Question

Answer the following question:
What is commercial bank? Explain its primary functions.

Answer 1

A commercial bank is a financial institution that accepts deposits from the general public and extends loans to the general public for various purposes such as consumption and investment. Commercial banks offer a rate of interest on the deposits (borrowing rate) and charge a rate of interest on the amount they lend (lending rate). The following are the primary functions of commercial banks:
i. Accepting deposits - Banks accept various types of deposits from the public such as savings account deposits, current account deposits and fixed account deposits and pay interest on them. They are indebted to repay the depositor the amount deposited by him or her. The following are the various types of deposits accepted by these banks:
a. Savings account deposits - Frequent withdrawals are restricted from the savings account. This type of account promotes the habit of saving in people having a fixed income. These deposits are chequeable deposits—that is, cheques can be issued against such deposits. Interest is credited to the depositor's account once in every six months.
b. Fixed account deposits - Fixed account deposits (also known as time deposits) refer to the deposits that are held for a fixed (specific) period of time (called maturity). These deposits cannot be withdrawn before maturity; hence, they are not payable on demand. Interest paid on these deposits is comparatively higher than that paid on savings account deposits.
c. Current account deposits - Current account deposits (also known as demand deposits) refer to the deposits that provide the depositor the liberty to withdraw money at any point in time. This type of bank account is usually held by businesspersons. The depositor can withdraw the required amount from the account through a cheque. No interest is paid on these deposits.
d. Recurring deposit account - This account carries higher interest rate than that carried by the savings account. A fixed amount is deposited in this account at regular intervals. That amount can be withdrawn only after maturity.
e. Multiple option deposit account - This account is a combination of the savings, current and fixed accounts. The interest is the same as that earned on a fixed account and the account is as liquid as a savings or current account. In this type of account, the amount is automatically transferred to the fixed deposit account once it crosses a specified amount. In case insufficient amount is available when a cheque is presented, the amount is deducted from the fixed deposit account and added to the savings account.
ii. Granting loans and advances - Banks grant loans and advances on the basis of the total deposits available with them. These loans and advances can be in the form of overdrafts, discounted trade bills, cash or consumer credits, etc. The interests charged on these loans are a major source of profits for banks. The following are the different types of advances offered by commercial banks:
a. Cash credit - Under this system, the bank first estimates the value of the assets held by the borrower. Based on this estimation, the bank decides the credit limit of the borrower. The borrower is liable to pay interest on the amount he/she actually withdraws.
b. Overdraft - This facility is provided to current account holders wherein they can withdraw amount in excess of the credit balance in the account. The bank charges interest on the amount overdrawn.
c. Discounted bills - A bill of discount is a negotiable instrument where the payment is made by the bank on behalf of the customer to the vendor before the due date. The bank collects the money from the customer on the arrival of the due date. The bank deducts some fee before making the payment to the vendor.