To know exactly what the functions of commercial banks are? Firstly we should try to understand that what commercial bank is? Commercial Banks are those institutes which deal with the money and engaged in performing the routine activities of banking business. Commercial banks are primarily established to earn profit. It deals with the funds of other. It takes money from one person and lends to another. They give fixed amount of interest while talking money from others and give to needy people and take a fixed amount of interest which is higher than previous one. So difference between both of them is actually the profit of bank. Along with this borrowing and lending money, there are a lot more functions of commercial bank, which play a vital role in the development of country and also give a lot benefits to the general public.
Primary Functions of Commercial Banks
Below are few very general functions of commercial banks, you must be familiar with all of them. The first two functions of commercial banks are known as primary functions of commercial banks and last two known as secondary functions of commercial banks.
- Accept Deposits
The most important function of commercial banks is that it collects the surplus money or saving of the people on accepting deposits. These deposits may be created in two ways, such as by direct deposits, when a customer deposit their money in the bank by opening a bank account such as current account, fixed account or saving account and secondly by indirect or derivative deposits, which is credited by giving loans to their customers.
- Advancing Loans
Next important functions of commercial banks are advancing loans to needy people at a higher rate of interest against security. It is a profit making concern. The banks usually provide short-term credit and avoid locking its funds for a long-period, because a major portion of the money comprises of current and saving deposits, withdrawal on demand without notice. Commercial banks issue the loan in the form of cash credit, overdraft, and fixed loans and by discounting of bill of exchange. However, while making or advancing loans; banks always take into consideration the credit worthiness of the applicants, i.e. four “C” of credit. These are the “character”, “capacity”, “capital” and “collateral” which are always guidelines to the bank for advancing loans.
Secondary Functions of Commercial Banks
- Agency Services
The commercial banks provide agency services to its customers. It acts as agent to its customers in the collection and payment of cheques, bill of exchange and promissory notes. The banks provide a useful service in the collection of dividend or interest earned on stock and share held by the customers. The bank purchases and sells the securities on behalf of his customers. Banks also make payments of regularly recurring nature of individual or firm, dues by debiting of his account, like insurance premium etc. A bank also acts as Trustee or Executor on the direction of the customers. Banks also transfer funds of the customers from one bank to another bank at home or abroad.
- General Utility Services
Besides the main functions of commercial banks, they also perform many other services of general utilities to its clients. A bank transacts in foreign exchange business by discounting foreign bill of exchange and then financing foreign trade. A bank also acts as referee for “credit worthiness” of its client. Bank provides “lockers” facility for keeping ornaments and other valuable documents in a safe custody. Banks also issue “letter of credit” to the businessmen and “travel’s cheque” to tourists. Banks create instruments of credit, a suitable substitute for money. They encourage the habit of the savings, which ultimately result in investment and capital formation. Bank also provides trade information by publishing monthly bulletin, which contain information regarding to trade, commerce and industry. In a sentence, banks provide indispensable services of general utilities.
The economic significance of commercial banks is as given below;
- Capital Formation
Capital formation is the basic requirement of country. It consists of three stages.
- Generation of savings
- Mobilization of savings
- Channelization of savings in productive uses
- Investment in New Enterprises
The commercial banks provide capital to the entrepreneurs to take risk and invest in new enterprises. The commercial banks thus help in increasing the productive capacity of the economy.
- Creators and Distributors of Money
The commercials banks are creators and distributors of money. They purchase securities and allow money to play an active role in the economy.
- Influencing Economic Activity
The commercials banks influence economic activity in two ways. First, the lowering of interest rate makes the investment more profitable and increases in the interest rate discourages investment. Secondly, the making of capital available to the investors increase investment, production and trade in the economy and vice versa.
- Effective Implementation of Monetary Policy
The control and regulation of credit by the central bank of the country is only possible and effective with the cooperation of the banking system in the country.
- Expansion in Trade and Industry
The use of cheques, drafts, bill of exchange etc by the banks, has lead to vast expansion in trade and industry in all over the world.
- Encouragement of Right Type of Industries
The banks advance short, medium and long term loans to the industrialists in accordance with the loan policies of the government. Thus helps in promoting right type of industrialization in the country.
- Balanced Development
The banks play an active role in balanced development in different regions of the country. They help in transferring funds from development regions to the less developed regions. The undeveloped areas of eth country thus get adequate funds for development.
- Development of Agricultural and Industry
The commercial banks, particularly in developing countries are providing short, medium and long term loans for the development of agricultural and industries in rural and urban areas.
- Reducing Reliance on Foreign Capital
A planned banking system in the country mobilizes savings and meets credits. Thus it results more investment in the country and reduces relying on foreign capital.