Commercial Banks - 15 Mints Seminar Notes

Commercial Banks - 15 Mints Seminar Notes

 

A commercial bank is a financial institution which accepts deposits from the public and gives loans for the purposes of consumption and investment to make profit.

It can also refer to a bank, or a division of a large bank, which deals with corporations or large/middle-sized business to differentiate it from a retail bank and an investment bank. Commercial banks include private sector banks and public sector banks.

PRIMARY FUNCTION

•    Commercial banks accept various types of deposits from the public especially from its clients, including saving account deposits, recurring account deposits, and fixed deposits. These deposits are returned whenever the customer demands it or after a certain time period.

•    Commercial banks provide loans and advances of various forms, including an overdraft facility, cash credit, bill discounting, money at call, etc. They also give demand and term loans to all types of clients against proper security. They also act as trustees for wills of their customers etc.

•    The function of credit creation is generated on the basis of credit and payment intermediary. Commercial banks use the deposits they absorb to make loans. On the basis of check circulation and transfer settlement, the loans are converted into derivative deposits. To a certain extent, the derivative funds of several times the original deposits are increased, which greatly improves the driving force of commercial banks to serve the economic development.
 

SERVICE BY PRODUCT

Commercial banks generally provide a number of services to its clients; these can be split into core banking services such as deposits, loans, and other services which are related to payment systems and other financial services.

Core products and services

•    Accepting money on various types of Deposit accounts

•    Lending money by overdraft, and loans both secured and unsecured.

•    Providing transaction accounts

•    Cash management

•    Treasury management

•    Private equity financing

•    Issuing Bank drafts and Bank cheques

•    Processing payments via telegraphic transfer, EFTPOS, internet banking, or other payment methods.

OTHER FUNCTIONS

Along with core products and services, commercial banks perform several secondary functions. The secondary functions of commercial banks can be divided into agency functions and utility functions.

Agency functions include:

•    To collect and clear cheques, dividends, and interest warrant

•    To make payments of rent, insurance premium

•    To deal in foreign exchange transactions

•    To purchase and sell securities

•    To act as the trustee, attorney, correspondent and executor

•    To accept tax proceeds and tax returns

Utility functions include:

•    To provide safe deposit boxes to customers

•    To provide money transfer facility

•    To issue traveler's cheques

•    To act as referees

•    To accept various bills for payment: phone bills, gas bills, water bills

•    To provide various cards such as credit cards and debit cards

TYPES OF COMMERCIAL BANKS

Primary Functions

1. 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, utilised 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.

2. Providing Loans – One of the main functions of commercial banks is providing credit to organisations 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.

Commercial banks provide both secured and unsecured loans, categories are-

•    Cash Credit – Commercial Banks and its Functions include extending advances to individuals and organisations 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 credits.

•    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.

3. 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.

Secondary Functions

The following can be considered as the secondary functions of commercial banks –

1. 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.

2. Dealing in Foreign Exchange – Commercial banks help provide foreign exchange to individuals and organisations which export or import goods from overseas. However, only certain banks which have the license to deal in foreign exchange are eligible for such transactions.

3. 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.

4. 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 as 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.

5. Bank as an Agent – Commercial Bank and its Function also requires 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.

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 categorised into three types.

1. 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 organisations 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.

2. 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.

3. 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.

Presented by

Deekshitha 

Banking Student

Magme School of Banking