Panchatantra

Download as docx, pdf, or txt
Download as docx, pdf, or txt
You are on page 1of 10

Commercial Banks

Introduction
Bank", this word is now getting familiar in each and every corner of the society. Today,
it becomes an integral part of our life. Bank extends its facilities to all irrespective of
their stature and position. Lay man can easily access various facilities provided by the
bank. Now- a-days, bank is not restricted within the traditional business operations: It
also plays an important role in nation building by fulfilling its national responsibilities.

Meaning of Commercial bank


A bank is an institution which deals with money and credit. A bank is a business
organisation which accepts deposits from the public and lends those who need it thereby
making a profit out of it. The lending rate of a bank is higher than the rate it pays to its
depositors. A bank, therefore, acts as a reservoir into which the idle surplus money of
individuals and households flow and from which loans are given to the needy borrowers.

Definition of bank
There are various opinions offered by many prominent experts and economists.

According to the Indian Central Banking Enquiry Committee, A banking company


is regarded as an organization carries on various financing activities such as acceptance
of money deposits on current account or otherwise subject to withdrawal by cheque draft
or order.

According to Crowther, a bank "collects money from those who have it to spare or
who are saving it out of their incomes, and it lends this money to those who require it."

Keeping in view the various definitions we may define the bank in the following words.
"A bank is defined as a reliable financial institution which receives the money from one
group of people and lends to other group of people with a profit earning motive. . So
bank performs the role of financial intermediary among the people and ensures flow of
cash"

Features
(i) Deals in money: it accepts deposits and advances loans in cash and cheques.
(ii) Deposits are withdrawable: the deposits made by the people are withdrawable.
(iii) Deals with credit : it has the ability to create credit.

1
(iv) Commercial in nature : it aims at earning profit. Profit of a bank arises due to
different in rate of interest offered on deposits and the rate of interest charged on
lending.
(v) Grants loan: A bank advances loans in various forms and for different time period.
(vi) Acts as agent: A bank performs various agency functions.

Functions of commercial banks


At present, the scope and functions of commercial banks are getting wider and
diversified in fulfilling the financial need of people. Commercial banks performs a
number of functions:

(i) Primary Functions


(ii) Secondary Functions

I. Primary Functions of Commercial Banks


The primary functions of the commercial banks are discussed below:

A. Acceptance of Deposits
The first important function of a bank is to accept deposits from those who can save but
cannot profitably utilise this saving themselves. To attract savings from all sorts of
individuals, the banks maintain different types of accounts.

(a) Fixed Deposit Account. Fixed deposits refer to the deposits accepted by banks for a
specified period of time. Money in these accounts is deposited for fixed period of time
(say one, two, or five years) and cannot be withdrawn before the expiry of that period.
The rate of interest on this account is higher than that on other types of deposits. The
longer the period, the higher will be the rate of interest. Fixed deposits are also called
term or time deposits and time liabilities for the banks.

(b) Recurring Deposit Account. The purpose of these accounts is to encourage regular
savings by the public particularly by the fixed income group. Generally money in these
accounts is deposited in monthly installments for a fixed period and is repaid to the
depositors along with interest on maturity. The rate of interest on these deposits is nearly
the same as on fixed deposits.

(c) Saving Deposit Account. Saving deposits are basically designed to meet the
requirement of small scale savers or persons interested in small amount of savings.
Certain restrictions are imposed on the depositors regarding the number of withdrawals

2
and the amount to be withdrawn in a given period. Cheque facility is provided to the
depositors. Rate of interest paid on these deposits is low as compared to that on fixed
and recurring deposits.

(d) Current Deposit Account. These accounts are generally maintained by the traders
and businessmen who have to make a number of payments every day. Money from these
accounts can be withdrawn in as many times and in as much amount as desired by the
depositors. Normally, no interest is paid on these accounts. Rather, the depositors have
to pay certain incidental charges to the bank for the services rendered by it. Current
deposits are also called demand deposits or demand liabilities.

(e) Home Safe Account. Home safe account is another scheme aiming at promoting
saving habits among the people. Under this scheme a safe is supplied to the depositor to
keep it at home and to put his small savings in it. Periodically, the safe is taken to the
bank where the amount of safe is credited to his account.

(f) Cash Certificates: Cash certificates are designed for a longer period of time in
which maturity value is in multiples of the sum invested. It is an attractive and high
yielding investment for those people looking for a long term investment. It is a very
useful account for meeting future financial requirements at the occasion of marriage,
education of children etc. Cash certificates are generally issued at discount to face value.

B. Advancing Loans:
Another primary function of a bank is advancing of loans to the public. After keeping
certain cash reserves, the banks lend their deposits to needy borrowers. Before
advancing loans, the banks satisfy themselves about the credits worthiness of the
borrowers. Various types of loans granted by the banks are discussed below: -

(a) Money at Call and short notice: Such loans are very short period loans and can be
called back by the bank a very short notice of say one day to fourteen days. These loans
are generally made to other banks or financial institutions to meet their urgent financial
needs. The rate of interest is very high on such loans.

(b) Cash Credit: Cash credit is treated as a form of working capital credit given to the
business firms. For availing such credit facility the customer has to open an account.
Once the loan got sanctioned the amount is credited directly to the customer's account.
The customer can operate that account within the sanctioned limit as and when required.
Cash credit can be given against security of his current assets, such as shares, stocks,

3
bonds, personal security etc. Interest is charged only on the amount actually withdrawn
from the account.

(c) Overdraft. Overdraft facility is provided to holders of current accounts only.


Through overdraft, a customer can withdraw money beyond his bank balance up to a
certain limit. This facility of over withdrawal is allowed as a short term arrangement of
credit and the bank will charge interest, on the Overdrawn amount. This facility is
generally available to industries, business firms and multinational companies.

(d) Discounting of Bills of Exchange. Discounting of Bills is a negotiable instrument


used as a medium of bank finance. Through this method, a holder of a bill of exchange
can get it discounted by the bank. After making some marginal deductions (in the form
of commission), the bank pays the value of the bill to the holder. When the bill of
exchange matures, the bank gets its payment from the party which had accepted the bill.
Thus, such a loan is self-liquidating.

(e) Term Loans. The banks have also started advancing medium-term and long-term
loans. The maturity period for such loans is more than one year. The amount sanctioned
is either paid or credited to the account of the borrower. The interest is charged on the
entire amount of the loan and the loan is repaid either on maturity or in instalments.

(f) Consumer Loans: One of the important areas for bank financing in recent years is
towards purchase of consumer durables like TV sets, Washing Machines, Micro Oven.
etc.

(g) Credit to Government: Commercial banks are also meeting the requirement of
government by investing money in government securities which helps in enhancing the
liquidity position of the government.

C. Credit Creation
A unique function of the bank is to create credit. When a bank advances a loan to its
customer, it does not lend cash but opens an account in the borrower's name and credits
the amount of loan to this account. Creation of such deposits is called credit creation
which results in a net increase in the money stock of the economy. Banks have the
ability to create credit many times more than their deposits and this ability of multiple
credit creation depends upon the cash-reserve ratio of the banks.

Primary or Passive Deposits

4
Primary deposits are created by a bank in the name of the customer who brings cash or
cheque into the bank.

Derivative or Active Deposits


When a bank grants loans to a customer, it does not pay the amount in cash rather it
Credits the amount of loans to his account are Active Deposits/derivative deposits.

Technique of Credit Creation


Case I
When a number of hank exist and
The cash reserve ratio is 10% i.e; the banks keep 10% of their deposits as cash reserves.

A customer Y deposited 20,000 in the Andhra Bank Now, Andhra Bank receives
20,000 from Y. The Balance Sheet of Andhra Bank will be as follows:
Andhra Bank
Liability Amt(Rs) Assets Amt(Rs)
Deposites 20,000 Cash 20,000
20,000 20,000

After keeping 2,000 (10% of 20,000) as cash reserves, the bank has an excess reserve of
Rs 18,000 which can be used for giving loans and advances to its customers. The
Balance Sheet of Andhra Bank after the loan is given will be as follows;

Andhra Bank
Liability Amt(Rs) Assets Amt(Rs)
Primary deposites 20,000 Cash Reserve 2,000
Loan to A 18,000
20,000 20,000

Let us suppose that Andhra Bank advanced a loan of 18,000 to A and A in repayment of
some business obligation gives a cheque of 18,000 to B. B deposited the cheque in his
account at Syndicate Bank. So, Syndicate Bank now receives 18,000. The Balance Sheet
of Syndicate Bank will be as follows.

5
Syndicate Bank
Liability Amt(Rs) Assets Amt(Rs)
Primary deposits 18,000 Cash Reserve 1,800
Loan to C 16,200
18,000 18,000

Now Syndicate Bank can lend 16,200, Let us further suppose that C borrowed from
Syndicate Bank 16,200 and gave a cheque to D who had an account with Union Bank of
India. D deposited the cheque. So a deposit is created. Out of F 16,200 , it can keep
1,620 and can lend 14,580. Its Balance Sheet will be as follows.

Union Bank of India


Liability Amt(Rs) Assets Amt(Rs)
Primary deposits 16,200 Cash Reserve 1,620
Loan to D 14,580
16,200 16,200

This process will continue until the entire excess reserves of


Banks Primary deposits Cash reserves Loans
(Derivative
deposits)
Andhra Bank 20,000 2,000 18,000
Syndicate Bank 18,000 1,800 16,200
Union Bank 16,200 1,620 14,580
Punjab National 14,580 1,458 13,122
Bank
13,122 1,312 11,810
United Bank
…….. ……. ……..
……..
…….. ……. ……..
……….

6
Total 2,00,000 20,000 1,80,000
As the minimum cash reserve ratio is 10%, the total deposits of all the banks taken
together is increased by 10 times of the original deposit of cash. This is termed as
deposit multiplier (K).

1
K = r (r = Cash reserve ratio)
1
= 0.1 = 10 times

If the CRR is 20%


1
Then K = 0.2 = 5 times
Thus, higher the cash reserve ratio, the lower will be the deposit (credit) multiplier, and
vice-versa. The credit multiplier is the reciprocal of cash reserve ratio.

Case II
Credit Creation (by a Single Bank)
The process of credit creation by a single bank is almost similar to the process of credit
creation when there exists multiple banks. It can be understood from the following
example;

A person named A made an initial deposit of 20,000 in a bank.

The bank, after keeping 2,000 (10% of 20,000) lends 18,000 to say B. In this case, a
deposit account is opened in the name of B. Again keeping 10% of 18,000 i.e 1,800; ,
the bank lends 16,200 (18,000-1,800) to C and credit the same to C's account. So a
deposit of 16,200 is created. From this, keeping 10%, ie. 1,620 it can lend 14,580. This
process goes on and on till the primary deposit of R 20,000 becomes 2,00,000 because;

1
K = r (r = Cash reserve ratio)
1
= 0.1 = 10 times

So, total credit created = 20,000 x 10= 2,00,000.


The process of credit creation is explained in the following table

Credit creation by a single Bank

7
Persons Primary deposit Cash Credit creation/
Reserves(10%)
Derivative
Deposits
A 20,000 (Initial deposits) 2,000 18,000
B 18,000 1,800 16,200
C 16,200 1,620 14,580
D 14,580 1,458 -----
- ------ ----- -----
- ------ -----
And so on
Total 2,00,000 20,000 1,80,000

Assumptions of credit creation


Credit creation by commercial banks is possible if the following conditions are satisfied.
1. The Reserve Bank does not adopt credit control policy.
2. The cash reserve ratio remains constant through all the stages of credit creation
process.
3. Excess cash reserves must be utilised to grant loans.

D. Cheques System of payment of Funds


Cheque is a negotiable instrument used in the banking business as a medium of
exchange. Customer can deposit and withdraw money from the bank through cheques.
Cheques can be endorsed to any person and bank makes the payment on demand to the
payee.

II. Secondary Functions


The secondary functions of the banks consist of agency functions and general utility
functions.

A. Agency Functions
Banks also perform certain agency functions for and on behalf of their customers:

(a) Collection of cheques, dividends, and interests etc., on behalf of its customers and
credits the amounts to their accounts.
8
(b) Payment of rent and insurance premiums: The bank helps in paying rent,
insurance premiums, and subscriptions on standing instructions of the customers.

(c) Purchasing and Sale of Securities: Banks undertake purchase and sale of various
securities like shares, stocks, bonds, debentures etc. on behalf of their customers.

(d) Income Tax Consultancy: Banks may also employ income-tax experts to prepare
income-tax returns for their customers and to help them to get refund of income-tax..

(e) Acting as Trustee and Executor: Banks preserve the wills of their customers and
execute them after their death.

(f) Acting as Representative and Correspondent: Sometimes the banks act as


representatives and correspondents of their customers. They get passports, traveller's
tickets, book vehicles, plots for their customers and receive letters on their behalf.

B. General Utility Services


Bank performs the following general utility services.

(a) Safety Locker facility: Safekeeping of important documents, valuables like


jewelleries are considered as one of the oldest services provided by commercial banks.
These lockers are made 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.

(b) Payment Mechanism or Money Transfer: Cheques and credit cards are two
important payment mechanisms through which banks are managing the transfer of
funds very efficiently.

(c) Travellers cheques: Travellers Cheques are used by both the domestic travellers and
international travellers. A bank issues travellers cheques to their customers on request.

(d) Letters of Credit: Letter of Credit is a document represents the credit worthiness of
the customers given by his banker in favour of seller. This document can be used as a
guarantee for the seller. The letter of credit is an important mode of payment in
international trade.

9
(e) Acting as Referees: The banks act as referees and supply information about the
business transactions and financial standing of their customers on enquiries made by
third parties.

(f) Provides Trade Information: The commercial banks collect information on


business and financial conditions etc., and make it available to their customers to help
plan their strategy

(g) ATM Cum Debit Cards: Automated Teller Machines (ATM) changed the entire
process of banking operations since its introduction. These machines are intended to
provide instant withdrawal facility and quick deposit of cash to the customers.

(h) Credit Cards : Credit cards are currently provided by many banks to their
customers. Credit cards are considered as plastic money acts as a credit instrument. The
persons holding credit card need not worry about cash payments. They can purchase
goods from many authorized dealers through credit card. Bank charges a nominal rate of
interest on such credit allowed.

(i) Mobile Banking : Customers can enjoy various banking services like money
transfer, bill payments, balance enquiry etc. This system makes banking possible within
the hands of customers. It is otherwise popular as M-Banking.

(j) Dealing in foreign exchange : Commercial banks deal in foreign exchange


according to the guideline of Reserve Bank of India Exchange Control Regulations.
They are authorized by the central bank of the country to transact foreign exchanges.

(k) Bullion trading: In many countries, banks are dealing with products like gold and
silver. In India commercial banks like State Bank of India, Indian Overseas Bank,
Canara Bank and Allahabad Bank have obtained the license to import of gold as per
general license category in October 1997.

10

You might also like