repayment. The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of a bank’s income.
Loans: A loan is granted for a specific time period. Generally, commercial banks grant short-term loans. But term loans (loan for more than a year) may also be granted. The borrower may withdraw the entire amount in lumpsum or in installments. However, interest is charged on the full amount of loan. Loans are generally granted against the security of certain assets. A loan may be repaid either in lumpsum or in instalments.
Advances: An advance is a credit facility provided by the bank to its customers. It differs from loan in the sense that loans maybe granted for longer period, but advances are normally granted for a short period of time. Further the purpose of granting advances is to meet the day to day requirements of business. The rate of interest charged on advances varies from bank to bank. Interest is charged only on the amount withdrawn and not on the sanctioned amount.
Discounting of bills: Banks provide short-term finance by discounting bills that is, making payment of the amount before the due date of the bills after deducting a certain rate of discount. The party gets the funds without waiting for the date of maturity of the bills. Incase any bill is dishonoured on the due date, the bank can recover the amount from the customer.

Secondary Functions

Besides the primary functions of accepting deposits and lending money, banks perform a number of other functions which are called secondary functions. These are as follows:
Issuing letters of credit, travellers cheques, circular notes etc.
Undertaking safe custody of valuables, important documents, and securities by providing safe deposit vaults or lockers.
Providing customers with facilities of foreign exchange.
Transferring money from one place to another; and from one branch to another branch of the bank.
Standing guarantee on behalf of its customers, for making payments for purchase of goods, machinery, vehicles etc.
Collecting and supplying business information.
Issuing demand drafts and pay orders.
Providing reports on the credit worthiness of customers.