Functions of Commercial Banks

The functions of a commercial banks are divided into two categories:

i) Primary functions, and

ii) Secondary functions including agency functions.

i) Primary functions:

The primary functions of a commercial bank include:

a) accepting deposits; and

b) granting loans and advances;

a) Accepting deposits

The most important activity of a commercial bank is to mobilise

deposits from the public. People who have surplus income and

savings find it convenient to deposit the amounts with banks.

Depending upon the nature of deposits, funds deposited with

bank also earn interest. Thus, deposits with the bank grow along

with the interest earned. If the rate of interest is higher, public

are motivated to deposit more funds with the bank. There is also

safety of funds deposited with the bank.

b) Grant of loans and advances

The second important function of a commercial bank is to grant

loans and advances. Such loans and advances are given to

members of the public and to the business community at a higher

rate of interest than allowed by banks on various deposit accounts.

The rate of interest charged on loans and advances varies

depending upon the purpose, period and the mode of repayment.

The difference between the rate of interest allowed on deposits

and the rate charged on the Loans is the main source of a bank’s


i) Loans

A loan is granted for a specific time period. Generally,

commercial banks grant short-term loans. But term loans,

that is, loan for more than a year, may also be granted.

The borrower may withdraw the entire amount in lumpsum

or in instalments. However, interest is charged on the full

amount of loan. Loans are generally granted against the

security of certain assets. A loan may be repaid either in

lumpsum or in instalments.

ii) Advances

An advance is a credit facility provided by the bank to its

customers. It differs from loan in the sense that loans may

be granted for longer period, but advances are normally

granted for a short period of time. Further the purpose of

granting advances is to meet the day to day requirements

of business. The rate of interest charged on advances varies

from bank to bank. Interest is charged only on the amount

withdrawn and not on the sanctioned amount.

Modes of short-term financial assistance

Banks grant short-term financial assistance by way of cash credit,

overdraft and bill discounting.

a) Cash Credit

Cash credit is an arrangement whereby the bank allows the

borrower to draw amounts upto a specified limit. The amount is

credited to the account of the customer. The customer can

withdraw this amount as and when he requires. Interest is charged

on the amount actually withdrawn. Cash Credit is granted as per

agreed terms and conditions with the customers.

b) Overdraft

Overdraft is also a credit facility granted by bank. A customer

who has a current account with the bank is allowed to withdraw

more than the amount of credit balance in his account. It is a

temporary arrangement. Overdraft facility with a specified limit

is allowed either on the security of assets, or on personal security,

or both.

c) Discounting of Bills

Banks provide short-term finance by discounting bills, that is,

making payment of the amount before the due date of the bills

after deducting a certain rate of discount. The party gets the

funds without waiting for the date of maturity of the bills. In

case any bill is dishonoured on the due date, the bank can recover

the amount from the customer.

ii) Secondary functions

Besides the primary functions of accepting deposits and lending money,

banks perform a number of other functions which are called secondary

functions. These are as follows -

a) Issuing letters of credit, travellers cheques, circular notes etc.

b) Undertaking safe custody of valuables, important documents, and

securities by providing safe deposit vaults or lockers;

c) Providing customers with facilities of foreign exchange.

d) Transferring money from one place to another; and from one

branch to another branch of the bank.

e) Standing guarantee on behalf of its customers, for making

payments for purchase of goods, machinery, vehicles etc.

f) Collecting and supplying business information;

g) Issuing demand drafts and pay orders; and,

h) Providing reports on the credit worthiness of customers. 


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