Lovely Professional University
Lovely School of Management
Term Paper of Financial Institution and Services
Topic: Changes in the concept of lending by commercial banks
Submitted to: Submitted by:
Introduction of commercial banks
Commercial banks are the banks which deal primarily in dealing with accepting deposits and lending loans to the large corporation or retail customers.
Categorization of commercial banks:
Functions of Commercial Banks
The functions of 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 mobilize 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.
A loan is granted for a specific time period. Generally, commercial banks grant short-term loans. But term loans that is, loan for more than a year may also be granted. The borrower may withdraw the entire amount in lump sum 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 lump sum or in instalments.
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 up to 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.
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 temporary arrangement. Overdraft facility with a specified limit is allowed either on the security of assets, or on personal security, or both.
c) Discounting of Bills
Banks provide short-term finance by discounting bills, that is, making payment of the amount before the due date of the bills...
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