Question

What are the two main functions of a commercial bank?

Explain the functions of a commercial bank.

Explain any four agency functions of the commercial bank.

Answer 1

1. Accepting Deposits: Commercial banks receive deposits from the public for the purpose of making investments and granting loans. People deposit their savings for the sake of safety and to earn interest. Depositors can withdraw their money either in the form of cash or through cheques. Commercial banks accept deposits of various types to meet the requirements of different people. Fixed deposits, savings deposits, recurring deposits and current deposits are the main forms of deposits. These are explained later in this chapter.
2. Lending Money: Commercial banks lend money to businessmen, farmers, artisans and others in the following ways:
   1. Overdraft: An overdraft is an arrangement under which a current account holder is allowed to withdraw more than the balance of his credit up to the specified limit. An overdraft is allowed for a short period and interest is charged on it. Commercial banks provide overdraft facilities on the security of some assets or on the personal security of the account holder.
   2. Cash Credit: In this arrangement, the bank advances cash loans to the borrower against some tangible security or personal guarantee. The borrower can withdraw up to his cash credit limit according to his needs and can deposit back any surplus. Interest is charged on the amount actually withdrawn and not on the whole amount granted. Cash credit is for a longer period of time than an overdraft. It is a popular method of borrowing for businessmen.
   3. Discounting of Bills: Businessmen receive bills of exchange from their customers who buy goods on credit. Commercial banks pay the amount of a bill before the date of its maturity after deducting discount (interest) charges. On the date of maturity, the bank gets payment of the bill from its acceptor. If the bill discounted is dishonoured, the bank receives the payment from the customer who discounted the bill.
   4. Loans and Advances: The bank advances a fixed amount in a lump sum to the borrower for an agreed period. The borrower may withdraw the whole amount at once or as per his needs. But interest is charged on the whole amount sanctioned. Commercial banks grant both short-term and medium-term loans. Loans are granted against the security of assets or against the personal security of the borrower.
3. Agency Functions: As an agent of its customers, a commercial bank performs the following functions:
   1. Collecting Receipts: Banks collect amounts of cheques, bills, promissory notes, and hundies on behalf of their customers. They also collect interest, dividends, and rent on the instructions of their customers.
   2. Making Payments: On the instructions of customers, banks make payments of loan instalments, interest, rent, insurance premiums, taxes, etc., on behalf of account holders.
   3. Buy and Sell Securities: Banks buy and sell shares, debentures, and other securities on behalf of their customers.
   4. Trustees and Executors: Commercial banks act as trustees and executors for their customers. They also act as representatives of their customers with other banks. Banks transfer money from one place to another within the country and abroad as per the instructions of customers.
4. General Utility Functions: Commercial banks also perform several general utility functions, which are given below.
   1. Issuing Credit Instruments: Banks issue letters of credit, drafts, and travellers' cheques to their customers. People can transfer funds from one place to another without carrying currency notes with them.
   2. Underwriting Capital Issues: Banks underwrite the shares and debentures issued by companies.
   3. Safe Custody of Valuables: Banks accept jewellery, documents, and other valuables for safe keeping. They provide safe deposit vaults (lockers) for storing these valuables.
   4. Advice and Information: Banks offer advice on financial matters. They provide information about the creditworthiness of customers to enable them to obtain credit facilities from suppliers. Banks also collect and provide information about trade and industry. They also give guarantees on behalf of their customers.