UNIT – I

CHAPTER – 2
Functions of Banks

OBJECTIVES:-
 To know the various kinds of functions rendered by banks
 To understand the agency services performed by bankers
 To understand the general utility services performed by bankers

1. INTRODUCTION
The functions of various banks may be different. In India, Reserve Bank of India
act as the central bank and under its control comes various banks like commercial banks,
cooperative banks, Regional Rural Banks, NABARD (National Bank Agriculture and Rural
Development). But functions of a bank is mainly understood as functions of a commercial
bank.

Functions of Commercial Banks

Primary function Secondary function

(Banking Activities) (Non-Banking Activities)

Accepting Discounting Granting Agency General Utility

Deposits Bills Loans Services Services

Term Cash Over

Loans Credit Drafts

Saving Current Fixed Recurring

Bank A/c A/c Deposit A/c Deposit A/c
2. Primary Functions
2.1 Acceptance of Deposits
A banker can accept various types of deposits like Savings bank account, Current
account, fixed deposit account and recurring Deposit account. Among them the savings bank
account and current account are called “Demand Deposit accounts” and fixed deposits and
recurring deposit accounts are called “Term Deposit or Time Deposit accounts”.
2.1.1 DEMAND DEPOSITS:
A. Savings Account
 Savings account can be opened by any person above the age of 18 and he/she has to be
introduced by another customer of the same branch.
 Now-a-days, banks insist on two copies of photographs of persons intending to open
account.
 In savings account, the credit balance of the customers must be sufficient enough so that
cheques issued by the customers could be honoured.
 If a customer issues a cheque without sufficient credit balance in his/her account, the
cheque will bounce or will be dishonoured.
 The customer who has issued such a cheque will be liable for legal action.
 A savings account can also be opened without a cheque book facility.
 In such a case, the customer will use the withdrawal slip provided by the bank.
 As per the latest guidelines from RBI, the interest on Savings Account is payable
quarterly. The interest is calculated on the daily balance outstanding in the account and is
credited to the account of the customer either on the 1st day of every quarter or a
convenient date, as decided by each bank.
 There is a ceiling on maximum amount that can be kept in credit balance.
 If deposits are kept beyond that limit, no interest will be payable for that excess amount.
 A minor can also open a savings account.

As per the new instructions by RBI, all banks have been asked to calculate interest rate
on savings account on daily basis and so the previous method of calculating interest rate has
been given up. This will benefit bankers, as cash withdrawals will come down and there will be
more arrival of deposits.
B. Current Account
 Unlike savings account, current account cannot be opened by every individual.
 For opening a current account, a letter of introduction is required which testifies the
character and conduct of the persons who intend to open the current account.
 This letter of introduction can be given either by another current account holder of the
same branch or by a well reputed person known to the banker or by an employee not
below the rank of an officer of the same bank.
 If a current account is opened without the letter of introduction, it will be an offence and
the banker will lose statutory protection.
 The advantage of current account is that the customer can draw more than his credit
balance, provided he is given overdraft facility.
 Banker will not pay interest for credit balance of the customer.
 Any debit balance in the current account will be charged interest rate on day-to-day basis,
and this will work out to be cheaper for the customer.
 The cheque book facility is given to all current account holders.
Difference between Savings Account and Current Account
Savings Account Current Account
1. Should always be in credit balance. 1. It can be in credit or debit balance.

2. No overdraft facility provided. 2. Overdraft and cash credit facility provided.

3. Interest is given on minimum credit 3. No interest is provided on credit balance.
balance between 10th and last working day
of each month.
4. Cheque book facility is left to the option of 4. Cheque book is given to all.
customer.
5. No third party cheque is allowed. 5. Third party cheque is allowed with
endorsement if it is order cheque and
without endorsement if it is bearer cheque.
6. Restriction on number of withdrawals. 6. No restriction in number of withdrawals.
7. At the time of opening savings account 7. Letter of introduction is required for
introducer's signature along with 2 opening current account and it is
photographs of the applicant are required. compulsory under Section 131 of N. I. Act.
8. There is a maximum limit of deposits, 8. There is no such maximum limit for
beyond, which interest will not be given. deposits.
2.3 Fixed Deposit
 When a customer deposits certain sum of money to be kept with the banker for a fixed
period, it is called a fixed deposit account.
 The banker will issue a receipt which is called fixed deposit receipt.
 Fixed deposit receipt is non transferable. This means that the amount is payable on
maturity only to that deposit holder in whose name the deposit receipt stands.
 A fixed deposit account can be opened even in the name of a minor.
 The deposit amount is payable along with the interest at the rate as agreed upon.
 A customer has the option to foreclose the deposit even before the date of maturity. In
such a case, the customer will not be entitled to the agreed rate of interest.
 In case of death of the owner, it can be given only to the legal heir.
2.4 Recurring Deposit
 A stipulated amount of money is deposited every month for a fixed period, say one or
two years, which is payable at the expiry of the fixed period along with interest is called
recurring deposit.
 Recurring deposit can be opened either in a bank or even in a post office savings account.
The interest rate on recurring deposits will be higher as they are calculated on a
cumulative basis.

3. Granting of Loans

Granting of loans

Clean loan Secured loan

Pledge Mortgage Hypothecation Assignment

3.1 Clean Loan
Clean Loan is a loan granted by the banker without any security but the banker
safeguards himself by granting clean loan to salaried people on the basis of their future income.
The employer of the salaried person will deduct from the salary and pay to the banker the
instalment amount due on the loan. Thus, a clean loan enables the banker to grant loan to salaried
people. Only condition is that the employment of the borrower should be permanent in nature.

3.2 Secured Loan

Pledge: When loans are granted against the security of the borrower, it is a secured loan.
The borrower will hand over the security to the banker under pledge (Example: Jewel loan).
Pledge is used when the lender (pledgee) takes actual possession of assets
(i.e. certificates, goods). Such securities or goods are movable securities. In this case the
pledgee retains the possession of the goods until the pledgor (i.e. borrower) repays the entire debt
amount. In case there is default by the borrower, the pledgee has a right to sell the goods in his
possession and adjust its proceeds towards the amount due (i.e. principal and interest amount).
Some examples of pledge are Gold /Jewellery Loans, Advance against goods,/stock, Advances
against National Saving Certificates etc.
Mortgage: In mortgage, the loan is granted against fixed immovable property. If the
borrower fails to repay the loan, the mortgaged property will be sold and the loan amount
realised.
Mortgage is used for creating charge against immovable property which includes land,
buildings or anything that is attached to the earth or permanently fastened to anything attached to
the earth (However, it does not include growing crops or grass as they can be easily detached
from the earth). The best example when mortage is created is when someone takes a Housing
Loan / Home Loan. In this case house is mortgaged in favour of the bank / financer but remains
in possession of the borrower, which he uses for himself or even may give on rent.
Hypothecation: Hypothecation is used for creating charge against the security of
movable assets. Hypothecation is a kind of loan wherein the borrower is enabled to purchase a
vehicle or a machinery with the help of bank loan. The document of title will have the mention
of hypothecation for example, R.C. book of vehicle containing hypothecation. If the borrower
fails to repay the loan, the bank will take over the possession of security and dispose the same
towards the recovery of the loan. On the repayment of the loan by the borrower, the
hypothecation will be cancelled.
Assignment : This is transfer of an actionable claim. If the borrower of a bank has an
insurance policy, he can transfer the policy in favour of the bank before its maturity and obtain a
loan. The bank will adjust the loan amount from the policy amount when it is matures.

Difference Between Pledge, Hypothecation and Mortgage at a Glance:

Pledge Hypothecation Mortgage

Type of Security Movable Movable Immovable

Possession of the Remains with lender Remains with Usually Remains with
security (pledgee) Borrower Borrower

Gold Loan, Advance

Car / Vehicle Loans,
Examples of against NSCs, Adv against
Adv against stock Housing Loans
Loan where used goods (also given under
and debtors
hypothecation)

3.3 Overdraft
This is a facility given to the current account holders wherein depending upon their credit
worthiness, the banker grants overdraft facility by which the customer can draw over and above
his credit balance upto a fixed amount. For example, if a customer has Rs. 10,000 in his account
as credit balance, he may be granted an overdraft of Rs. 5,000 by which he can draw upto Rs.
15,000. As and when the customer deposits money or cheque, the loan amount will be adjusted.
The interest rate is calculated on day-to-day basis and hence this interest will be cheaper for the
customer.
3.4 Cash Credit
For the benefit of businessmen who are in need of working capital, cash credit system is
arranged. Under this system, the customer may be given for example, Rs. 1 lakh as credit from
1st January to 31st December. If the customer draws Rs. 30,000 in March and another Rs. 30,000
in August and the remaining Rs. 40,000 in December, the bank will charge interest according to
the period of the loan. The first Rs. 30,000 will carry interest rate for a period of 10 months, the
next Rs. 30,000 will carry interest rate for a period of 5 months and the last loan of Rs. 40,000
will carry interest rate for a period of 1 month. Thus, this system not only leaves certain amount
of money at the disposal of the customer but also carries lesser rate of interest.

4. Secondary function
Agency Services

a) Collecting cheque, bills and pronotes for customers.

b) Payment of bills (Telephone bills, insurance premium etc) on standing

instruction of customers.
c) Purchasing or selling securities as per customer’s instructions.

d) Collecting dividend and interest warrants on various securities.

e) Undertakes to transfer funds from one branch to another.

f) Acting as Trustee or Executor of will for the customer.

g) Disperses salary to employees on instruction of the employer.

General Utility Services

1) On permission of RBI the bank purchases or sells foreign exchange.

2) Banker acts as “Drawee in case of need” by accepting bills on behalf of customer.

3) On behalf of importer the banker issues letter of credit to the exporter.

4) Providing safe deposit vault in which customers can keep their valuables.

5) Banker undertakes merchant banking activity (underwriting of shares and debentures).

6) Bank also supplies data and trade information required by businessmen.

7) On behalf of the Government bank mobilises huge amount of foreign

exchange for investing in infrastructure.
4.1 Agency Services
1) Banker acts as an agent to the customer. When a customer deposits cheques, draft, bills or
any other promissory notes, the banker collects them and on realisation credits the
account of the customer. For this activity, the banker is given commission.

2) As the customer has to pay certain periodical payments such as monthly, quarterly, half
yearly, the banker is informed by a standing instruction. Thus, club subscription,
insurance premium, road tax, electricity charges and telephone bills of the customers are
paid by the bank after debiting the customer’s account.

3) As the customer may be a shareholder or debentureholder of companies, he will be

receiving dividend warrants and interest warrants, which will be deposited by the
customer in the bank. The bank will collect the same and credit it to the account of
respective customers.

4) When customers are left with huge amount of money in their account, they can be
invested in company securities for capital appreciation or for getting a good return. The
banker will be able to advise the customers as he has the services of experts.

5) When customers die suddenly leaving behind minor children, the court may appoint the
banker to act as executor of will. Similarly, in the case of certain companies, the bank
may act as trustee for their property in the interest of creditors of the company.

6) In certain business transactions, payments are made with the help of banks by transferring
funds to different centres. In the present days, these transfers could be made within few
hours through electronic media. We have electronic transfer with the help of computers.

7) In the case of foreign transactions or even domestic transactions, the banks will undertake
collection of funds on behalf of customers.

8) In a huge factory, employing thousands of persons, salary disbursement can be done

through bank branches. The salary of the employee will be credited to his individual
account every month and he can either make cheque payment or even withdraw cash.

9) On the basis of the credit worthiness of the customer, banks issue credit card. The
purchases made by customers by using the credit card are being settled by the banker and
 later on the banker collects the amount from the customer. In rural areas, the farmers are
given green cards by which they are enabled to purchase agricultural inputs on credit.
They will repay amount to the bank after the harvest.

4.2 General Utility Services

1) RBI allows certain branches to undertake foreign exchange transactions. They are called
authorised dealers. The bank purchases and sells foreign currency at the rate prescribed
by RBI.

2) The bank enables foreign trade by issuing letter of credit on behalf of the importer. It is a
letter of guarantee and that enables the importer to purchase goods.

3) In the case of foreign trade or domestic trade, bankers accept bills on behalf of customers
and make payment on the due date on these bills. Later on, they collect from the
customers.

4) In order to promote capital market and to encourage issue of shares both in the primary
market and secondary market, the banker acts as an under- writer for certain companies.
This will enable the companies to sell their shares.

5) The bank provides safe custody of valuables by providing safe deposit vaults. However,
the bank will not give any guarantee for the safety of valuables. The relationship here is
only that of a tenant and owner. And the banker as owner, collects rent for the safe
deposit vault. This has been explained in detail in the following paragraphs.

4.2.1 Safe Deposit Vault and Safe Custody Deposit

Commercial banks provide safe deposit vault to its customers. It is a safety locker with
different sizes provided to the customers according to their requirements. When a customer
wishes to open a safe deposit vault account, the banker will insist on the customer opening an
account with him. The customer will have to pay rent for the safe deposit vault which is collected
annually. The safe deposit vault will have two key holes of which one key will be with the
customer and the other key which is called the master key will be with the banker. The locker
can be opened only when both keys are simultaneously operated.
After opening a safe deposit locker account, a locker number is given to the customer. If
the customer wishes to operate the locker vault, he/she will have to fill up the locker register
before entering the locker room in the bank. The locker register will contain date, time, name of
the locker holder and his/her signature. The time in and time out will have to be notified by the
customer. The entry of the customer in the locker room will be kept confidential and even the
banker, after helping to open the locker with his master key will come out of the locker room,
leaving the customer alone. Thus, the operation of the locker by the customer is kept strictly a
secret and the banker will not know the contents of the locker.

5. Modern Functions of Commercial Banks

1) ATM-Automatic Teller Machine: Under this system, a customer can withdraw money by
using his credit card. The customer who wants to avail ATM facility will be given a code
number, which will be kept secret by the customer. On the basis of credit limit, a
customer is allowed to draw money from the ATM.

2) Home Banking: Instead of going to the bank for withdrawal of money or for depositing
of cheques, a customer can do his banking business by sitting at home. For this purpose,
the personal computer of the customer will be connected with the bank's computer
through a network. The customer will have a secret code for operating his account from
home. He will instruct the bank for different payments. Similarly, he will also receive
credit from his debtors.

3) Green card: In India, credit card facility is given to the farmers by issue of Green card to
them. This will enable them to buy all their inputs by using the Green card. They can buy
seeds, fertilizers and pesticides through this card. Thus, the bank is providing credit to the
farmers by this Green card.

4) Factoring: Commercial banks in India are undertaking factoring business. Under this, the
bills drawn by customers on the buyer will be handed over to the bank for collection. The
bank will pay 80% of the value of the bill to the customer and the balance 20% will be
paid after realising the bill from the buyer. For this purpose, the bank will be paid
factoring commission. SBI and Canara Bank were the two banks which initially started
factoring business. Other banks are now undertaking factoring business.

5) Mutual funds: To enable the customers to avail the benefit of investments, banks in India
have started mutual funds. The savings of the customers are invested in mutual funds by
 purchase of units. The bank, after mobilising the funds, invest the same in various
company securities. Every day, the bank will give the value of the units in the form of
Net Present Value, which is calculated by the total value of investments divided by the
total number of units. This NPV may change according to the fluctuations in the market
value. It is the endeavor of every bank to maintain a higher NPV.

6) Electronic Clearing System (ECS): The telephone charges are being paid through this
system. The banks are connected to the telephone department through a network by
which, the telephone charges of the customers are paid. The customers will present their
telephone bills to the bank which intimates electronically to the telephone department and
the bills are paid by the bank. The use of computers in the payment of telephone bills is
called ECS.

7) Gold or Platinum Card: Generally, customers are given credit card facility through the
banks according to their credit worthiness.

8) Gold Banking: It is a scheme introduced in 2000-2001 budget year by the Union finance
minister and State Bank of India is the first bank in India to introduce Gold Deposit
Scheme.

9) E-Banking: e-Banking refers to electronic banking, wherein the entire operations are
done by the customer through his computer system by using a code, which maintains
secrecy of transactions. The customer will be instructing the banker through the computer
with regard to transfer, investment and repayment of loans or appropriation of different
payments.

10) Innovative Banking

When banks deviate from their traditional functioning of accepting deposits and
lending for various activities, such functions come under innovative banking. In India,
particularly, after the nationalization of major scheduled banks in 1969, banks started
lending to certain new areas which were neglected beforehand. For example, (i) loans
given to weaker sections, (ii) to self-employment schemes and also (iii) to manual
rickshaw-pullers for switching over to power-driven vehicles.
 11) Discounting of Foreign Bills/Forfaiting

This is an arrangement under which the exporter is provided finance against his
bills by the forfaiting bank. In domestic trade, it is discounting of bills whereas in foreign
trade, it is discounting of foreign bill in favour of the exporter. The risk of the bill is
completely borne by the bank which is forfaiting the export bill. For this purpose, the
importer and the importer’s bank will be contacted by the forfaiting bank. Thus, it is an
understanding between the exporter’s bank, forfaiting bank and the importer’s bank. Due
to this, the exporters are able to get finance immediately after export and the risk of bad
debts is eliminated.

12) Core Banking

It is a device whereby a bank will link all its branches through a network system.
By this method, a customer will be able to operate his account in any of the branches of a
particular bank. Under core banking, the account number of customer will have 10 digits
(which will reflect the city, the branch and the account of the customer of a bank). This
enables a customer to operate his account throughout the country from any branch of that
particular bank.
Example: If a person has an account in SBI, Tiruchirapalli Main Branch , he can
operate his account through any branch of SBI in any part of India, provided all the
branches of SBI are brought under single network. Through this, transfer of funds,
collection of cheques are made easy and both the customer as well as banks are benefited
as there will be increasing activity of banking operations with fewer cash transactions. In
a way, this will prevent the generation of unaccounted money.

CONCLUSION
A modern banker provides various primary functions and in addition various subsidiary
services to his customers. It includes various agency services in which the banker acts on behalf
of his customer. Bankers also provide numerous other services which are meant for general
utility of customers and public. The latest services are inter bank money transfer and various
foreign exchange related services.
 EXERCISES
Short Answer questions
1. What do you mean by a savings Bank account?
2. Define a Current Account.
3. What are Term deposit Accounts?
4. What is a Clean Loan?
5. Explain pledge.
6. What is charge on immovable properties?
Big Answer Questions
1. Explain the primary functions of a Banker.
2. Enumerate the agency services rendered by banks.
3. Write short notes on facility of Safe Deposit Lockers and Safe custody articles provided
by bankers.
4. What are the general utility services rendered by banks?