5 Major Functions of Commercial Banks:
In this article, we are going to explain,
- 5 Major functions of Commercial Banks.
- What are Commercial Banks?
- Commercial Banking in India.
but before we start, let us know What are the Commercial Bank first.
“Commercial Banks are those financial institutions which accept deposits from the public and advance credit to their customers at the higher interest rate for the purpose of making profits and regulated under the RBI Banking and Regulation Act.”
Therefore, we can say the general public can open their accounts like saving account, current accounts, overdraft accounts etc in commercial banks and can take the advantages of services offered by these banks. Basically, all banks know to us are comes under the category of commercial banks for example State Bank of India, Punjab National Bank, Bank of Baroda, Union Bank of India etc.
Hope you would have understood the meaning and definition of Commercial Banks. Now let us explain which are the 5 major functions of Commercial Banks.
The functions of commercial banks can be categorised into two parts, one is Primary Functions of Commercial Bank and another is Secondary Functions of Commercial Banks. Here I will explain you top 5 functions comprising the above two.
1) Commercial Banks are Creator and Allocator of Credits:
This functions of creating and providing of credit are the most important and unique function of commercial banks. Commercial Banks increases the flow of funds from depositors to creditors virtually, in other words, Commercial Banks increases the supply of artificial money without having the actual amount in cash.
Therefore, the artificial supply of money increases as the number of depositor and creditors increases. Thus we can say, commercial banks deal in virtual funds not in actual because of its unique function of Creating Money. Hence the assets of these banks increase exponentially in Balance Sheet day by day.
2) Commercial Banks Accept Deposits from Public or Private Entities:
Accepting deposits is one of the important functions of Commercial Banks because this is the only and easiest way to generate funds. Commercial Banks are authorised to take deposits from their customers which can be people, small enterprise or private entities.
These deposit of funds may be in the form of following.
- Demand Deposits
- Time Deposits
Demand deposits are those deposits which can be demanded at any time by the depositors, for example, money deposited in savings accounts or current accounts can be withdrawn any time. Time deposits are those which depends on a specific time period at which it is agreed by the depositors at the time of making deposits. Recurring Deposits and Fixed Deposits are examples of Time Deposits.
3) Commercial Bank advances loans to its customers:
This is also one of the most important functions of commercial banks. All commercial banks provide loans to their customers to make a profit. There are several forms of loan and credit (short term and long term basis) is being advanced by commercial banks.
Few of them are:
- Personal loan
- Home loan
- Business loan
- Vehicle loan
- Education loan
- Cash credit
- Overdraft facilities
- Discounting of bills
We can differentiate Loan and cash credits by the period of borrowing. Loans are known for long term borrowing (More than 1 year) whereas, cash credit is for less than one year. Overdraft facility is available only for current accounts where beneficiaries are allowed to withdraw money from their account up to a certain limit whether the balance is available or not. The beneficiary has to pay back that amount with interest.
Discounting of bills is an agreement between buyer and seller and commercial banks play the role of agent to cash bill on behalf of buyers. The above functions are considered as Primary Functions of Commercial Banks which plays a crucial role in making a profit for the commercial banks.
4) Commercial Banks function as an Agents/ Mediators:
The role of Commercial bank becomes so essential when it comes to some services for individuals or any organisation. Here are a few examples which would help you to understand the importance of commercial banks as an agent.
- Collection and payment of money for a Government or private entities: The banks play a very important role when it comes to collection or payment of fees, bills, service charge, taxes, fines, policy premium, tickets etc on the behalf of a company or Government entities. The banks as a mediator facilitate individuals as well as enterprises. In this case, banks act as a power of attorney or trustee for an organisation.
- E-Banking: We all know how important is E-Banking services of the commercial banks in day to day life. We can transfer money from one account to another account anywhere anytime using IMPS, NEFT, RTGS etc. We also pay bills, recharge mobile through e-Banking. Thus commercial banks act as a mediator between individuals and companies or different banks.
- Trading in Stock Market: Banks also facilitate trading in stock exchange being an agent between D-Mat accounts of buyers and sellers of shares.
5) Commercial Banks deal in foreign exchange and also issue Letter of Credit:
Another important function of commercial banks is to avail the foreign currency and facilitate transactions between the different currency of the different country.
The commercial banks also issue the letter of credit means any person who has issued the letter of credit can cash it anywhere in the world. This letter of credit is also known as Bank Guarantee. The benefit of issuing a letter of credit is that anybody doesn’t need to carry cash.
Last two functions of commercial banks are under the Secondary function of commercial banks.
Thus we discussed the major functions of commercial banks and How banks play a very important role in our life, hope you would have understood clearly.
For more detail explanation about the Structure of Banking System (Type of Banking in India). Check the link below.