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Functions of Commercial Banks

Introduction
Commercial banks play a crucial role in our financial system. They facilitate the flow of funds,
offer various banking services, and contribute to economic growth. In this comprehensive
document, we will explore the primary and secondary functions of commercial banks, along with
their significance.

Table of Contents
1. Introduction
2. Primary Functions
o Accepting Deposits
o Providing Loans and Advances
o Credit Creation
3. Secondary Functions
o Discounting Bills of Exchange
o Overdraft Facility
o Purchasing and Selling Securities
o Locker Facilities
o Paying and Collecting Credit
4. Types of Commercial Banks
o Private Banks
o Public Sector Banks
o Foreign Banks
5. Importance of Commercial Banks in the Economy
6. Conclusion

Primary Functions
1. Accepting Deposits

 Commercial banks accept deposits from the public, including savings, current, and fixed deposits.
 These surplus balances collected from individuals and firms serve as a source of funds for lending
and investment activities.

2. Providing Loans and Advances

 A critical function of commercial banks is to offer loans and advances to entrepreneurs,

businesses, and individuals.
 Different types of loans include demand loans, overdrafts, cash credits, and short-term loans.

3. Credit Creation

 When a customer is granted credit or a loan, the bank doesn’t provide liquid cash directly.
 Instead, a bank opens an account for the customer and transfers the money to that account,
effectively creating money in the process.

Secondary Functions
1. Discounting Bills of Exchange

 Commercial banks facilitate the discounting of bills of exchange.

 Bills of exchange are written agreements acknowledging the amount of money to be paid for
goods purchased at a future date.

2. Overdraft Facility

 Banks offer an overdraft facility to customers with current accounts.

 Customers can overdraw up to a specified limit.

3. Purchasing and Selling Securities

 Commercial banks provide the facility to buy and sell securities.

 This includes government bonds, corporate bonds, and other financial instruments.

4. Locker Facilities

 Banks offer safe deposit lockers to customers for storing valuables and important documents.
 Customers pay an annual fee for this service.

5. Paying and Collecting Credit

 Banks use instruments like promissory notes, cheques, and bills of exchange for transactions.

Types of Commercial Banks

1. Private Banks

 Owned by private individuals and businesses.

 Registered as companies with limited liability.
 Examples include Housing Development Finance Corporation (HDFC) Bank, Industrial Credit and
Investment Corporation of India (ICICI) Bank, and Yes Bank.

2. Public Sector Banks

 Owned and operated by the government.

 Serve the public interest and contribute to economic development.

3. Foreign Banks

 Operate in a country other than their home country.

 Provide international banking services.

Importance of Commercial Banks in the Economy

 Commercial banks ensure economic stability, promote investment, and facilitate trade and
commerce.
 They are essential for our financial system, ensuring sustainable growth.

Conclusion
Commercial banks are the backbone of our financial infrastructure. Understanding their functions
and significance is crucial for anyone interested in finance and economics

Functions of Commercial Banks

Introduction
Commercial banks play a crucial role in our financial system. They facilitate the flow of funds,
offer various banking services, and contribute to economic growth. In this comprehensive
document, we will delve deeper into their functions and explore their significance through real-
life examples.

Primary Functions
1. Accepting Deposits

 Real-Life Example: Imagine a small business owner, Sarah, who wants to save money for future
expansion. She deposits her surplus funds into a savings account at her local commercial bank.
The bank pays her interest on the deposit, and Sarah’s money becomes part of the bank’s pool of
funds for lending to other borrowers.

2. Providing Loans and Advances

 Real-Life Example: John, an entrepreneur, approaches a commercial bank for a business loan to
purchase new machinery. The bank evaluates his creditworthiness, approves the loan, and
disburses the funds. John can now expand his business, hire more employees, and contribute to
economic growth.

3. Credit Creation

 Real-Life Example: When a bank grants a home loan to a family, it doesn’t physically transfer
cash. Instead, it credits the borrower’s account with the loan amount. This process effectively
creates new money in the economy, stimulating economic activity.

Secondary Functions
1. Discounting Bills of Exchange

 Real-Life Example: An exporter sells goods to an overseas buyer and receives a bill of exchange.
The exporter can discount this bill at a commercial bank, receiving immediate cash. The bank
holds the bill until maturity and collects the payment from the buyer.

2. Overdraft Facility

 Real-Life Example: Mary, a business owner, faces a temporary cash crunch. She uses the
overdraft facility provided by her bank to cover urgent expenses. The bank allows her to
withdraw more than her account balance (up to a specified limit) without prior approval.

3. Purchasing and Selling Securities

 Real-Life Example: Commercial banks invest in government bonds, corporate bonds, and stocks.
By doing so, they contribute to capital markets’ liquidity and stability. For instance, a bank
purchasing government bonds helps finance public infrastructure projects.

4. Locker Facilities

 Real-Life Example: Individuals and businesses rent safe deposit lockers at banks to safeguard
valuable items, important documents, and family heirlooms. These lockers provide security and
peace of mind.

5. Paying and Collecting Credit

 Real-Life Example: When you write a check to pay your utility bills, the bank acts as an
intermediary. It debits your account and credits the recipient’s account. Similarly, when you
receive a salary through direct deposit, the bank facilitates the process.

Importance of Commercial Banks in the Economy

 Economic Stability: Commercial banks stabilize the economy by managing money supply,
controlling inflation, and ensuring financial stability.
 Investment and Growth: They channel funds from savers to borrowers, promoting investment in
businesses, infrastructure, and innovation.
 Trade and Commerce: Banks facilitate international trade by providing letters of credit, foreign
exchange services, and trade financing.
 Financial Inclusion: They extend banking services to the unbanked population, promoting
financial literacy and inclusion.

Conclusion
Commercial banks are the backbone of our financial infrastructure. Understanding their functions
and real-world impact is essential for anyone interested in finance and economics. As we
continue to evolve, these institutions will remain vital for economic progress. 🏦💰