Banks are financial institutions authorized by the government to accept surplus money from the public and lend it to those in need for various investment purposes.
They operate with a profit motive, earning their income through the “spread”—the difference between the lower interest rate paid to depositors and the higher rate charged to borrowers.
The functions of commercial banks are broadly classified into two categories: Primary Functions and Secondary Functions.
1. Primary Functions
These core activities focus on the mobilization of savings and the allocation of credit.
- Accepting Deposits: Banks provide several ways for the public to store their money
- Current Account Deposits: These are demand deposits, meaning they are payable whenever the customer requests them.
- Savings Account Deposits: Designed for individual savings, these are also demand deposits but accrue interest at a fixed rate set by the bank.
- Fixed Deposits: Often called time deposits, these have a specific maturity period and can only be withdrawn after that period ends.
- Granting Loans and Advances: After keeping a portion of deposits as a reserve, banks lend the balance to borrowers to earn interest.Common forms include:
- Cash Credit: A short-term loan for businesses to meet working capital needs, where a specific credit limit is sanctioned.
- Demand Loans: Loans that must be repaid whenever the lender demands them; however, borrowers can also repay them at any time without prepayment charges.
- Short-term Loans: Personal loans given against security to finance working capital or priority sector advances.
2. Secondary Functions
Beyond basic lending and depositing, banks offer a range of specialized financial and administrative services.
- Discounting Bills of Exchange: A bank may pay the value of a “promise to pay” (bill of exchange) to a person beforehand at a discounted rate. The difference between the face value and the amount paid is the bank’s return.
- Credit Creation: By the act of granting loans, banks effectively create credit within the economy.
- Financing Foreign Trade: Banks facilitate international commerce by transacting in foreign currency and accepting foreign bills of exchange.
- Agency Functions: Banks act as agents for their customers for a commission. This includes:
- Collection and transfer of funds
- Payment of bills and taxes
- Purchase and sale of shares and securities
- General Utility Services: Banks provide practical facilities for public convenience, such as lockers, traveller’s cheques, and gift cheques.
Summary Table of Bank Functions
| Category | Function | Key Feature |
|---|---|---|
| Primary | Accepting Deposits | Includes Current, Savings, and Fixed deposits [3]. |
| Granting Loans | Includes Cash Credit, Demand, and Short-term loans [4], [5]. | |
| Secondary | Agency Services | Acts as an agent for bills, taxes, and fund transfers [6]. |
| Utility Services | Provides lockers and specialized cheques [7]. | |
| Economic Facilitation | Includes Credit Creation and Foreign Trade financing [6]. |