Commercial Banks: Functions and Importance

In our routine life, we must have visited banks. These banks help us in many banking activities like maintaining our savings account, depositing cash, and withdrawing the same, thus we see these banks are always at our service. These are the commercial banks, which operate commercially for serving the common people.

Commercial banks have a lot of other functions to do than what is mentioned above. What are those functions? What will happen if the commercial banks cease to perform all the banking activities? Are there any other types of banks that might help the masses? All these questions will be addressed in our discussion that is based on the functions of Commercial Banks.

What are Commercial Banks?

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Before diving straight into the topic of functions of commercial banks, first, it is obligatory to know what are Commercial Banks.

A commercial bank is a typical financial institution that accepts as well as deposits from the general public and also, they give loans for the purposes of consumption activities and investment activities, to make their own profit.

Commercial banks are profit-based institutions that offer financial services like loans, as well as services like deposits, electronic transfers of funds, etc. to their customers. Commercial banks have a significant role in a country’s economy as these organizations fulfill the short and mid-term financial requirements of industries.

The functions of commercial banks are primarily based on a business model of accepting public deposits and utilizing that fund for various investment purposes. Such functions can be classified into two categories, primary and secondary functions.

These functions will be discussed in our upcoming section.

What are the Functions of Commercial Bank?

Commercial Banks have both primary and secondary functions that as explained in detail below.

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Primary Functions

• Accepting Deposits – Commercial banks accept deposits from their customers in the form of saving, fixed, and current deposits. 

• Savings Deposits – Savings deposits allow a customer to credit funds towards their accounts for up to a certain limit. These deposits are preferred by individuals with a fixed income, utilized to create savings over time.

• Fixed Deposits – Fixed deposits come with a predetermined lock-in period. Fixed deposits are also referred to as time deposits as the funds are deposited for a specific time frame.

• Current Deposits – Current deposits allow account holders to deposit and withdraw money whenever necessary. In some cases, current accounts also offer overdrafts until a pre-specified limit to individuals and businesses.

• Providing Loans – One of the main functions of commercial banks is providing credit to organizations and individuals, and profit from the earned interest. Usually, banks retain a small reserve for their expenses while offering the remaining amount to customers as various types of short and long-term credits.

• Credit Creation – A unique function of commercial banks is credit creation. Instead of offering liquid cash, banks create a line of credit and transfer the loan to a business or commercial body all at once.

Categories of Secured and Unsecured Loans provided by Commercial Banks

• Cash Credit – Commercial Banks and their Functions include extending advances to individuals and organizations against bonds, inventories, and other types of securities. This facility, commonly known as cash credit, provides a more substantial sum when compared to other forms of credit.

• Short-Term Credits – Short-term loans are usually pledged without any security, offering a smaller loan amount and repayment tenor. These are also referred to as personal loans.

Secondary Functions

The following can be considered as the secondary functions of commercial banks – 

• Providing locker Facilities – Commercial banks provide locker facilities to customers who want to store valuables safely. Locker facilities eliminate the impending risk of theft or loss, which prevail when kept at home.

• Dealing in Foreign Exchange – Commercial banks help provide foreign exchange to individuals and organizations that export or import goods from overseas. However, only certain banks which have the license to deal in foreign exchange are eligible for such transactions. 

• Exchange of Securities – Another function of commercial banks is to trade in bonds and securities. Customers can purchase or sell the units from the financial institution itself, which offers more convenience than alternate approaches.

• Discounting Bills of Exchange – The main function of a commercial bank in today’s date is to discount bills of businesses. Bill discounting is considered a profitable investment for banks. Bills create a steady flow of funds, while not becoming a risky venture during payment as it is considered as a negotiable instrument. These also do not involve the financial institution in any litigation. 

• Bank as an Agent – Commercial Bank and its Function also require them to provide finance-related services to customers, fulfilling the role of an agent. These services usually include – 

• Acting as an administrator, trustee, or executor of a customer-owned estate.

• Assisting customers with tax returns, tax refunds, and other similar tasks.

• Serving as a platform to pay premiums, repay loan installments, etc.

• Offering a platform for electronic transaction of funds, processing of cheques, drafts, bills, etc.

Importance of Commercial Banks

Thus, we now know how important are commercial banks in performing the balanced function in an economy. In a parallel universe, if commercial banks cease to perform these banking functions, then the economy will collapse out of thirst for money liquidity. Along with the growth, economic and social stability will be shattered completely. 

Types of Commercial Banks

It is necessary to understand the different types of financial institutions to explain the functions of commercial banks effectively. Commercial banks are commonly categorized into three types. They are as follows:

• Public sector banks

• Private sector banks

• Foreign banks

Public Sector Banks

Public sector banks refer to a type of financial institution that is state-owned by the corresponding Government. A significant part of the share of such organizations is held by the Government. In India, the Reserve Bank of India, which acts as the central bank, creates operating guidelines for the public sector banks. 

Private Sector Banks

Private sector banks are financial institutions registered as companies with limited liabilities. The major part of the share capital of such companies is owned by individuals or private businesses. 

Foreign Banks 

Foreign banks are financial institutions that are operating overseas within a foreign nation. Post the financial reform of India (in 1991), there was a marked increase in the number of foreign banks on Indian soil. They are essential for the economic development of a nation.

Apart from these commercial banks that lend and deposit money, there is Central Bank which is known as the ‘head honcho’ in terms of banks. The Central Bank supervises the commercial banks, sets their interest rates, and controls the money flow in the economy. This bank, unlike the commercial banks, does not engage with the general public in terms of providing banking services. Thus, Central Bank will never be as helpful as commercial banks to the general mass. 

Did You Know?

In this section, we will know about some interesting commercial banking facts. 

• Allahabad bank is the oldest joint stock bank existing in India.

• Bank of India was the first bank to open branches in foreign nations. 

• Canara Bank is the first bank to be receiving the ISO 9002 Certificate.

• Bharatiya Mahila Bank is the first all-women bank formed in India.  

• Reserve Bank of India served as the central bank of two countries at a time. It was the central bank for Pakistan after the partition of India until June 1948.

From the above-mentioned details, you will get a clear idea about commercial bank definition as well as its functions. For more information on the discussed topic students can refer to Vedantu’s website today. They can also avail study solutions on the introduction of commercial banks from us and avail a detailed idea.