Functions of Commercial Banks:
The two main functions of a commercial bank are borrowing and lending. In other words, banks borrow to lend. The rate of interest offered by banks to depositors is called the borrowing rate while the rate at which banks lend out is called the lending rate. The difference between the two rates is called ‘spread’ which is profit appropriated by the banks.
The functions of a bank can be divided into two groups
1. Primary Functions:
The primary functions of a bank include accepting deposits from public and advancing loans to public.
2. Secondary Functions :
Secondary functions include all the functions performed by a bank other than accepting deposits and advancing loans. These are as follows :
1. Overdraft Facility
2. Discounting Bills of Exchange
3. Facilitation of Payments through Cheques
4. Agency Functions
5. General Utility functions
6. Credit Creation
1. Overdraft Facility:
- Overdraft facility is the facility that allows the customers to overdraw from the amount of his current account up to an agreed limit.
- Overdraft facility is provided to the current account holders in the bank against appropriate securities, for maximum 90 days.
- In this facility the customer is allowed to draw cheques in excess of the balance standing in his account to the extent of the amount of overdraft.
- The bank charges interest only on the amount overdrawn.
2. Discounting Bills of Exchange:
- It is the form of bank lending through discounting or purchasing the bills of exchange.
- It is a paper that is signed by a debtor and creditor for a fixed amount payable in a specific date.
- Such bills of exchange are normally issued for a period of 90 days.
- If the creditor needs money, he can present this bill of exchange to the bank and get funds from the bank.
- Bank will deduct a commission and pay the present value of the bill.
- At the time of maturity bank will get the payment directly from the debtor, who has accepted the bill.
- Thus, by discounting bills of exchange, the bank pay money to the creditor when he needs it and allows the debtor to make payment only when the bill is due for payment.
3. Facilitation of Payments through Cheques:
- The cheque is a convenient, safe and cheap method of payment.
- We can receive payments from others through cheques and deposit these cheques in our bank.
- These cheques may be drawn on some other commercial banks, but our bank will collect payment from these banks on our behalf.
4. Agency Functions:
The banks act as an agent of its customers and gets commission for performing agency functions as under –
a. Transfer of Funds:
The bank provides facility for cheap and easy remittance of funds from place to place through cheques, demand – draft, pay – orders, mail – transfers, telegraphic transfer etc.
b. Collection of funds:
Bank collects funds through cheques, bills, hundies and demand draft on behalf of its customers.
c. Making Payments:
Bank makes payment of taxes, Insurance premium, bills etc on behalf of its customers from their deposits.
d. Collection of Payments:
Bank receives payments of insurance claims, pensions, dividends and interest on shares and debentures on behalf of their customers and credit them to their account.
e. Purchase and Sale of Shares and Securities:
The bank, buys and sells and keeps in safe custody securities and shares on behalf of its customers.
f. Acts as trustee and executor of property –
The bank acts as Trustee and Executor of property of its customers on advice of its customer.
g. Letters of Reference :
It gives information about economic position of its customers to traders and provides similar information about other traders to its customers.
5. General Utility Function:
a. Locker Facility:
Commercial banks provide their customers with the facility of lockers or safety vaults so they can keep their valuable things in safe custody.
b. Traveller’s Cheques:
To avoid the risk of taking cash on their journey, commercial banks provide their customers with the facility of traveller’s cheques.
c. Underwriting Securities:
Commercial banks also performs the function of underwriting securities. As the public has full faith in the bank’s creditworthiness, they do not hesitate in purchasing the securities which are underwritten by banks.
d. Collection of Statistics:
Commercial banks advice their customers on financial matters by collecting and publishing statistics related to commerce, trade and industry.
7. Credit Creation:
- Credit creation is the most important and unique function of commercial banks.
- Banks create money in the form of deposit money.
- A commercial bank creates credit in the sense that it gives more loans than the cash deposits received from the depositors.
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