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A commercial bank is a type of bank that provides services such as accepting deposits, making

business loans, and offering basic investment products.


Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits
and loans from corporations or large businesses, as opposed to individual members of the public
Definition of 'Commercial Bank'
A financial institution that provides services, such as accepting deposits, giving business loans and
auto loans, mortgage lending, and basic investment products like savings accounts and certificates of
deposit. The traditional commercial bank is a brick and mortar institution with tellers, safe deposit
boxes, vaults and ATMs. However, some commercial banks do not have any physical branches and
reuire consumers to complete all transactions by phone or !nternet. !n exchange, they generally pay
higher interest rates on investments and deposits, and charge lower fees.
15 main Functions of Commercial Banks
Nupur Singh
The commercial banks serve as the king pin of the financial system of the country. They render
many valuable services. The important functions of the Commercial banks can be explained with
the help of the following chart.
Primary Functions
The primary functions of the commercial banks include the following"
A. Acceptance of Deposits
1. Time Deposits:
These are deposits repayable after a certain fixed period. These deposits are not withdrawn able
by cheue, draft or by other means. !t includes the following.
(a) Fixed Deposits:
The deposits can be withdrawn only after expiry of certain period say # years, $ years or %&
years. The banker allows a higher rate of interest depending upon the amount and period of time.
'reviously the rates of interest payable on fixed deposits were determined by (eserve )ank.
'resently banks are permitted to offer interest as determined by each bank. However, banks are
not permitted to offer different interest rates to different customers for deposits of same maturity
period, except in the case of deposits of (s. %$ lakhs and above.
These days the banks accept deposits even for %$ days or one month etc. !n times of urgent need
for money, the bank allows premature closure of fixed deposits by paying interest at reduced
rate. *epositors can also avail of loans against +ixed *eposits. The +ixed *eposit (eceipt cannot
be transferred to other persons.
(b) ecurrin! Deposits:
!n recurring deposit, the customer opens an account and deposit a certain sum of money every
month. After a certain period, say % year or # years or $ years, the accumulated amount along
with interest is paid to the customer. !t is very helpful to the middle and poor sections of the
people. The interest paid on such deposits is generally on cumulative basis. This deposit system
is a useful mechanism for regular savers of money.
(c) Cas" Certificates:
Cash certificates are issued to the public for a longer period of time. !t attracts the people because
its maturity value is in multiples of the sum invested. !t is an attractive and high yielding
investment for those who can keep the funds for a long time.
!t is a very useful account for meeting future financial reuirements at the occasion of marriage,
education of children etc. Cash certificates are generally issued at discount to face value. !t
means a cash certificate of (s. %, &&,&&& payable after %& years can be purchased now, say for
(s. ,&,&&&.
#. Demand Deposits:
These are the deposits which may be withdrawn by the depositor at any time without previous
notice. !t is withdraw able by cheue-draft. !t includes the following"
(a) $a%in!s Deposits:
The savings deposit promotes thrift among people. The savings deposits can only be held by
individuals and non.profit institutions. The rate of interest paid on savings deposits is lower than
that of time deposits. The savings account holder gets the advantage of liuidity /as in current
a-c0 and small income in the form of interests.
)ut there are some restrictions on withdrawals. Corporate bodies and business firms are not
allowed to open 1) Accounts. 'resently interest on 1) Accounts is determined by ()!. !t is 2.$
per cent per annum. Co.operative banks are allowed to pay an extra &.$ per cent on its savings
bank deposits.
(b) Current Account Deposits:
These accounts are maintained by the people who need to have a liuid balance. Current account
offers high liuidity. 3o interest is paid on current deposits and there are no restrictions on
withdrawals from the current account.
These accounts are generally in the case of business firms, institutions and co.operative bodies.
3owadays, banks are designing and offering various investment schemes for deposit of money.
These schemes vary from bank to bank.
!t may be stated that the banks are currently working out with different innovative schemes for
deposits. 1uch deposit accounts offer better interest rate and at the same time withdraw able
facility also. These schemes are mostly offered by foreign banks. !n 41A, Current Accounts are
known as 5Checking Accounts5 as a cheue is euivalent to check in America.
B. Ad%ancin! of &oans
The commercial banks provide loans and advances in various forms. They are given below"
1. '%erdraft:
This facility is given to holders of current accounts only. This is an arrangement with the bankers
thereby the customer is allowed to draw money over and above the balance in his-her account.
This facility of overdrawing his account is generally pre.arranged with the bank up to a certain
limit.
!t is a short.term temporary fund facility from bank and the bank will charge interest over the
amount overdrawn. This facility is generally available to business firms and companies.
#. Cas" Credit:
Cash credit is a form of working capital credit given to the business firms. 4nder this
arrangement, 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 reuired.
!t is made against security of goods, personal security etc. 6n the basis of operation, the period
of credit facility may be extended further. 6ne advantage under this method is that bank charges
interest only on the amount utili7ed and not on total amount sanctioned or credited to the
account.
(eserve )ank discourages this type of facility to business firms as it imposes an uncertainty on
money supply. Hence this method of lending is slowly phased out from banks and replaced by
loan accounts. Cash credit system is not in use in developed countries.
(. Discountin! of Bills:
*iscounting of )ills may be another form of bank credit. The bank may purchase inland and
foreign bills before these are due for payment by the drawer debtors, at discounted values, i.e.,
values a little lower than the face values.
The )anker5s discount is generally the interest on the full amount for the unexpired period of the
bill. The banks reserve the right of debiting the accounts of the customers in case the bills are
ultimately not paid, i.e., dishonored.
The bill passes to the )anker after endorsement. *iscounting of bills by banks provide
immediate finance to sellers of goods. This helps them to carry on their business. )anks can
discount only genuine commercial bills i.e., those drawn against sale of goods on Credit. )anks
will not discount Accommodation )ills.
). &oans and Ad%ances:
!t includes both demand and term loans, direct loans and advances given to all type of customers
mainly to businessmen and investors against personal security or goods of movable or
immovable in nature. 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 he withdraws the money from his account or
not. 1hort.term loans are granted to meet the working capital reuirements where as long.term
loans are granted to meet capital expenditure.
'reviously interest on loan was also regulated by ()!. Currently, banks can determine the rate
themselves. 8ach bank is, however reuired to fix a minimum rate known as 'rime 9ending (ate
/'9(0.
Classification of &oans and Ad%ances
9oans and advances given by bankers can be classified broadly into the following categories"
/i0 Advances which are given on the personal security of the debtor, and for which no tangible or
collateral security is taken: this type of advance is given either when the amount of the advance
is very small, or when the borrower is known to the )anker and the )anker has complete
confidence in him /Clean Advance0.
(ii) Advances which are covered by tangible or collateral security. !n this section of the study we
are concerned with this type of advance and with different types of securities which a )anker
may accept for such advances /1ecured Advance0.
(iii) Advances which are given against the personal security of the debtor but for which the
)anker also holds in addition the guarantee of one or more sureties. This type of advance is often
given by )anker to persons who are not known to them but whose surety is known to the )anker.
)ankers also often take the personal guarantee of the *irectors of a company to whom they agree
to advance a clean or unsecured loan.
/iv0 9oans are also given against the security of +ixed *eposit receipts.
*. +ousin! Finance:
3owadays the commercial banks are competing among themselves in providing housing finance
facilities to their customers. !t is mainly to increase the housing facilities in the country. 1tate
)ank of !ndia, !ndian )ank, Canara )ank, 'un;ab 3ational )ank, has formed housing
subsidiaries to provide housing finance.
The other banks are also providing housing finances to the public. <overnment of !ndia also
encourages banks to provide adeuate housing finance.
)orrowers of housing finance get tax exemption benefits on interest paid. +urther housing
finance up to (s. $ lakh is treated as priority sector advances for banks. The limit has been raised
to (s. %& lakhs per borrower in cities.
,. -ducational &oan $c"eme:
The (eserve )ank of !ndia, from August, %=== introduced a new 8ducational 9oan 1cheme for
students of full time graduate-post.graduate professional courses in private professional colleges.
4nder the scheme all public sector banks have been directed to provide educational loan up to
(s. %$,&&& for free seat and (s. $&,&&& for payment seat student at interest not more than %, per
cent per annum. This loan is on clean basis i.e., without calling for security.
This loan is available only for students whose annual family income does not exceed (s. %,
&&,&&&. The loan has to be repaid together with interest within five years from the date of
completion of the course. 1tudies in respect of the following sub;ects-areas are covered under the
scheme.
(a) Medical and dental course.
(b) 8ngineering course.
(c) Chemical Technology.
(d) Management courses like M)A.
(e) 9aw studies.
/f0 Computer 1cience and Applications.
This apart, some of the banks have other educational loan schemes against security etc., one can
check up the details with the banks.
.. &oans a!ainst $"ares/$ecurities:
Commercial banks provide loans against the security of shares-debentures of reputed companies.
9oans are usually given only up to $&> value /Market ?alue0 of the shares sub;ect to a
maximum amount permissible as per ()! directives. 'resently one can obtain a loan up to (s.%&
lakhs against the physical shares and up to (s. ,& lakhs against demateriali7ed shares.
0. &oans a!ainst $a%in!s Certificates:
)anks are also providing loans up to certain value of savings certificates like 3ational 1avings
Certificate, +ixed *eposit (eceipt, !ndira ?ikas 'atra, etc. The loan may be obtained for personal
or business purposes.
1. Consumer &oans and Ad%ances:
6ne of the important areas for bank financing in recent years is towards purchase of consumer
durables like T? sets, @ashing Machines, Micro 6ven, etc. )anks also provide liberal Car
finance.
These days banks are competing with one another to lend money for these purposes as default of
payment is not high in these areas as the borrowers are usually salaried persons having regular
incomeA +urther, bank5s interest rate is also higher. Hence, banks improve their profit through
such profitable loans.
12. $ecuriti3ation of &oans:
)anks are recently trying to securities a part of their part of loan portfolio and sell it to another
investor. 4nder this method, banks will convert their business loans into a security or a document
and sell it to some !nvestment or +und Manager for cash to enhance their liuidity position.
!t is a process of transferring credit risk from the banker to the buyer of securiti7ed loans. !t
involves a cost to the banker but it helps the bank to ensure proper recovery of loan. Accordingly,
securiti7ation is the process of changing an illiuid asset into a liuid asset.
11. 't"ers:
Commercial banks provide other types of advances such as venture capital advances, ;ewel
loans, etc.
%. 8ffective 6ctober %B, %==2 banks were free to determine their own prime lending rates /'9(s0
for credit limit over (s. , lakh. *ata relate to public sector banks.
,. The stipulation of minimum maturity period of term deposits was reduced from #& days to %$
days, effective April ,=, %==B. *ata relate to public sector banks.
#. The change in the )ank (ate was made effective from the close of business of respective dates
of change except April ,=, %==B.
2. 8ffective April ,=, %==B.
C. Credit Creation
Credit creation is one of the primary functions of commercial banks. @hen a bank sanctions a
loan to the customer, it does not give cash to him. )ut, a deposit account is opened in his name
and the amount is credited to his account. He can withdraw the money whenever he needs.
Thus, whenever a bank sanctions a loan it creates a deposit. !n this way the bank increases the
money supply of the economy. 1uch functions are known as credit creation.
$econdary Functions
The secondary functions of the banks consist of agency functions and general utility functions.
A. A!ency Functions
Agency functions include the following"
4i5 Collection of c"e6ues7 di%idends7 and interests:
As an agent the bank collects cheues, drafts, promissory notes, interest, dividends etc., on
behalf of its customers and credit the amounts to their accounts.
Customers may furnish their bank details to corporate where investment is made in shares,
debentures, etc. As and when dividend, interest, is due, the companies directly send the
warrants-cheues to the bank for credit to customer account.
(ii) Payment of rent7 insurance premiums:
The bank makes the payments such as rent, insurance premiums, subscriptions, on standing
instructions until further notice. Till the order is revoked, the bank will continue to make such
payments regularly by debiting the customer5s account.
(iii) Dealin! in forei!n exc"an!e:
As an agent the commercial banks purchase and sell foreign exchange as well for customers as
per ()! 8xchange Control (egulations.
(iv) Purc"ase 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. They run a separate 5'ortfolio Management
1cheme5 for their big customers.
(v) Act as trustee7 executor7 attorney7 etc:
The banks act as executors of @ill, trustees and attorneys. !t is safe to appoint a bank as a trustee
than to appoint an individual. Acting as attorneys of their customers, they receive payments and
sign transfer deeds of the properties of their customers.
(vi) Act as correspondent:
The commercial banks act as a correspondent of their customers. 1mall banks even get travel
tickets, book vehicles: receive letters etc. on behalf of the customers.
(vii) Preparations of 8ncome9Tax returns:
They prepare income.tax returns and provide advices on tax matters for their customers. +or this
purpose, they employ tax experts and make their services, available to their customers.
B. :eneral ;tility $er%ices
The <eneral utility services include the following"
(i) $afety &ocker facility:
1afekeeping of important documents, valuables like ;ewels are one of the oldest services
provided by commercial banks. 59ockers5 are small receptacles which are fitted in steel racks and
kept inside strong rooms known as vaults. These lockers are available on half.yearly or annual
rental basis.
The bank merely provides lockers and the key but the valuables are always under the control of
its users. Any customer cannot have access to vault.
6nly customers of safety lockers after entering into a register his name account number and time
can enter into the vault. )ecause the vault is holding important valuables of customers in lockers,
it is also known as 51trong (oom5.
(ii) Payment <ec"anism or <oney Transfer:
Transfer of funds is one of the important functions performed by commercial banks. Cheues
and credit cards are two important payment mechanisms through banks. *espite an increase in
financial transactions, banks are managing the transfer of funds process very efficiently.
Cheues are also cleared through the banking system. Correspondent banking is another method
of transferring funds over long distance, usually from one country to another. )anks, these days
employ computers to speed up money transfer and to reduce cost of transferring funds.
8lectronic Transfer of funds is also known as 5Cheueless banking5 where funds are transferred
through computers and sophisticated electronic system by using code words. They offer Mail
Transfer, Telegraphic Transfer /TT0 facility also.
4iii5 Tra%elers' c"e6ues:
Travelers Cheues are used by domestic travelers as well as by international travelers. However
the use of traveler5s cheues is more common by international travelers because of their safety
and convenience. These can be also termed as a modified form of traveler5s letter of credit.
A bank issuing travelers cheues usually have banking arrangement with many of the foreign
banks abroad, known as correspondent banks. The purchaser of traveler5s cheues can encase the
cheues from all the overseas banks with whom the issuing bank has such an arrangement.
Thus traveler5s cheues are not drawn on specific bank abroad. The cheues are issued in foreign
currency and in convenient denominations of ten, twenty, fifty, one hundred dollar, etc. The
signature of the buyer-traveler is written on the face of the cheues at the time of their purchase.
The cheues also provide blank space for the signature of the traveler to be signed at the time of
encashment of each cheue. A traveler has to sign in the blank space at the time of drawing
money and in the presence of the paying banker.
The paying banker will pay the money only when the signature of the traveler tallies with the
signature already available on the cheue.
A traveler should never sign the cheue except in the presence of paying banker and only when
the traveler desires to encash the cheue. 6therwise it may be misused. The cheues are also
accepted by hotels, restaurants, shops, airlines companies for respectable persons.
8ncashment of a traveler cheue abroad is tantamount to a foreign exchange transaction as it
involves conversion of domestic currency into a foreign currency.
@hen a traveller cheue is lost or stolen, the buyer of the cheues has to give a notice to the
issuing bank so that stop order can be issued against such lost-stolen cheues to the banks where
they are permitted to be encased.
!t is also difficult to the finder of the cheue to draw cash against it since the encasher has to sign
the cheue in the presence of the paying banker. 4nused travellers cheues can be surrendered to
the issuing bank and balance of cash obtained.
The issuing bank levies certain commission depending upon the number and value of travellers
cheues issued.
(iv) Circular =otes or Circular &etters of Credit:
4nder Circular 9etters of Credit, the customer-traveller negotiates the drafts with any of the
various branches to which they are addressed. Thus the traveller can obtain funds from many of
the branches of banks instead only from a particular branch. Circular 9etters of Credit are
therefore a more useful method for obtaining funds while travelling to many countries.
!t may be noted that travellers letter of credit are usually paid for in advance. !n other words, the
traveller first makes payments to the issuing bank before obtaining the Circular 3otes.
(v) 8ssue >Tra%ellers C"e6ues>:
)anks issue travellers cheues to help carry money safely while travelling within !ndia or
abroad. Thus, the customers can travel without fear, theft or loss of money.
(vi) &etters of Credit:
9etter of Credit is a payment document provided by the buyer5s banker in favour of seller. This
document guarantees payment to the seller upon production of document mentioned in the 9etter
of Credit evidencing dispatch of goods to the buyer.
The 9etter of Credit is an assurance of payment upon fulfilling conditions mentioned in the
9etter of Credit. The letter of credit is an important method of payment in international trade.
There are primarily 2 parties to a letter of credit.
The buyer or importer, the bank which issues the letter of credit, known as opening bank, the
person in whose favour the letter of credit is issued or opened /The seller or exporter, known as
5)eneficiary of 9etter of Credit50, and the credit receiving-advising bank.
The 9etter of Credit is generally advised-sent through the seller5s bank, known as 3egotiating or
Advising bank. This is done because the conditions mentioned in the 9etter of Credit are, in the
first instance: have to be verified by the 3egotiating )ank. !t is mostly used in international
trade.
(vii) Actin! as eferees:
The banks act as referees and supply information about the business transactions and financial
standing of their customers on enuiries made by third parties. This is done on the acceptance of
the customers and help to increase the business activity in general.
(viii) Pro%ides Trade 8nformation:
The commercial banks collect information on business and financial conditions etc., and make it
available to their customers to help plan their strategy. Trade information service is very useful
for those customers going for cross.border business. !t will help traders to know the exact
business conditions, payment rules and buyers5 financial status in other countries.
(ix) AT< facilities:
The banks today have ATM facilities. 4nder this system the customers can withdraw their money
easily and uickly and ,2 hours a day. This is also known as 5Any Time Money5. Customers
under this system can withdraw funds i.e., currency notes with a help of certain magnetic card
issued by the bank and similarly deposit cash-cheue for credit to account.
(x) Credit cards:
)anks have introduced credit card system. Credit cards enable a customer to purchase goods and
services from certain specified retail and service establishments up to a limit without making
immediate payment. !n other words, purchases can be made on credit basis on the strength of the
credit card.
The establishments like Hotels, 1hops, Airline Companies, (ailways etc., which sell the goods or
services on credit forward a monthly or fortnightly statements to the bank.
The amount is paid to these establishments by the bank. The bank subseuently collects the dues
from the customers by debit to their accounts. 4sually, the bank receives certain service charges
for every credit card issued. ?isa Card, )6) card are some examples of credit cards.
(xi) :ift C"e6ues:
The commercial banks offer <ift cheue facilities to the general public. These cheues received
a wider acceptance in !ndia. 4nder this system by paying euivalent amount one can buy gift
cheue for presentation on occasions like @edding, )irthday.
(xii) Acceptin! Bills:
6n behalf of their customers, the banks accept bills drawn by third parties on its customers. This
resembles the letter of credit. @hile banks accept bills, they provide a better security for payment
to seller of goods or drawer of bills.
(xiii) <erc"ant Bankin!:
The commercial banks provide valuable services through their merchant banking divisions or
through their subsidiaries to the traders. This is the function of underwriting of securities. They
underwrite a portion of the 'ublic issue of shares, *ebentures and )onds of Coint 1tock
Companies.
1uch underwriting ensures the expected minimum subscription and also convey to the investing
public about the uality of the company issuing the securities. Currently, this type of services can
be provided only by separate subsidiaries, known as Merchant )ankers as per 18)! regulations.
(xiv) Ad%ice on Financial <atters:
The commercial banks also give advice to their customers on financial matters particularly on
investment decisions such as expansion, diversification, new ventures, rising of funds etc.
(xv) Factorin! $er%ice:
Today the commercial banks provide factoring service to their customers. !t is very much helpful
in the development of trade and industry as immediate cash flow and administration of debtors5
accounts are taken care of by factors. This service is again provided only by a separate subsidiary
as per ()! regulations.
)alance sheet is a statement of assets and liabilities on a given date. !n !ndia, banks have to
publish their balance sheets according to the preformed i.e., 5+orm A5 given in the !!! schedule of
the )anking (egulation Act, %=2=. The study of the balance sheet along with its profit and loss
account reveals its financial soundness.
A customer has to carefully study these statements to choose his banks. The combined balance
sheet of all banks in the country reveals certain economic trends. A specimen of a )ank5s )alance
1heet is given at the end of this chapter.
%. Accepting deposits
,. <iving loans
#. 6verdraft
2. *iscounting of )ills of 8xchange
$. !nvestment of +unds
D. Agency +unctions
E. Miscellaneous +unctions

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