A commercial bank is a financial institution which
performs the functions of accepting deposits from the general public and giving loans for investment with the aim of earning profit. In fact, commercial banks, as their name suggests, axe profit-seeking institutions, i.e., they do banking business to earn profit. Functions The two most distinctive features of a commercial bank are borrowing and lending, i.e., acceptance of deposits and lending of money to projects to earn Interest (profit). The difference between the rates is called ‘spread’ which is appropriated by the banks. Functions of commercial banks are classified in to two main categories—(A) Primary functions and (B) Secondary functions. Primary Functions: 1. It accepts deposits: Deposits are of three types as under: (i) Current account deposits: (ii) Fixed deposits (Time deposits): (iii) Savings account deposits: 2. It gives loans and advances: (i) Cash Credit: (ii) Demand Loans: (iii) Short-term Loans: Investment: Commercial banks invest their surplus fund in 3 types of securities: (i) Government securities, (ii) Other approved securities and (iii) Other securities. Banks earn interest on these securities. (B) Secondary (i) Discounting bills ofFunctions: exchange or bundles: (ii) Overdraft facility:. Difference between Overdraft facility and Loan: 1. Overdraft is made without security in current account but loans are given against security. 2. In the case of loan, the borrower has to pay interest on full amount sanctioned but in the case of overdraft, the borrower is given the facility of borrowing only as much as he requires. 3. Whereas the borrower of loan pays Interest on amount outstanding against him but customer of overdraft pays interest on the daily balance. Secondary Functions: (iii) Agency functions of the bank The bank acts as an agent of its customers and gets commission for performing agency functions as under:- (i) Transfer of funds (ii) Collection of funds (iii) Payments of various items (iv) Purchase and sale of shares and securities (vii) Letters of References Secondary Functions: The banks provide many general utility services, some of which are as under: (i) Traveller’s cheques (ii) Locker facility. (iii) Underwriting securities issued by government, public or private bodies. (iv) Purchase and sale of foreign exchange (currency). Types of Commercial Banks: Scheduled banks are those banks which are included in Second Schedule of Reserve Bank of India. Non-scheduled Banks: The banks which are not included in Second Schedule of RBI are known as non-scheduled banks. Other types of Banks: Industrial Banks provide finance to industrial concerns by subscribing (buying) shares and debentures of companies and also give long-term loans to acquire machinery, plants, etc. Foreign Exchange Banks are commercial banks which are branches of foreign banks and facilitate international financial transactions through buying and selling of foreign bills. Agricultural Banks finance agriculture and provide long-term loans for buying tractors and installing tube-wells. Post office saving bank. Cooperative Banks are organised by the people for their own collective benefits. Lending principles of Banks Banks follow the following principles of lending: 1. Liquidity 2. Safety 3. Diversity 4. Stability 5. Profitability Priority Sector lending The objective of priority sector lending program is to ensure that adequate credit flows into some of the vulnerable sectors of the economy, which may not be attractive for the banks from the point of view of profitability. These sectors include agriculture, small scale enterprises, retail trade, etc. Small housing loans, loans to individuals for pursuing education, loans to weaker sections of the society etc also qualify as priority sector loans. Priority Sector The RBI guidelines requirelending banks to lend at least 40% of Adjusted Net Bank Credit (ANBC) or credit equivalent amount of Off-Balance Sheet Exposure (CEOBSE), whichever is higher. In case of foreign banks, the target for priority sector advances is 32% of ANBC or CEOBSE, whichever is higher. A bank having shortfall in lending to priority sector lending target or sub-target shall be required to make contribution to the Rural Infrastructure Development Fund (RIDF) established with NABARD or funds with other financial institutions as specified by the RBI. Export Credit RBI requires banks to make loans to exporters at concessional rates of interest. Export credit is provided for pre-shipment and post-shipment requirements of exporter borrowers in rupees and foreign currencies. At the end of any fiscal year, 12.0% of a bank's credit is required to be in the form of export credit. This requirement is in addition to the priority sector lending requirement but credits extended to exporters that are small scale industries or small businesses may also meet part of the priority sector lending requirement. Retail Loan Banks offer a range of retail asset products, including home loans, automobile loans, personal loans (for marriage, medical expenses etc), credit cards, consumer loans (such as TV sets, personal computers etc) and, loans against time deposits and loans against shares. Banks also may fund dealers who sell automobiles, two wheelers, consumer durables and commercial vehicles. Retail Loan Customers for retail loans are typically middle and high-income, salaried or self-employed individuals, and, in some cases, proprietorship and partnership firms. Except for personal loans and credit through credit cards, banks stipulate that (a) a certain percentage of the cost of the asset (such as a home or a TV set) sought to be financed by the loan, to be borne by the borrower and (b) that the loans are secured by the asset financed. Home Finance: Banks extend home finance loans, either directly or through home finance subsidiaries. Such long term housing loans are provided to individuals and corporations and also given as construction finance to builders. The loans are secured by a mortgage of the property financed. These loans are extended for maturities generally ranging from five to fifteen years and a large proportion of these loans are at floating rates of interest. Fixed rate loans may also be provided; usually with banks keeping a higher margin over benchmark rates in order to compensate for higher interest rate risk. Equated monthly installments are fixed for repayment of loans depending upon the income and age of the borrower(s). Personal Loans: These are often unsecured loans provided to customers who use these funds for various purposes such as higher education, medical expenses, social events and holidays. Sometimes collateral security in the form of physical and financial assets may be available for securing the personal loan. Portfolio of personal loans also includes micro-banking loans, which are relatively small value loans extended to lower income customers in urban and rural areas. International Loans Extended by Banks Indian corporate raise foreign currency loans from banks based in India as well as abroad as per guidelines issued by RBI/ Government of India. Banks raise funds abroad for on-lending to Indian corporate. Further, banks based in India have an access to deposits placed by Non Resident Indians (NRIs) in the form of FCNR (B) deposits, which can be used by banks in India for on-lending to Indian customers. Significance of Commercial Banks: (i) They promote savings and accelerate the rate of capital formation. (ii) They are source of finance and credit for trade and industry. (iii) They promote balanced regional development by opening branches in backward areas. (iv) Bank credit enables entrepreneurs to innovate and invest which accelerates the process of economic development. (v) They help in promoting large-scale production and growth of priority sectors such as agriculture, small-scale industry, retail trade and export. (vi) They create credit in the sense that they are able to give more loans and advances than the cash position of the depositor’s permits. (vii)They help commerce and industry to expand their field of operation. (viii) Thus, they make optimum utilisation of resources possible.