Analysing Functions Of Commercial Banks (2024)

A commercial bank is a financial organisation that accepts deposits from the general public and provides loans for investment to make a profit. In reality, commercial banks, as their name implies, target profit-seeking institutions, i.e., they perform banking to make money.

They usually use short-term loans to finance trade and commerce. They offer borrowers a high-interest rate but pay their depositors a significantly lower rate, resulting in the disparity between the two interest rates becoming the banks’ primary source of profit. From the preceding definitions, we conclude that banks’ primary functions are to receive deposits, lend these deposits, and allow deposits to withdraw funds through a check whenever they choose.

Primary Functions

The primary functions of the bank are to receive deposits and make loans.

• Accepting Deposits: Commercial banks view accepting monetary deposits from the public as their primary function, promising reimbursem*nt upon request by check, order, or other means. The commercial bank promotes cash flow to the deficit units by raising funds from the surplus units. They participate in financial intermediation and profit as a result of this. As a result, they rely on deposits to raise capital from units with a cash surplus. These deposits are included in the Commercial Bank Liabilities section of the balance sheet.

These deposits can be categorised into three categories:

1. Current Deposits orDemand Deposits – By writing checks, demand deposits can be transferred to other people. These demand deposits do not pay interest.
2. Savings Deposits – By writing checks, demand deposits can be transferred to other people. These demand deposits do not pay interest.
3. Fixed Deposits – Deposits that may be redeemed after the expiration date are fixed deposits. For these, a higher interest rate is charged. Fixed deposits provide the advantage of getting a loan by pledging the fixed deposit if needed.

• Providing of loans: Commercial banks must lend the deposits they acquire to another individual to generate a profit. Individuals can borrow money from commercial banks for several reasons.

1. Providing loans to entrepreneurs for factory building
2. Providing higher education loans to students
3. Providing consumer loans for the purchase of automobiles
4. Providing loans to the Treasury to cover the government’s cash shortfall

Importance of commercial banks

The importance of commercial banks in the economy is vast. They provide a necessary service to customers, but they also assist in creating capital and liquidity in the market.

They maintain liquidity by borrowing monies from their clients’ accounts and lending them out to others. Commercial banks help create credit, which leads to increased production, employment, and consumer spending, all of which help grow the economy.

Commercial banks provide loans with collateral. Commercial bank loans may be split into two kinds according to the payback time:

• Short Term Loans

1. Overdrafts
2. Short-term loans are available.
3. Make a money call

• Long Term Loans

1. Loans for the acquisition of fixed assets
2. Loans for the start-up of a business
3. Loans for commercial reasons
4. Loans to launch businesses

Because commercial banks can earn from lending, they are included as assets on their balance sheet. These are also referred to as earnings assets since they generate revenue for the bank.

The importance of Commercial banks’ lending serves three purposes:

1. The flow of production in the economy
2. Increasing the economy’s added value
3. Increasing the economy’s profit

Secondary functions

1. Overdraft Facility: This secondary function allows a customer to overdraw his current account up to a certain limit. This service is usually provided to reputable and trustworthy consumers for a limited time. Customers must pay interest to the bank on any amounts they have overdrawn.

2. Discounting Bills of Exchange: This secondary function allows the holder of a bill of exchange to have it discounted with a bank before its maturity date. After subtracting the fee, the bank returns the remaining funds to the account holder. The bank receives money from the party who accepted the note upon maturity.

3. Agency Purposes: Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients.

Conclusion

Economic progress needs a well-functioning financial sector with effective payment and financing mechanisms. Given banks’ importance in infrastructure maintenance, the biggest risk is that a crisis would disrupt the payment system, as was warned during the 2008 financial crisis. Excessive lending can damage economic development, even though money facilitates growth. Many European countries’ public and private debts have reached record levels. Lending is pro-cyclical, with an increase in good times and contraction in bad times, harmful to balanced economic development. There are issues with credit allocation in addition to the volume of loans. Mortgages and interbank loans, in particular, have increased dramatically, raising questions about whether the existing type and amount of these products are sustainable.