Question

Explain in detail the different functions of commercial banks.

Explain primary and secondary functions of commercial bank.

Answer 1

The functions of commercial banks can be broadly divided into two groups as follows:

1. Primary Functions: The primary functions of commercial banks are known as core banking functions. The primary functions are as follows:
   A. Accepting Deposits: Commercial banks collect deposits from individuals and organizations.
   The deposits can be classified into two types i.e. Time Deposits and Demand deposits.
   a. Time Deposits: Time deposits are called time deposits because they are repaid to the customers after the expiry of the decided time.
   1. Fixed Deposit: Fixed deposit account is an account where a fixed amount is kept for a fixed period of time bearing a fixed interest rate. The rate of interest is more as compared to a savings bank account and varies with the deposit period.
   Normally, withdrawal of the amount is not permitted before the maturity date. However, depositors can withdraw the amount before the maturity date for which the bank will reduce the interest rate. For the amount deposited in this account, a fixed deposit receipt (FDR) is issued by the bank. Against this receipt, the loan can be taken from the bank.
   2. Recurring Deposit: It is operated by salaried persons and businessmen having a regular income. A certain fixed sum of money is deposited into the account every month. Withdrawal of accumulated amount along with interest is paid after the maturity date. The rate of interest is higher which is similar to a fixed deposit account. A separate passbook is provided to know the position of the RD account.
   b. Demand Deposits: Demand deposits are those which are repaid to customers whenever they demand. That means money can be withdrawn as per the wish of the customer through withdrawal slips, Cheques, ATM cards, online transfers, etc.
   1. Saving Account: It is generally operated by those who earn regular or fixed income such as salary or wages. The main aim of this deposit account is to encourage the habit of savings among people. These deposit accounts are meant for the purpose of maximum savings. There are restrictions on withdrawal limits from these accounts. These accounts carry low-interest rates. Interest is credited monthly, quarterly, half-yearly, and yearly basis on this account. Passbook facility, balance on SMS, account statement, etc. facilities are provided to account holders to ascertain financial position. For saving account holders some banks provide separate facilities for Flexi deposits. This facility combines the advantages of a savings account and a fixed deposit account. This is not a separate deposit account. It is a type of saving bank account or current deposit account with special features and benefits. In the case of a multiple-option deposit account, the excess amount after a particular limit gets automatically transferred to a fixed deposit. When adequate funds are not available to honor payments or cheques in a savings account, funds get transferred from fixed deposits to saving banks account.
   2. Current Account: This account is operated by business firms and other commercial organizations such as hospitals, educational institutions, etc. who have regular banking transactions. In this account, there is no restriction on deposits and withdrawals of amounts. No interest is paid by the bank on this account. An overdraft facility is available for this account. For current accounts, banks provide statements of account every month.
   B. Granting loans and advances: Banks grant loans and advances to business firms and others who are in need of bank funds. The loans are provided for a longer period of time from 1 year and more. Advances are provided for shorter periods from 4 months to 1 year. The advances are in the form of cash credit, overdraft and discounting of bills, etc.
   1. Loans: Commercial banks provide loans to businessmen and others. The borrowers can use the entire amount sanctioned or can withdraw in installments. Interest is charged on the amount sanctioned.
   The loans are as follows:
   a. Short Term Loans are for a period of up to 1 year to meet the working capital requirements of the borrower.
   b. Medium Term Loans are for a period of 1 year to 5 years to meet the working capital as well as fixed capital requirements of the borrower.
   c. Long Term loans are for a period of 5 years or more to meet the long-term capital requirements of the borrower.
   2. Advances: Advances are small-term funds provided to businessmen to satisfy different financial requirements of the business. Advances are as follows:
   a. Cash Credit: Cash credit advances are provided to the current account and savings account holders. It provides working capital for a longer period of time. The interest rate is higher on CC. A separate CC account has to be maintained by the borrower.
   b. Overdraft: This facility is offered to current account holders to meet their working capital requirements. The period can vary from 15 to 60 days. Interest is charged on the actual amount withdrawn. No separate account is maintained, and entries are shown in the current account. It is a temporary arrangement for a short period.
   c. Discounting of bills of exchange: The drawer of bills of exchange or beneficiary can discount the bill with the bank and obtain an advance. On the due date of the bill, the bank will recover the amount from the drawee.
2. Secondary Functions: Secondary functions of commercial banks are classified into two groups:
   A. Agency Functions
   B. Utility Functions
   A. Agency Functions: A commercial bank acts as an agent or representative of its client and performs certain functions as follows:
   1. Periodic Collections and Payments: Commercial bank collects salary, dividends, interests, and any other income periodically as well as makes periodical payments such as taxes, bills, premiums, rent, etc. on the standing instructions provided by the customer. Commercial bank charges a certain fixed amount quarterly or annually in the form of service charges from the customer for providing such services.
   2. Portfolio Management: Large commercial banks undertake to purchase and sell securities such as shares, bonds, debentures, etc. on behalf of the clients. This handling of securities is known as portfolio management. Due to this facility, more clients are opting for such services of commercial banks.
   3. Fund Transfer: Commercial banks provide the facility of fund transfer from one branch to another branch or branch of another bank. Commercial banks come with various initiatives to make these transfers hassle-free.
   4. Dematerialization: Banks provide dematerialization facilities to their clients to hold their securities in an electronic format. On behalf of clients, it undertakes the electronic transfer of shares in case of purchase or sale.
   5. Forex Transactions: Forex is an abbreviation for foreign exchange. A bank may purchase or sell foreign exchange on behalf of its clients. A bank purchases forex from its clients which the clients receive from foreign transactions and sell the forex when the clients need it for overseas transactions.
   B. Utility Functions: A commercial bank performs utility functions for the benefit of its clients.
   It provides certain facilities or products to its clients as follows:
   1. Issue of Drafts and Cheques: A draft/cheque is an order to pay money from one branch of a bank to another branch of the same bank or another bank. A bank issue drafts to its account holders as well as nonaccount holders whereas cheques are issued only to the account holders. Bank charges a commission for issuing a bank draft.
   2. Locker Facility: This is a common utility function of any commercial bank. The bank provides a locker facility for the safe custody of valuables, documents, gold ornaments, etc.
   3. Project Reports: A bank may prepare project reports and feasibility studies on behalf of the clients. Project reports enable the business firm to obtain funds from the market and obtain clearance from government authorities.
   4. Gift Cheques: Banks issue gift cheques and gold coins to account holders as well as to non-account holders. The gift cheques/coins can be used by the clients for the purpose of gifting on occasions like weddings, birthdays, etc.
   5. Underwriting Services: A commercial bank may underwrite the issue of securities issued by companies. If the shares are not fully subscribed, the underwriting bank agrees to take up the unsubscribed portion of the securities.
   6. Gold-related Services: Nowadays many banks are providing gold services to their customers. Some banks also provide advisory services to their customers in terms of gold funds, gold ETFs, etc.