Functions of Commercial Banks

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33
Functions of Commercial Banks

33.1 Introduction
You have studied in the earlier lesson about different types of banks and their nature. It may be of interest to you now to know about the various services/functions performed by commercial banks. In this lesson, you will study about the various services provided by commercial banks to the business community in particular and the public in general.

33.2 Objectives
After studying this lesson, you will be able to describe the various functions of commercial banks; d ifferentiate between primary and secondary functions of
commercial banks;
classify and discuss the primary functions of modern commercial banks;
enumerate the various modes of acceptance of deposits;
identify various methods of granting loans;
describe agency and general utility services of modern commercial banks.

22 :: Business Studies

33.3 Functions of Commercial Banks
The functions of a commercial banks are divided into two categories: i)

Primary functions, and

ii)

Secondary functions including agency functions.

i)

Primary functions:

The primary functions of a commercial bank include:
a)

accepting deposits; and

b)

granting loans and advances;
a)

Accepting deposits

The most important activity of a commercial bank is to mobilise deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with

bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank.

b)

Grant of loans and advances

The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to
members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies
depending upon the purpose, period and the mode of repayment. The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of a bank’s income.

i)

Loans
A loan is granted for a specific time period. Generally,
commercial banks grant short-term loans. But term loans,

Functions of Commercial Banks :: 23

that is, loan for more than a year, may also be granted.
The borrower may withdraw the entire amount in lumpsum
or in instalments. However, interest is charged on the full
amount of loan. Loans are generally granted against the
security of certain assets. A loan may be repaid either in
lumpsum or in instalments.
ii)

Advances

An advance is a credit facility provided by the bank to its
customers. It differs from loan in the sense that loans may
be granted for longer period, but advances are normally
granted for a short period of time. Further the purpose of
granting advances is to meet the day to day requirements
of business. The rate of interest charged on advances varies from bank to bank. Interest is charged only on the amount
withdrawn and not on the sanctioned amount.
Modes of short-term financial assistance
Banks grant short-term financial assistance by way of cash credit, overdraft and bill discounting.
a)

Cash Credit
Cash credit is an arrangement whereby the bank allows the
borrower to draw amounts upto a specified limit. The amount is credited to the account of the customer. The customer can
withdraw this amount as and when he requires. Interest is charged on the amount actually withdrawn. Cash Credit is granted as per agreed terms and conditions with the customers.

b)

Overdraft
Overdraft is also a credit facility granted by bank. A customer who has a current account with the bank is allowed to withdraw more than the amount of credit balance in his account. It is a...
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