COMMERCIAL BANK

- What is a Commercial Bank?

- How do Commercial Bank Works?
- Functions of Commercial Bank
o Primary Function
o Secondary Function
- Services offered by Commercial Banks
- Role of Commercial Banks
- Types of Commercial Banks

WHAT IS A COMMERCIAL BANK

A commercial bank is a kind of financial institution that carries all the operations related to deposit and
withdrawal of money for the general public (individuals, organizations, and businesses), providing loans
for investment, and other such activities. These banks are profit-making institutions and do business
only to make a profit.

HOW DO COMMERCIAL BANK WORKS

The two primary characteristics of a commercial bank are lending and borrowing. The bank receives the
deposits and gives money to various projects to earn interest (profit). The rate of interest that a bank
offers to the depositors is known as the borrowing rate, while the rate at which a bank lends money is
known as the lending rate.

FUNCTIONS OF COMMERCIAL BANK

The functions of commercial banks are classified into two main divisions:

A. PRIMARY FUNCTIONS
1. Accepts deposit: The bank takes deposits in the form of saving, current, and fixed
deposits. The surplus balances collected from the firm and individuals are lent to the
temporary requirements of the commercial transactions.

The main kinds of deposits are:

 (i) Current Account Deposits or Demand Deposits: These deposits refer to those
deposits which are repayable by the banks on demand:
1. Such deposits are generally maintained by businessmen with the
intention of making transactions with such deposits.
2. They can be drawn upon by a cheque without any restriction.
3. Banks do not pay any interest on these accounts. Rather, banks
impose service charges for running these accounts.

(ii) Fixed Deposits or Time Deposits: Fixed deposits refer to those deposits, in
which the amount is deposited with the bank for a fixed period of time.
1. Such deposits do not enjoy cheque-able facility.
2. These deposits carry a high rate of interest.

iii) Saving Deposits: These deposits combine features of both current account
deposits and fixed deposits:
1. The depositors are given the facility to withdraw money from their
account. But, some restrictions are imposed on number and amount of
withdrawals, in order to discourage frequent use of saving deposits.
2. They carry a rate of interest which is less than interest rate on fixed
deposits.
3. Ideal for customers wishing to build up small savings.

2. Provides loan and advances: Another critical function of this bank is to offer loans and
advances to the entrepreneurs and business people, and collect interest. For every
bank, it is the primary source of making profits. In this process, a bank retains a small
number of deposits as a reserve and offers (lends) the remaining amount to the
borrowers in demand loans, overdraft, cash credit, short-run loans, and more such
banks.
Different types of loans and advances made by Commercial banks are:

(i) Cash Credit: Cash credit refers to a loan given to the borrower against his
current assets like shares, stocks, bonds, etc. A credit limit is sanctioned and
the amount is credited in his account. The borrower may withdraw any
amount within his credit limit and interest is charged on the amount actually
withdrawn
 (ii) Demand Loans: Demand loans refer to those loans which can be recalled on
demand by the bank at any time. The entire sum of demand loan is credited to
the account and interest is payable on the entire sum. Easy repayment, no
installments, no prepayment fees

(iii) Short-term Loans: They are given as personal loans against some collateral
security. The money is credited to the account of borrower and the borrower
can withdraw money from his account and interest is payable on the entire sum
of loan granted.

3. Creation of credit: When a customer is provided with credit or loan, they are not
provided with liquid cash. First, a bank account is opened for the customer and then the
money is transferred to the account. This process allows the bank to create money.

4. Clearing of cheques: It is the process of moving a cheque from the bank where it was
deposited - to the bank on which it was drawn, and the movement of the money in the
opposite direction. This process is called the clearing cycle and normally results in a
credit to the account at the bank of deposit, and an equivalent debit to the account at
the bank on which it was drawn

B. SECONDARY FUNCTIONS

1. Agency Services: Banks act as agents to their customers in different ways:

(i) Collection and Payment of Various Items: Banks collect cheques, rent,
interest etc. on behalf of their customers and also make payment of taxes,
insurance premium etc. on their behalf.

(ii) Purchase and Sale of Securities: Banks normally are more knowledgeable
with regard to stock and share business. As such they buy, sell and keep in
safe custody the securities on behalf of their customers.

(iii) Trustee and Executor: Banks also act as trustees and executors of the
property of their customers on their advice.

(iv) Remitting of Money: Banks also remit money from one place to the other
through bank drafts.

(v) Purchase and Sale of Foreign Exchange: Banks buy and sell foreign exchange
and thus promote international trade.

(vi) Letter of References: Banks also give information about economic position
of their customers to domestic and foreign traders and likewise provide
information about economic position of domestic and foreign traders to their
customers.
 2. General Utility Services: Commercial banks also provide certain services of general
utility to the society:

(i) Locker Facilities: Banks provide locker facilities to their customers. People
can keep their gold or silver jewelry or other important documents in these
lockers. Their annual rent is very nominal.

(ii) Business Information and Statistics: Being familiar with the economic
situation of the country, the banks give advice to their customers on financial
matters on the basis of business information and statistical data collected by
them.

ROLES OF COMMERCIAL BANKING

The banking industry as a whole runs the economy of a nation. The roles of a commercial bank are as
follows:
 They aid in the successful implementation of monetary policies
 They boost the industrial sector by offering short, medium, and long term finance
 They accelerate trade by offering agency services, overdraft facilities, and other solutions to
wholesale and retail businesses
 These financial institutions help lower and middle-class customers in procuring consumer
products on loans – easy repayment options
 Banks also operate on rural and regional fronts
 The agricultural sector receives strong financial backing from commercial institutions
facilitating crop cultivation, irrigation facilities, dairy farming, poultry farming, horticulture and
pisciculture
 They adopt innovative ways to facilitate easy banking – automation, digitalization, and artificial
intelligence
 They ensure a superior level of data security for their clients

TYPES OF COMMERCIAL BANK

They are further classified into the following categories:

1. Private Sector Banks: The majority stake is owned by private shareholders (individuals or
corporate). They accept deposits and distribute loans to individual customers, small businesses,
and medium-sized businesses.
2. Public Sector Banks: For public banks, majority equity lies in the hands of the government.
Nationalized banks provide financial services to mass customers at affordable rates.
3. Foreign Banks: As the name suggests, these financial institutions operate in foreign countries
but have head offices in the parent country. The bank’s foreign branches take deposits, extend
loans, engage in securities trading, and facilitate foreign exchange functions.