GE: MONEY AND BANKING

TOPIC: COMMERCIAL BANK- MEANING AND

FUNCTIONS
By

Kriti Gandhi(2021443)

Mansha Arora(2021449)

Vanshika Sharma(2021508)
A commercial bank is a financial institution that provides services like loans, certificates of deposits,
savings bank accounts bank overdrafts, etc. to its customers. These institutions make money by
lending loans to individuals and earning interest on loans. Various types of loans given by a
commercial bank are business loans, car loans, house loans, personal loans, and education loans.
They give out these loans from the money deposited by their customers in different types of
accounts. They use the deposits as capital for providing loans.

TYPES OF COMMERCIAL BANK

Public Sector Bank

Public Sector Banks (PSBs) are a major type of government owned banks in India, where a majority
stake (i.e., more than 50%) is held by the Ministry of Finance of the Government of India or State
Ministry of Finance of various State Governments of India.

Example:- Union Bank of India, UCO Bank, State Bank of India, Punjab National Bank, Punjab and
Sind Bank, Indian Overseas Bank, Indian Bank, Central Bank of India, Canara Bank, Bank of
Maharashtra, Bank of India, and Bank of Baroda.

Private sector bank

Private Sector Commercial Banks are financial institutions that primarily owned and operated by
high-net-worth private individuals and business organizations.

Example:- HDFC bank, axis Bank, ICICI Bank.

Regional Rural Banks

Regional Rural Banks are government owned scheduled commercial banks of India that operate at
regional level in different states of India. These banks are under the ownership of Ministry of
Finance, Government of India. They were created to serve rural areas with basic banking and
financial services. Wikipedia.

Example:-

1. Example:- Andhra Pragathi Grameen Bank - Andhra Pradesh

2. Arunachal Pradesh Rural Bank - Arunachal Pradesh
3. Aryavart Bank - Uttar Pradesh
4. Assam Gramin Vikash Bank – Assam

The functions performed by commercial banks can be broadly categorised under two
heads:

• Primary Functions
• Secondary Functions

PRIMARY FUNCTIONS
Commercial banks perform three primary functions:

Accepting Deposits
Advancing of loans
Credit Creation

Accepting Deposits
Accepting deposits is the most important function of a commercial bank. The bank borrows money
from the public by way of accepting different kinds of deposits. They are repayable on demand.
Generally, banks accept the following types of deposits:

Current Deposits
Savings Deposits
Fixed Deposits
Recurring Deposits

1. Current Deposits
Current deposits are also called as current accounts. Businessmen generally operate current account
for carrying out their banking transactions more conveniently. A customer can open a current
account in a bank by making an initial deposit prescribed by the bank time to time. The customers
can remit any amount to the bank and also withdraw amount in any quantity by issuing cheques
without any prior notice to the banker. But a customer will not be permitted to withdraw more than
what he has paid to the credit of his account unless there is an arrangement to overdraw the
account. Generally, no interest is allowed on the current account.

The bank charges certain amount on the customers having current accounts. These deposits are
repayable on demand. Hence, they are also known as demand deposits. However, as all the
depositors do not withdraw the money at the same time, bank can use a large part of the money in
current accounts for profitable purposes.

2. Savings Deposits:
Savings deposit accounts are maintained by commercial banks to mobilize the savings of the
salaried, middle and low-income group. They encourage thrift among the persons who earn fixed
income every month. Only individuals and non-profit organizations can open this type of accounts.
Any person who wants to open a savings bank account in any commercial bank has to deposit a
prescribed amount as deposit initially say Rs.500. Restrictions as to number of withdrawals in a week
and the amount of withdrawal at each time have been imposed on the customers under this
account. These restrictions may vary from bank to bank. Bank offers Cheques facility to depositors to
withdraw money from the account. The rate of interest allowed on this account is rather low.

3. Fixed Deposits
Fixed deposits are also called as time deposits. Here the customer deposits a certain sum of money
for a fixed period, which is not withdrawable before the maturity date. He gets interest on the
deposit for the period. The rate of interest charged on these deposits is normally higher than that
allowed on current and savings deposits. The banker fixes the rate of interest by considering the
amount and period of deposits i.e., longer the period and greater the amount, higher the rate of
interest. Customers are allowed to borrow money on the security of their fixed deposits. The fixed
deposit receipts are not transferable to other persons.

Under the account, banker receives money for a fixed period and the money is withdrawable on the
expiry of the said period. In the mean time, banker can make use of the money for granting loans
and advances.
4. Recurring Deposits
In recurring deposits, customers remit certain sum of money on monthly instalments for a period
ranging from 12 months to 120 months on a uniform pattern. The entire amount along with interest
is payable after the payment of last instalment. This type of deposits is much useful to the middle
and low-income group of the people. It works on the principle of “little drops of water make a big
ocean”. Any person can open this account. It can be opened in joint names also. The rate of interest
paid on this deposit is generally compounded.

Advancing Of Loans
The second important function of commercial banks is to advance loans to its customers. Banks
charge interest from the borrowers and this is the main source of their income. Banks advance loans
not only on the basis of the deposits of the public rather they also advance loans on the basis of
depositing the money in the accounts of borrowers. In other words, they create loans out of
deposits and deposits out of loans. This is called as credit creation by commercial banks.

Modern banks give mostly secured loans for productive purposes. In other words, at the time of
advancing loans, they demand proper security or collateral. Generally, the value of security or
collateral is equal to the amount of loan. This is done mainly with a view to recover the loan money
by selling the security in the event of non-refund of the loan. At times, banks give loan on the basis
of personal security also. Therefore, such loans are called as unsecured loan.

Banks generally give following types of loans and advances:

➢ Cash Credit: In this type of credit scheme, banks advance loans to its customers on the
basis of bonds, inventories and other approved securities. Under this scheme, banks enter
into an agreement with its customers to which money can be withdrawn many times during
 a year. Under this set up banks open accounts of their customers and deposit the loan
money. With this type of loan, credit is created.
➢ Demand loans: These are such loans that can be recalled on demand by the banks. The
entire loan amount is paid in lump sum by crediting it to the loan account of the borrower,
and thus entire loan becomes chargeable to interest with immediate effect.
➢ Short-term loan: These loans may be given as personal loans, loans to finance working
capital or as priority sector advances. These are made against some security and entire loan
amount is transferred to the loan account of the borrower.

Credit Creation
Demand deposits are an important constituent of money supply and the expansion of
demand deposits means the expansion of money supply. The entire structure of banking is
based on credit.
Credit basically means getting the purchasing power now and promising to pay at some time
in the future. Bank credit means bank loans and advances.
A bank keeps a certain part of its deposits as a minimum reserve to meet the demands of its
depositors and lends out the remaining to earn income. The loan is credited to the account
of the borrower. Every bank loan creates an equivalent deposit in the bank. Therefore, credit
creation means expansion of bank deposits.
The two most important aspects of credit creation are:
1. Liquidity - The bank must pay cash to its depositors when they exercise their right to
demand cash against their deposits.
2. Profitability - Banks are profit-driven enterprises. Therefore, a bank must grant loans in
a manner which earns higher interest than what it pays on its deposits.

The bank's credit creation process is based on the assumption that during any time interval,
only a fraction of its customers genuinely need cash. Also, the bank assumes that all its
customers would not turn up demanding cash against their deposits at one point in time.
Process of Credit Creation
Credit creation by a single bank.
There are two ways of analysing the credit creation process:
Credit creation by a single bank
Credit creation by the banking system as a whole
In a single bank system, one bank operates all the cash deposits and cheques. The process of
creating credit is explained with the hypothetical example below:

Let's assume that the bank requires to maintain a CRR of 20 percent.

If a person (person A) deposits 1,000 rupees with the bank, then the bank keeps only 200
rupees in the cash reserve and lends the remaining 800 to another person (person B). They
open a credit account in the borrower's name for the same. Similarly, the bank keeps 20
percent of Rs. 800 (i.e., Rs. 160) and advances the remaining Rs. 640 to person C.
Further, the bank keeps 20 percent of Rs. 640 (i.e., Rs. 128) and advances the remaining Rs.
512 to person D. This process continues until the initial primary deposit of Rs. 1,000 and the
initial additional reserves of Rs. 800 lead to additional or derivative deposits of Rs. 4,000
(800+640+512+....).
Adding the initial deposits, we get total deposits of Rs. 5,000. In this case, the credit
multiplier is
5 (reciprocal of the CRR) and the credit creation is five times the initial excess reserves of Rs.
800.

Multiple Credit Creation by the Banking System

The banking system has many banks in it and it cannot grant loans in excess of the cash it
creates. When a bank creates a derivative deposit, it loses cash to other banks.
The loss of deposit of one bank is the gain of deposit for some other bank. This transfer of
cash within the banking system creates primary deposits and increases the possibility for
further creation of derivative deposits. Here is an illustration to explain this process better:
As explained above, the initial deposit of Rs. 1,000 with bank A leads to a creation of total
deposits
of Rs. 5,000.

The above graph shows CRR rate of past 10 years.

Cash reserve ratio is the portion of net deposits that banks have to maintain with the RBI as
liquid cash. This percentage is determined by the RBI and it can be changed periodically by
the central bank. The lower the CRR, the higher liquidity with the banks, which in turn goes
into investment and lending and vice-versa. Higher CRR can also negatively impact the
economy as lesser availability of loanable funds, in turn, slows down investment. It thereby
reduces the supply of money in the economy.
 SECONDARY FUNCTIONS
In addition to primary functions, commercial banks also perform the following secondary
functions:
Overdraft Facility
Discounting Bills of Exchange
Agency Functions
General Utility Functions

Overdraft Facility
Bank overdraft is a type of financial instrument that is provided to some customers by the bank in
the form of an extended credit facility, which comes into effect once the main balance of the
account reaches zero.

In other words, bank overdraft is an unsecured form of credit that is mainly used for covering short
term cash requirements.

Banks offer a credit limit to the bank customers based on their relationship with the bank. The bank
levies separate interest and charges towards non-maintenance of account. The interest rate for the
overdraft facility may vary from bank to bank.

Types of Bank Overdrafts

There are two types of bank overdraft accounts

1. Authorised Bank Overdraft: In this type of overdraft account there is arrangement made in
advance between the account holder and the bank. Both the parties mutually agree on a limit which
can be used for all the payments and a daily, monthly or yearly service fee that can vary from bank
to bank.

2. Unauthorised Bank Overdraft: This type of overdraft occurs when the bank account holder has
spent more than his available balance without prior authorisation or any such arrangement with the
bank or if there was an arrangement done before but the limit of overdraft is exceeded.
Discounting Of Bills of Exchange
Discounting of Bills of Exchange is another popular type of loan by modern banks. This method
allows the owner of the bill of exchange to receive a discount from the bank. In exchange bills, the
debtor accepts the bills drawn by the creditor (that is, the owner of the bills) and agrees to pay the
amount stated at maturity. After making a small deduction (in the form of a fee), the bank pays the
owner the value of the invoice. When the bill of exchange expires, the bank receives payment from
the party that accepts the bill. Therefore, such a loan is self-clearing. An exchange invoice is a
written, legally binding document that indicates the seller’s obligation to pay a particular amount to
the seller or recipient on a particular day.
TYPES OF BILL OF EXCHANGE

•Documentary Bill

•Usance Bill /Time Bill

•Demand Bill

•Inland Bills

•Foreign Bills

•Clean Bill

•Trade Bill

•Accommodation Bills

•Supply Bills

•Hundis

•Fictitious Bill

Utility Functions of Commercial Banks

The primary function of bank consists of a wide variety of services such as accepting
deposits, investment of funds, and lending money. A commercial bank accepts deposits in
numerous forms including demand or current deposits, time or fixed deposits, savings
deposits, and recurring deposits. Commercial banks lend money to its customers in the form
of loans, overdrafts, cash credit, and so on. Despite these primary functions, it also performs
several utility functions. General utility services are provided to the public as well as its
customers. A commercial bank provides the following vital general utility services.
It allows for the simple and rapid movement of payments from one location to other using
drafts, cheques, TT, MT, and other methods. It issues letters of credit, gift cheques,
traveller's cheques, and other similar documents. It handles foreign exchange transfers,
assisting exporters and importers alike. It is in charge of storing assets in a secure location.
Safe deposit boxes are kept on hand for this function. The vaults are a secure place where
treasures can be kept. The bank arranges commodities transportation, insurance, and
storage. It underwrites the recently launched joint-stock firms' debentures and shares.
Several commercial banks offer merchant banking technology leasing services. It offers tax
consulting services. It provides tax guidance on income as well as other personal income tax.
It creates yearly statements for consumers, files appeals, and so on. It offers technical,
managerial, financial and economic consulting services to various small and micro-
businesses. The primary function of bank along with these general utility functions prove to
be the major backbone of the banking industry.

Modern Utility Functions of a Bank

With the progress observed in the banking sector, queries such as what is e-banking and
what additional functions it performs revolve around everyone's mind. Cash is being
exchanged for bank deposits, and vice-versa. Bank deposits are transferred between people
and/or businesses. Deposits are exchanged for government bonds, bills of exchange,
unsecured and secured trade as well as industrial units and trade commitments. Capital
issue underwriting. Payments may be made at ATMs round the clock. It is in charge of
issuing smart cards, credit cards, and other similar products. With the introduction of e-
banking, customers can access their bank accounts and perform a variety of functions with
just a single click.

Agent Function of Commercial Banks

Agency functions of commercial banks Agency Services or Agency functions of commercial
banks are elaborated in detail below:

Go through with of Stock Exchange Transactions

Banks buy and sell different protections, for example, shares, debentures, bonds and so on
of business entities both private and Government for the benefit of their clients.

Going about as Executor, Trustees, Attorneys and so

on

Banks go about as agents of will, legal administrators, lawyers and chairmen. As an agent it
saves the "Wills" of the clients and executes them after their passing. As a legal
administrator, it deals with the assets of the clients. As a lawyer, it signs move structures and
reports for the client.
As the client needs to pay specific periodical instalments, for example, month to month,
quarterly, half yearly, the financier is educated by a standing guidance. Subsequently, club
membership, insurance payment, street charge, power charges and phone bills of the clients
are paid by the bank in the wake of charging the clients' record. As the client might be an
investor or debenture holder of organizations, he will get profit warrants and premium
warrants, which will be stored by the client in the bank. The bank will gather something
similar and credit it to the record of particular clients.

At the point when clients are left with enormous measure of cash in their record, they can
be put resources into organization protections for capital appreciation or for getting a
decent return. The financier will actually want to exhort clients about different venture open
doors as he has the administrations of specialists.

At the point when clients kick the bucket out of nowhere abandoning minor kids, the court
might select the investor to go about as agent of will. Likewise, on account of specific
organizations, the bank might go about as legal administrator for their property in light of a
legitimate concern for lenders of the organization.

In specific deals, instalments are made with the assistance of banks by moving assets to
various focuses. In the current days, these exchanges could be made in no less than few
hours through electronic media. We have electronic exchange with the assistance of PCs. On
account of unfamiliar exchanges or even homegrown exchanges, the banks will embrace
assortment of assets for clients.

Compensation payment

In a colossal processing plant, utilizing great many people, pay dispensing should be possible
through bank offices. The compensation of the representative will be credited to his singular
record consistently and he can either cause actually look at instalment or even to pull out
cash.

Based on the credit value of the client, banks issue

charge card

The buys made by clients by utilizing the charge card are being settled by the financier and
later on the broker gathers the sum from the client. In rustic regions, the ranchers are given
green cards by which they are empowered to buy agrarian contributions using a loan. They
will reimburse sum to the bank after the reap.
Readiness Of Income Tax Returns

Banks plan personal expense forms for their clients through their assessment administration
divisions.

Going through with Foreign Exchange Transactions

Commercial banks buy and sell unfamiliar trade for their clients.
Investor goes about as a specialist to the client

At the point when a client stores checks, drafts, bills or some other promissory notes, the
investor gathers them and on acknowledgment credits the record of the client. For this
movement, the investor is given commission. Banks likewise go about as a reporter,
delegate of their clients. A few banks might try and get the explorers' tickets, identification
and so on for their clients.

As the client needs to pay specific periodical instalments, for example, month to month,
quarterly, half yearly, the financier is educated by a standing

Assortment of Checks, Dividends, Interests and so

forth

Collecting checks, drafts, bill of trade, profits, interests and so on for its clients and credit the
sum in their record is one of the main organization administrations delivered by the banks.
Financier acknowledges standing guidelines from the clients and orchestrates to gather
profit, interest, benefits, pay rates, bills and so on for his clients.

Instalment of Subscription, Rent, Insurance Payment

and so on

Banks attempt the instalment of memberships, lease, insurance payment and so forth in the
interest of the clients and charge the record with the sum. It acknowledges the standing
directions of the client and orchestrates for. The instalment of such costs for their sake. It
charges a limited quantity via commission for these administrations.

CASE STUDY

The basic function of a commercial bank is to accept people’s deposits , but sometimes this
can also lead to money laundering . For this , the launderer initially introduces his illegal
profits into the financial system. This might be done by breaking up large amounts of cash
into less conspicuous smaller sums that are then deposited directly into a bank account .
After the funds have entered the financial system, the launderer engages in a series of
movements of the funds to distance them from their source. The funds might be channelled
through the purchase and sales of investment instruments. This use of widely scattered
accounts for laundering is especially prevalent in those jurisdictions that do not co-operate
in anti-money laundering investigation. One such case happened in India in 2016 , Vijay
Mallya , an Indian businessman at present fighting extradition from the UK. Mallya, who
owes 17 Indian banks an estimated Rs 9,000 crore, is accused of fraud and money laundering
in the country. SBI has the highest exposure of Rs 1,600 crore out of original loan of Rs 6,900
crore to the defunct Kingfisher Airlines. Other banks that have exposure to the airline
include Punjab National Bank (Rs 800 crore) and IDBI Bank (Rs 800 crore), Bank of India (Rs
650 crore), Bank of Baroda (Rs 550 crore), Central Bank of India (Rs 410 crore).
Led by the State Bank of India (SBI), a consortium of 11 banks that gave Mallya loans, had
approached a special Prevention of Money Laundering Act (PMLA) court seeking restoration
of his properties seized by the Enforcement Directorate.

The special PMLA court in Mumbai allowed the restoration of properties worth Rs 5,646.54
crore to banks. The recovery process in banks are guided by Securitisation and
Reconstruction of Financial Assets and Enforcement of security Interest (SARFAESI) Act,
2002, adding that auction or sale of those properties would be done as per the guidelines in
due course of time.

As of July 11,2022 The Supreme Court on awarded four-month sentence to fugitive

businessman. The apex court had in 2020 dismissed Mallya's plea seeking review of the 2017
verdict which held him guilty of contempt for transferring USD 40 million to his children
inviolation of court orders. SC has also ordered Mallya to deposit back USD 40 million with
interest within 4 weeks. he fails to do so, this will lead to attachment of properties.
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