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Functions of Commercial Bank

Commercial Banks not only deal in money and credit but they also perform various functions, viz.,
agency functions, credit creation, and other agency functions and general utility services. The
various functions of commercial banks can be explained with the help of the following chart.

Functions of Commercial Bank

Primary Functions Secondary Functions Other major Functions

1. Investment Functions
2. Credit Creation
Accepting Deposits Loans and Advances 3. Foreign Trade Management

1. Savings Deposits
2. Current Account Agency Services General Utility Services
Deposits
3. Fixed Deposits
4. Recurring Deposits 1. Overdraft 1. Collection of 1. Safety locker
5. Cash Certificates 2. Cash Credit cheques, dividends facility
3. Discounting of etc 2. Money transfer
6. Others
2. Payment of rents 3. Travellers cheque
Bills
Insurance premium and letters of
4. Loans and credit
etc.
Advances 3. Underwriting 4. Acts as referees
5. Other advances functions 5. Information
4. Purchase and sale relating to trade
of securities and economic
5. Acts as trustees, position
executor etc. 6. Depository
6. Preparation of services
Income Tax returns 7. Credit/Debit cards
etc. 8. ATM facility
7. Acts as 9. Management of
correspondent public debt
8. Dealing in foreign 10. Others
exchange

Primary Functions
These functions are performed by commercial banks from their very existence. They are classified
into two categories, namely, (1) Accepting Deposits and (2) Advancing Loans
(1) Accepting Deposits: Being advancing loans as the primary function, banks require money to
fulfil this objective. Hence they accept deposits from individuals and institutions and make payment
for deposits as interest. For this purpose banks operate various types of accounts in which the
deposits are attracted. Generally commercial banks operate following types of accounts.
(i) Savings Deposits: The savings deposit promotes thrift habit among people. Small savings are
collected and deposited in such accounts which are used for capital formation in the country. The
rate of interest paid on savings deposits is comparatively lower. Even though there are restrictions
on making withdrawal, liquidity of such accounts is higher in comparison with time deposits.
Corporate business houses and firms are generally not allowed to open Savings Bank accounts.
Those customers, who maintain a minimum balance as directed by the bank, can avail cheque

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facility with their accounts. Recently, most of the commercial banks provide ATM (Automated
Teller Machine) cards to their customers with an additional feature as International Debit Card as
per the terms and conditions of the bank.
(ii) Current Account Deposits: This account is generally opened by traders, businessmen and
industrialists, which offers high liquidity. No interest is paid on such deposits and there is no
restriction on number of withdrawals. However, some charges are levied by the bank on such
accounts. Customers are also given overdraft facility as per their credit.
(iii) Fixed Deposits: It is also called time deposit account. In such accounts money is deposited for
a fixed period. After the maturity of the account the bank repays the principal plus interest for that
given period. The interest on such accounts is pre-decided. The rate of interest is comparatively
high and it varies as per the duration of the account. Interest rates are fixed as per the RBI rules
and regulations. In times of urgent need for money, the bank allows premature closure of fixed
deposits by paying interest at reduced rate. Depositors can also avail of loans against Fixed
Deposits.
(iv) Recurring Deposits: In Recurring Deposit account, the customer opens an account and deposit
a certain sum of money every month and is deposited for a given period. After the maturity the
accumulated amount along with the interest rate is paid to the customer. The rate of interest
generally is higher than the saving deposit account and lower than the fixed deposit account.
(v) Cash Certificates: Cash Certificates are issued to the public for a longer period of time. It attracts
the people because its maturity value is in multiples of the sum invested. It is an attractive and high
yielding investment of those who can keep the funds for a long time. Cash Certificates are generally
issued at discount to face value. It means a cash certificate of Rs. 1,00,000 payable after 10 years
can be purchased now, say for Rs. 20,000.
(1) Advancing Loans: The commercial banks provide loans and advances in various forms.
Interest rate charged by banks on loans is higher than the interest rate paid by banks on deposits
and thereby banks earn profit. Generally, commercial banks advance loans in following forms.
(i) Overdraft: When a bank allows its customers having current account to withdraw the amount
more than the deposits in the account is called Overdraft. This facility of overdrawing his account is
generally pre-arranged with the bank up to a certain limit. It is short-term temporary fund facility
from bank and the bank will charge interest over the amount withdrawn. This facility is generally
available to business firms and companies.
(ii) Cash Credit: Under this form of advancing credit, the customer opens an account and the
sanctioned amount is credited with that account. The customer can operate that account within the
sanctioned limit as and when required. It is made against security of movable and immovable
properties, shares and debentures, personal security etc. On the basis of operation, the period of
credit facility may be extended further. The bank charges interest only on the amount actually
withdrawn from the account. Central Bank discourages this type of advances as it imposes
uncertainty on money supply. Hence this form of lending is slowly phased out from banks and
replaced by loan accounts. Cash Credit system is not in use in developed countries.
(iii) Discounting Bills of Exchange1: Under this method of lending, bank provides credit against the
dated bill of exchange before its maturity at discounted values, i.e., values a little lower than the
face values. The bank can discount genuine commercial bills, i.e., those drawn against sale of
goods on Credit. The banker’s discount is generally the interest on the full amount for the unexpired
period of the bill. If the buyer does not make the payment of the bill then the bank gets the payment
from the seller of the bill.

1 According to Section 5 of the Indian Negotiable Instruments Act, “a Bill of Exchange is an instrument in writing
containing an unconditioned order signed by the maker directing a certain person to pay a certain sum of money only, to,
or to the order of, a certain person or to the bearer of the instrument”.

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(iv) Loans and Advances: Banks provide loans and advances to its customers against adequate
collaterals. The loan amount is paid in cash or by credit to customer account which the customer
can draw at any time. The interest is charged for the full amount whether the customer withdraws
the money from the account or not. The loan is sanctioned for a given period time. As per the terms
and conditions, the customer has to repay the loaned amount with the interest rate within the
stipulated time. On default, the bank can attach the collaterals to recover the amount advanced by
the bank.
Previously interest on loan was also regulated by RBI. Currently, banks can determine the rate
themselves. Each bank is, however required to fix a minimum rate known as Prime Lending Rate
(PLR)2.
(v) Other Advances: Nowadays commercial banks have extended their traditional function of
making loans and advances by starting many innovative schemes in giving advances to their
customers. They provide housing finance facilities to their customers in order to participate in the
working of achieving the goal of increase in better housing facilities in the country and thereby a
better standard of living for the people. Government of India also encourages banks to provide
housing finance. Borrowers of housing finance get tax exemption benefits on interest paid.
Apart from providing housing loan scheme, the Reserve Bank of India, from August, 1999
introduced a new Educational Loan Scheme for students of full time graduate/post-
graduate/professional courses in professional colleges. As per the RBI guidelines, the loan can be
sanctioned to students, whose annual income does not exceed Rs. 1,00,000 with an extremely
liberal terms and conditions. The loan has to be repaid together with interest within five years from
the date of completion of the course.
Adding to their loan portfolio, many of the banks provide loans against shares and securities,
Savings Certificates like National Savings Certificate, Fixed Deposit Receipt, Indira Vikas Patra etc.
One of the important areas for bank financing in recent years is towards purchase of consumer
durables. Commercial Banks also provide other types of advances such as venture capital
advances to promote new entrepreneurs, jewel loans, etc.
Secondary Functions
The secondary functions of the banks consist of agency functions and general utility functions.
(1) Agency Functions: Commercial banks act as agent of their customers and render services.
Some charges are levied by the banks on such services. However some of the services are
rendered free of charges as its commitment to maintain a better customer friendly relationship.
Agency functions include the following.
(i) Collection of cheques, dividends, interests etc: Bank collects cheques, drafts, promissory notes,
interest, dividends etc., on behalf of its customers and credits the amounts to their accounts.
(ii) Payment of rent, insurance premiums: The bank makes the payments such as rent, insurance
premiums, subscriptions etc. on instructions by the customer. Till the order is revoked, the bank will
continue to make such payments regularly by debiting the customer’s account.

2 PLR: The loan interest rate a financial institution uses as a base to calculate interest rates. At present, loans up to Rs.2
lakhs carry the prescription of not exceeding the Benchmark Prime Lending Rate (BPLR) and on the loans above Rs.2
lakhs, banks are free to determine rate of interest subject to BPLR and spread guidelines. Keeping in view the
international practice and to provide operational flexibility to commercial banks in deciding their lending rate, banks may
offer loans at below BPLR to exporters or other creditworthy borrowers including public enterprises on the basis of a
transparent and objective policy approved by the respective Boards.

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(iii) Underwriting functions: Large industrial and business units raise capital from the market.
Debentures are underwritten by the banks. It helps the companies to collect the minimum capital on
their guarantee. If the shares and debentures are not purchased in adequate quantum, the bank
itself purchases all these shares and debentures. It increases the trust of the public in the company
concerned.
(vi)Purchase and sale of securities: Commercial banks undertake the purchase and sale of different
securities such as shares, debentures, bonds etc., on behalf of their customers.
(v) Act as trustee, executor, attorney, etc.: The banks act as executors of Will, trustees and
attorneys. It is safe to appoint a bank as a trustee than to appoint an individual.
(vi) Preparation of Income-Tax returns: Banks prepare income-tax returns and provide advices on
tax matters for their customers. For this purpose they employ tax experts and make their services
available to their customers.
(vii) Act as correspondent: Banks also do correspondence on behalf of customers relating to
booking vehicles, travel tickets, passport etc.
(viii) Dealing in foreign exchange: As an agent, commercial bank purchase and sell foreign
exchange as per RBI guidelines.
(2) General Utility Services:
(i). Safety locker facility: Safekeeping of important documents, valuables like jewels is one of the
important service other than banking provided by commercial banks. These lockers are available on
half-yearly or annual rental basis.
(ii) Money transfer: Transfer of funds is another service provided by banks. Apart from traditional
instruments/mechanisms such as cheques, Demand Draft (DD), Mail Transfer (MT), Telegraphic
Transfer (MT), banks nowadays make use of credit cards, debit cards, internet banking, ATM facility
etc. to transfer funds from one place to another. By taking advantage of the communication
development, money can be transferred from one place to another even without bank
charges/commission.
(iii) Travellers cheque and Letters of credit: Banks issue travellers cheques and letters of credit to
help carry money safely while travelling within the country or abroad. Traveller’s cheque is a
medium of exchange that can be used in place of hard currency. Travellers' cheques are often used
by individuals who are travelling on vacation to foreign countries. The cheques were first introduced
by American Express back in 1891. The cheque can then be used virtually anywhere in the world
once it has been countersigned with the same signature. The advantage to the traveller is that the
traveller’s cheque cannot be used by someone else if it is lost or stolen, and can be replaced
usually anywhere in the world.
Letter of credit is a letter by which one banker requests another, to whom the said letter is
addressed, to hold a certain sum at the disposal of the third person who is the holder of that letter,
and to pay him such amount as he requires against either cheques on the banker giving the letter or
on the banker to whom the letter is addressed, but not exceeding in total the whole amount covered
by the said letter.
(iv) Acts as referees: The banks act as referees and supply information about the business
transactions and financial standing of their customers on enquiries made by third parties. This is
done on the acceptance of the customers and help to increase the business activities in general.
(v) Information relating to trade and economic position: Large commercial banks collect information
relating to economic and business activities and provide in published form in annual reports or in
new letters to help its customers to take business decisions easily and quickly.
(vi) Depository services:
(vii) Credit/Debit cards: Banks have introduced credit/debit card system. These plastic cards enable
a customer to purchase goods and services from certain specified retail and service establishments

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up to a limit without making direct payment. In the case of credit card, the amount is paid to these
establishments by the bank. The bank subsequently collects the dues from the customers by
means of cheque or by transferring money from the customer’s bank account though internet
banking. In the case of debit card, the amount is paid to the merchant establishments by debiting
funds to the customer’s bank account and credits it to the account of the concerned establishment.
(viii) ATM facility: Under this system the customers can do banking transactions like withdrawal of
money, cash deposit, money transfer, submit request for stop payment of cheques, submit request
for new cheque book etc. at any time from any ATM centres provided/directed by the bank.
(ix) Management of public debt: Commercial banks manage public debts on behalf of central bank
when central and state governments raise loans through debentures of bonds.
(x) Others: Apart from the above said services provided by the banks, there are whole lot of
services are rendered by commercial banks, which differ from banks to bank. They provided
services with regard to share market function, merchant banking, factoring services etc.
Other Major Functions
Other major functions of a commercial bank today include; Investment Functions, Credit Creation
and Foreign Trade Management.
(1) Investment Functions: One of the major functions of commercial banks is to assist the
economy in enhancing its productivity. By channelling productive investments, banks gear up the
productive efficiency of the economy as a whole. The banker while making investments has to
observe certain important principles. The basic principles of a good investment policy include (a)
safety, (b) Liquidity and (c) profitability. The general principles include principle of diversification,
principle of purpose, principle of security, principle of national interest and suitability. Based on
these principles the Board of Directors, bank make their own investment policies as per the rules
and regulations of the central bank.
(2) Credit Creation: Banks attract deposits from the public and on the basis of these deposits; they
make loans and advances to the public. Such amount of loan is deposited in the account of the
loanee (debtor). Thus loans create deposits. On the basis of these deposits loans are further
granted. Thus loans from deposits and deposits from loans are encouraged. This process is called
credit creation. The supply of money thus increased indirectly through the process of credit
creation.
(3) Foreign Trade Management: Commercial Banks have played a dominant role in the
expansion of foreign trade. Short term credit is provided for commercial bills, hundies, letters of
credit to serve business people engaged in foreign trade. It facilitates in the international
transactions by contacting the importers and exporters and finalise the transactions between the
two parties. International payments can be made only through a bank. That is, a trader must have a
banker in dealing international transaction. Apart from these technical roles, banker also performs
as a consultant for foreign trade.
In this note, we provide a comprehensive picture on functions of commercial banks. By unravelling
various functions at length we can establish the importance of modern bank in economic
development. We can firmly argue that in the absence of banking activates, the process of
economic development will be hindered. Economic activities like, consumption, production, trade,
business and industries are all depended on banking system in a country. It is not an exaggeration
in saying that banking system is the foundation of economic progress in modern times.

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