Commercial Banks: Banking Activities Performed, Types of Banks
In our routine life, we must have visited banks. These banks help us in many
banking activities like maintaining our savings account, depositing cash, and
withdrawing the same, thus we see these banks are always at our service. These
are the commercial banks, which operate commercially for serving the common
people.
Commercial banks have a lot of other functions to do than what is mentioned
above. What are those functions? What will happen if the commercial banks
cease to perform all the banking activities? Are there any other types of banks
that might help the masses? All these questions will be addressed in our
discussion that is based on the functions of Commercial Banks.
What are Commercial Banks?
Before diving straight into the topic of functions of commercial banks, first, it is
obligatory to know what are Commercial Banks.
A commercial bank is a typical financial institution that accepts as well as
deposits from the general public and also, they give loans for the purposes of
consumption activities and investment activities, to make their own profit.
Commercial banks are profit-based institutions that offer financial services like
loans, as well as services like deposits, electronic transfers of funds, etc. to their
customers. Commercial banks have a significant role in a country’s economy as
these organizations fulfill the short and mid-term financial requirements of
industries.
The functions of commercial banks are primarily based on a business model of
accepting public deposits and utilizing that fund for various investment
purposes. Such functions can be classified into two categories, primary and
secondary functions.
These functions will be discussed in our upcoming section.
What are the Functions of Commercial Bank?
Commercial Banks have both primary and secondary functions that as explained
in detail below.
Primary Functions
Accepting Deposits – Commercial banks accept deposits from their
customers in the form of saving, fixed, and current deposits.
Savings Deposits – Savings deposits allow a customer to credit funds
towards their accounts for up to a certain limit. These deposits are
preferred by individuals with a fixed income, utilized to create savings
over time.
Fixed Deposits – Fixed deposits come with a predetermined lock-in
period. Fixed deposits are also referred to as time deposits as the funds
are deposited for a specific time frame.
Current Deposits – Current deposits allow account holders to deposit
and withdraw money whenever necessary. In some cases, current
accounts also offer overdrafts until a pre-specified limit to individuals and
businesses.
Providing Loans – One of the main functions of commercial banks is
providing credit to organizations and individuals, and profit from the
earned interest. Usually, banks retain a small reserve for their expenses
while offering the remaining amount to customers as various types of
short and long-term credits.
Credit Creation – A unique function of commercial banks is credit
creation. Instead of offering liquid cash, banks create a line of credit and
transfer the loan to a business or commercial body all at once.
Categories of Secured and Unsecured Loans provided by Commercial
Banks
Cash Credit – Commercial Banks and their Functions include extending
advances to individuals and organizations against bonds, inventories, and
other types of securities. This facility, commonly known as cash credit,
provides a more substantial sum when compared to other forms of credit.
Short-Term Credits – Short-term loans are usually pledged without any
security, offering a smaller loan amount and repayment tenor. These are
also referred to as personal loans.
Secondary Functions
The following can be considered as the secondary functions of commercial
banks –
Providing locker Facilities – Commercial banks provide locker facilities
to customers who want to store valuables safely. Locker facilities
eliminate the impending risk of theft or loss, which prevail when kept at
home.
Dealing in Foreign Exchange – Commercial banks help provide foreign
exchange to individuals and organizations that export or import goods
from overseas. However, only certain banks which have the license to
deal in foreign exchange are eligible for such transactions.
Exchange of Securities – Another function of commercial banks is to
trade in bonds and securities. Customers can purchase or sell the units
from the financial institution itself, which offers more convenience than
alternate approaches.
Discounting Bills of Exchange – The main function of a commercial
bank in today’s date is to discount bills of businesses. Bill discounting is
considered a profitable investment for banks. Bills create a steady flow of
funds, while not becoming a risky venture during payment as it is
considered as a negotiable instrument. These also do not involve the
financial institution in any litigation.
Bank as an Agent – Commercial Bank and its Function also require
them to provide finance-related services to customers, fulfilling the role
of an agent. These services usually include –
Acting as an administrator, trustee, or executor of a customer-
owned estate.
Assisting customers with tax returns, tax refunds, and other similar
tasks.
Serving as a platform to pay premiums, repay loan installments,
etc.
Offering a platform for electronic transaction of funds, processing
of cheques, drafts, bills, etc.
Importance of Commercial Banks
Thus, we now know how important are commercial banks in performing the
balanced function in an economy. In a parallel universe, if commercial banks
cease to perform these banking functions, then the economy will collapse out of
thirst for money liquidity. Along with the growth, economic and social stability
will be shattered completely.
Types of Commercial Banks
It is necessary to understand the different types of financial institutions to
explain the functions of commercial banks effectively. Commercial banks are
commonly categorized into three types. They are as follows:
Public sector banks
Private sector banks
Foreign banks
Public Sector Banks
Public sector banks refer to a type of financial institution that is state-owned by
the corresponding Government. A significant part of the share of such
organizations is held by the Government. In India, the Reserve Bank of India,
which acts as the central bank, creates operating guidelines for the public sector
banks.
Private Sector Banks
Private sector banks are financial institutions registered as companies with
limited liabilities. The major part of the share capital of such companies is
owned by individuals or private businesses.
Foreign Banks
Foreign banks are financial institutions that are operating overseas within a
foreign nation. Post the financial reform of India (in 1991), there was a marked
increase in the number of foreign banks on Indian soil. They are essential for
the economic development of a nation.
Apart from these commercial banks that lend and deposit money, there is
Central Bank which is known as the ‘head honcho’ in terms of banks. The
Central Bank supervises the commercial banks, sets their interest rates, and
controls the money flow in the economy. This bank, unlike the commercial
banks, does not engage with the general public in terms of providing banking
services. Thus, Central Bank will never be as helpful as commercial banks to
the general mass.
Did You Know?
In this section, we will know about some interesting commercial banking facts.
Allahabad bank is the oldest joint stock bank existing in India.
Bank of India was the first bank to open branches in foreign nations.
Canara Bank is the first bank to be receiving the ISO 9002 Certificate.
Bharatiya Mahila Bank is the first all-women bank formed in India.
Reserve Bank of India served as the central bank of two countries at a
time. It was the central bank for Pakistan after the partition of India until
June 1948.
From the above-mentioned details, you will get a clear idea about commercial
bank definition as well as its functions.
