Functions of Commercial Banks

The functions of commercial banks are of two types.

1.  Primary functions    

2. Secondary functions

PRIMARY FUNCTIONS

The primary functions of commercial banks are ACCEPTING DEPOSITS, GRANTING LOANS AND ADVANCES.

Received 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 gets motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank.

Some important account under received deposits.

Savings Account: - It is generally opened in bank by salaried persons or by the persons who have a fixed regular income. This facility is also given to students, senior citizens, pensioners and so on. If a person wants to save money for future needs, the saving account is most suited for his purpose. This type of account can be opened with a minimum initial deposit the varies from bank to bank. Money can be deposited any time in this account. The saving account holder is allowed to withdraw money from the account as and when required and withdrawals can be made either by signing a withdrawal form or by issuing a cheque or by using ATM card. Normally banks put some restriction on the number of withdrawals from this account. Interest is allowed on the balance of deposit in the account. The rate of interest on savings bank account varies from bank to bank and also changes from time to time. A minimum balance has to be maintained in the account as prescribed by the bank.

Current Account: - Big businessmen, companies and institutions such as schools, colleges and hospitals have to make payment through their bank accounts. Since there is restriction on number of withdrawals from savings bank account, that type of account is not suitable for them. The need to have an account from which withdrawal can be made any number of times. For this purpose banks open current account for them, like savings account, this account also requires certain minimum amount of deposit while opening the account. On this deposit bank does not pay any interest on the balances. Rather the account holder pays certain amount each year as operational charge. For the convenience of the account holders banks also allow withdrawal of amounts in excess of the balance of deposit. This facility is known as overdraft facility. It is allowed to some specific customer and upto a certain limit subject to previous agreement with the bank concerned.

Fixed Deposit Account :-  In fixed deposit account a deposit of money pays higher interest than a savings account. This type of deposit account allows deposit to be made of an amount for a specified period. This period of deposit may range from 7 day to 10 years or more, during which no withdrawal is allowed. However, on request the depositor can encash the amount before its maturity. In that case banks give lower interest that what was agreed upon. The interest on fixed deposit account can be withdrawn at certain intervals of time. At the end of the period the deposit may be withdrawn or renewed for a further period. Banks also grant loan on the security of fixed deposit receipt.

Recurring Deposit Account: - In banking terminology, the term recurring deposit refers to the periodic placement of a fixed sum of funds with a bank or financial institution into a special term account with specified tenure generally between 1 and 5 years. At the end of the tenure the funds are typically withdrawn by the depositor with accrued interest. While opening the account a person has to agree to deposit a fixed amount once in a month for a certain period. The total deposit along with interest therein is payable on maturity. However the depositor can also be allowed to close the account before its maturity and get back the money along with the interest till that period. The account can be opened by a person individually or jointly with another or by the guardian in the name of a minor. The rate of interest allowed on the deposits is higher than that on a savings account but lower than the rate allowed on a fixed deposit account for the same period.       

 To lend Money

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 according to the purpose and period of loan and also the mode of repayment.

Loans :- A loan is granted for a specific time period. Generally commercial banks provide short-term loans and long-term loans. The borrower may be given the entire amount in lump sum or in installments. Loans are generally granted against the security of certain assets. A loan is normally repaid in installments. However, it may also be repaid in lump sum.

Advances :-  An advance is a credit facility provide by the bank to its customers. It differs from loan in the sense that loans may be 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 advance varies from bank to bank. Interest is charged only on the amount withdrawn and not on the sanctioned amount.

Non Performing Asset :- Non Performing Asset means an asset or account of borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing loan and NPA has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by the Reserve Bank of India.

SARFAESI ACT 2002

The full form of SARFAESI Act as we know is Securitization an Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Banks utilize this act as an effective tool for band loans (NPA) recovery. It is possible where non-performing assets are backed by securities charged to the Bank by way of hypothecation or mortgage or assignment.

Upon loan default, banks can seize the securities (except agricultural land) without intervention of the court.

SARFAESI is effective only for secured loans where bank can enforce the underlying security eg hypothecation, pledge and mortgages. In such cases, court intervention is not necessary, unless the security is invalid or fraudulent. However, if the asset in question is an unsecured asset, the bank would have to move the court to file civil case against the defaulters.

The SARFAESI Act, 2002 gives powers of "seize and desist" to banks. Banks can give a notice in writing to the defaulting borrower requiring it to discharge its liabilities within 60 days. If the borrower fails to comply with the notice, the Bank may take recourse to one or more of the following measures:

:- Take possession of the security for the loan.

:- Sale or lease or assign the right over the security.

:- Manage the same or appoint any person to manage the same.

Types of Advances

Cash Credit (CC) :- Cash Credit is a type of facility provided by the bank or financial institution in which, a company can withdraw an amount more than what he holds to his credit against the security of stock. Interest is charged on the amount actually withdrawn. Cash Credit is granted as per terms and conditions agreed with the customers.

Overdraft (OD) :- Overdraft is also a credit facility granted by bank. A Customer who has a current account with the bank is allowed to withdraw more than the amount of credit balance in his account. It is a temporary arrangement. Overdraft facility with a specified limit may be allowed either on the security of assets or on personal security or both.

Difference between Cash Credit Facility and Overdraft Facility

Account requirement: 

CC- One needs to usually open a separate cash credit account with a bank to avail cash credit facility.

OD- Overdraft can be availed on the existing current account. It is a facility of "excess withdrawal" given in current account.

Security Requirement:

CC- Company inventory and receivables are usually taken as security for allowing cash credit facility.

OD- Overdraft facility does not necessarily require current assets as security. An overdraft facility may be extended by taking shares, other investments like FDs, insurance policies as security. At times even on the credibility of the person, overdraft limit may be approved.

End Use:

CC- This is generally given specifically for the purpose of the business operation.

OD- Overdraft facility can be used for any purpose and not necessarily for business.

Rate of Interest:

CC- The rate of interest charged under cash credit facility is lesser than what is usually charged under the overdraft facility.

OD- The rate of interest charged under overdraft facility is higher than what is usually charged under the cash credit facility.

Length of Credit Period:

CC- Cash Credit is usually for a short period. That means, the limit is allowed for a period of 1 year and is renewed every year. In some cases, renewals or review may be stipulated half yearly as well.

OD- Overdraft facility is allowed for a very short duration at times (Say a month or even for a week in some cases), but can be allowed for a period of up to 1 year. (Say a month or even for a week in some cases), but can be allowed for a period of up to 1 year.

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. In case any bill is dishonored on the due date the bank can recover the amount from the customer.

SECONDARY FUNCTIONS

1.  Transfer of Funds:

Banks provide the facility of economical and easy remittance of funds from place-to-place with the help of instruments like demand drafts, mail transfers, etc.

2. Collection and Payment of Various Items:

Commercial banks collect cheques, bills,’ interest, dividends, subscriptions, rents and other periodical receipts on behalf of their customers and also make payments of taxes, insurance premium, etc. on standing instructions of their clients.

3. Purchase and Sale of Foreign Exchange:

Some commercial banks are authorized by the central bank to deal in foreign exchange. They buy and sell foreign exchange on behalf of their customers and help in promoting international trade.

4.  Purchase and Sale of Securities:

Commercial banks buy and sell stocks and shares of private companies as well as government securities on behalf of their customers.

5. Income Tax Consultancy:

They also give advice to their customers on matters relating to income tax and even prepare their income tax returns.

6.  Trustee and Executor:

Commercial banks preserve the wills of their customers as trustees and execute them after their death as executors.

7. Letters of Reference:

They give information about the economic position of their customers to traders and provide the similar information about other traders to their customers.

8. Locker Facility:

Commercial banks provide facility of safety vaults or lockers to keep valuable articles of customers in safe custody.

10.  Traveller’s Cheques:

Commercial banks issue traveler’s cheques to their customers to avoid risk of taking cash during their journey.

11. Letter of Credit:

They also issue letters of credit to their customers to certify their creditworthiness.

12.  Underwriting Securities:

Commercial banks also undertake the task of underwriting securities. As public has full faith in the creditworthiness of banks, public do not hesitate in buying the securities underwritten by banks.

13. Collection of Statistics:

Banks collect and publish statistics relating to trade, commerce and industry. Hence, they advice customers on financial matters. Commercial banks receive deposits from the public and use these deposits to give loans. However, loans offered are many times more than the deposits received by banks. This function of banks is known as ‘Money Creation’.