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Commercial Banks

Commercial Banks are like other financial institutions ( eg. money lenders, indigenous bankers, cooperative societies, agricultural and industrial credit institutions) which are in the business of lending and borrowing of money or credit.

Functions of C. B.
A) Accepting Deposits i) Demand or Current Account Deposits: A depositor can withdraw it in part or in full at any time he likes without notice It carries no interest Only small savings of businessmen Cheque facilities

ii) Fixed Deposits or Time Deposits Fixed deposits for 15days to few years Withdrawn at expiry of term High rate of interest A source of investment iii) Saving Bank Deposits small saving deposits salaried people less rate of interest money can be withdrawn through cheques

B) Advancing Loans This is the most important means of earnings for the banks Giving loans to businessmen But it keeps a fine balance between deposits and loans Banks profitability depends on this as well. Two ways of advancing loans I) By allowing an over draft facility cheques are honoured even if deposits is less facility for businessmen only interest on overdraft amount

II) Loans by creating a deposit Banks give loans to people by charging interest Bank asks for security Simply opens an account in name of needy person and issues a cheque book to transact Loans granted mostly for business

C) Discounting Bills of Exchange or Hundies If a seller sells some goods to a buyer who does not pay in cash. But the seller draws a bill of exchange which is signed by buyer. There is maturity or payment period, say one month Now the seller can give this hundy to a bank which will give him cash against it Bank charges interest on it till one month.

D) Agency Services Collection of bills, cheques Collection of dividends, interest, premium Purchase and sale of shares and debentures Payment of insurance premiums Acts as trustee when nominated

E) General services Travellers cheques, bank draft Safe vaults for valuables Supplying trade information Economic surveys Projects report preparation

Objectives of nationalization
1. to reduce concentration of economic powers with only a few industrial magnets and to prevent monopolies. 2)Mobilize resources even from backward and rural areas 3)To prevent lopsided regional development 4)To prevent corruption and misuse of firms: the trustees were only benefiting from huge resources and it was at the cost of general development in the country.

5)To provide aid to the poor, small artisans and small scale industries. Small scale industries contributed 40% of industrial output but received only 4% of bank funds . 6) To fulfill credit needs of farmers: hardly 2.2% of funds were available for agriculture.

7) To finance governments development projects; specially five year plans To prevent giving loans to those firms were not existing in the priority list. To prevent loan/advances to black marketers and hoarders.

creation of credit.
One of the important functions of commercial bank is the creation of credit. Credit creation is the multiple expansions of banks demand deposits. It is an open secret now that banks advance a major portion of their deposits to the borrowers and keep smaller parts of deposits to the customers on demand. Even then the customers of the banks have full confidence that the depositors lying in the banks are quite safe and can be withdrawn on demand. The banks exploit this trust of their clients and expand loans by much more time than the amount of demand deposits possessed by them. This tendency on the part of the commercial banks to expand their demand deposits as a multiple of their excess cash reserve is called creation of credit.

The single bank cannot create credit. It is the banking system as a whole which can expand loans by many times of its excess cash reserves. Further, when a loan is advanced to an individuals or a business concern, it is not given in cash. The bank opens a deposit account in the name of the borrower and allows him to draw upon the bank as and when required. The loan advanced becomes the gain of deposit by some other bank. Loans thus make deposits and deposits make loans

The most common mechanism used to measure this increase in the money supply is typically called the money multiplier. It calculates the maximum amount of money that an initial deposit can be expanded to with a given reserve ratio.

Credit Creation By Banks Definition: It is the process of creation of credit by commercial banks. More use of DD and cheques is CC and not cash. Cheques and deposit money are as good as legal tender money on account of their acceptability by the general public .

Banks create credit by creating cheque money or deposit money which on account of its free acceptability, circulates like legal tender money. This increases or decreases money in circulation without increase or decrease in currency or legal tender money.

Suppose the Cash Reserve Ratio is 20% and a person deposits Rs. 10,000/- with Bank of India. This is primary deposit. The bank keeps Rs. 2000 as CRR and balance of Rs. 8000 is used for granting credit. Now suppose Bank of India lends Rs. 8000 to Mr. A and Mr. A pays a cheque of Rs. 8000 to Mr. B, who has an account in Bank Of baroda. Then Bank Of Baroda receives Rs. 8000 as primary deposit. It keeps Rs. 1,600 (20%) as CRR and excess amount of Rs. 6,400 is used for giving credit. Now if, Mr. C is granted this loan and Mr.C gives a cheque of Rs. 6,400 to another person who may deposit it in Bank of Maharashtra. Bank of Maharashtra will keep Rs. 1,280 as CRR and issue a loan of Rs. 5,120. This process continues until the original excess reserves of Rs. 8000 with the first Bank of India, have been parceled out among various banks and have been required resources. As a result, the aggregate of derivative deposits in the entire banking system, approximates 5 times the initial derivative deposit over a period of time.

Limits of credit creation


1) Amount of cash of banks. Greater is amount, larger is its capacity for c.c. 2) Cash reserve ratio: lower is csr, higher is credit creation capacity 3) External drain: larger is amount of money withdrawn from bank, lower is its cc. 4)extent of borrowing of funds by business. More c.c. when business is prospering.

5) supply or collateral security: larger and better is availability of security against loan, greater is extent of C.C.

6) Banking habit of people: if people use more of cash and less of cheque then CC is not possible. 7) Monetary policy of central bank: central bank can influence CC by credit control tools