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Banking
Commercial Bank
Commercial bank is an institution which performs the functions of accepting deposits,
granting loans and making investments with the aim of earning profits.

Functions of a Commercial Bank

Primary functions
Accepting deposits

Current account deposits or demand deposits -

Repayable by the banks on demand.

Generally maintained by businessmen.

Can be drawn upon by a cheque without any restrictions.

No interest is paid on these accounts.

Service charges are imposed for running these accounts.

Fixed deposits or time deposits -

The amount is deposited with the bank for a fixed period of time.

No chequable facility.

High rate of interest.

Savings deposits -

Cheque facility is available but restrictions are imposed on number and amount of
withdrawals.

Lower rate of interest than fixed deposits.

Advancing loans

Cash credit - Loan given to the borrower against his current assets likes shares,
stocks, bonds, etc.

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 Demand loans - Loans which can be recalled on demand by the bank at any time.

Term loans/short term loans - Personal loans given against some collateral security.

Secondary Functions
Overdraft facility - Customer is allowed to overdraw his current account upto an agreed
limit.

Discounting bills of exchange - Holder of a bill of exchange can get the bill discounted
with the bank before maturity.

Agency function -

Transfer of funds

Collection and payment of various items

Purchase and sale of foreign exchange

Purchase and sale of securities

Income tax consultancy

Letters of reference

General utility functions:

Locker facility

Traveller’s cheques

Letter of credit

Underwriting securities

Collection of statistics

Money Creation
Through the process of money creation, commercial banks are able to create credit,
which is in far excess of initial deposits.

It is legally compulsory for banks to keep a certain minimum fraction of their deposits as
reserves.

Legal reserve ratio (LRR)

Cash reserve ratio (CRR) - part of LRR kept in central bank.

Statutory Liquid Ratio (SLR) - part of LRR kept with commercial banks

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 Money multiplier or deposit multiplier measures the amount of money that Banks are
able to create in the form of deposits with every unit of money it keeps as reserves.

Money multiplier = 1/LRR

Central Bank
Central Bank is an ‘apex’ body that controls, operates, regulates and directs the entire
banking and monetary structure of the country.

RBI was established in INdia on 1st April 1935 under Reserve Bank of India Act, 1934.

Functions of Central Bank:

Currency authority:

Uniformity in note circulation

Power to influence money supply

Government supervision and control over Central Bank.

Public faith in currency system.

Stabilisation of internal and external value of currency.

Banker to the government:

Maintains current account for keeping cash balances.

Accepts receipts and makes payments for the government and carries out
exchange, remittance and other banking operations.

Gives loans and advances to the government for temporary periods.

Banker’s bank and supervisor:

Custodian of cash reserves

Lender of last resort

Clearing house

Controller of money supply and credit:

Repo purchase rate - Repo rate is the rate at which central bank of a country
lends money to commercial banks to meet their short-term needs.

Bank rate - Bank rate is the rate at which the central bank of a country lends
money to commercial banks to meet their long-term needs.

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 Open market operations - OMO refers to buying and selling of government
securities by the Central Bank from/to the public and commercial banks.

Legal reserve requirements -

CRR

SLR

Margin requirements - Difference between the amount of loan and market value
of the security offered by the borrower against the loan.

Other instruments of credit control:

Moral suasion - It is a combination of persuasion and pressure that Central

Bank applies on other banks in order to get them to act in a particular manner,
in line with its policies.

Selective credit controls - The Central Bank gives directions to other banks to
give or not to give credit for certain purposes to particular sectors.

Central Bank Vs Commercial Bank

Basis Central Bank Commercial Bank

Meaning An apex body that controls, An institution which performs the functions
operates, regulates and directs the of accepting deposits, granting loans and

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 entire banking and monetary making investments with the objective of
structure of the country. making profits.

It is merely a unit in the banking structure of

It is the apex institution in the
Status the country and operates under the control
money market.
of the central bank.
It is generally owned and governed It can be owned and governed by the
Ownership
by the government. government or private sector.

It operates in public interest

Objective It aims to maximise profit.
without profit motive.

It has sole monopoly in issue of

Issue of Currency It has no power to issue currency.
currency.

It does not deal directly with the

Public Dealing It deals directly with the public.
public.

There is only one central bank in a

There are a number of commercial banks in
Number of Banks country due to peculiar nature of its
a country.
activities.

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