Functions of Commercial Banks

The functions of a commercial bank are conveniently grouped under three heads — primary functions, secondary (agency) functions, and general utility functions. The primary functions are the ones that define banking itself; the others are services the bank provides using the machinery it already possesses.

A. Primary functions

1. Accepting deposits. This is the bank's first and most fundamental function — mobilising the idle savings of the community. Deposits are accepted in several forms, each suited to a different kind of depositor:

• Current account (demand) deposits — kept mainly by traders and businesses; money can be paid in and withdrawn any number of times by cheque, but the bank pays little or no interest because it must keep such funds ready at all times.
• Savings account deposits — meant for households and small savers; withdrawals are allowed with some restrictions and the bank pays a modest rate of interest, encouraging the habit of saving.
• Fixed (term) deposits — a sum placed for a fixed period at a higher rate of interest; the bank can lend such money more freely because it knows the date of repayment.
• Recurring deposits — a fixed sum paid in every month for an agreed period, combining regular saving with a higher rate of interest than an ordinary savings account.

2. Advancing loans. The bank lends the deposits it has collected — this is where most of its income arises. The main forms of lending are:

• Cash credit — the borrower is allowed to draw up to a sanctioned limit against the security of stock or other assets, paying interest only on the amount actually used.
• Overdraft — a current-account holder is permitted to overdraw the account up to an agreed limit for a short period.
• Term loans / demand loans — a fixed sum lent for a stated purpose, repayable in instalments or on demand.
• Discounting of bills of exchange — the bank pays the holder of a bill its value less a discount before the bill matures, giving the trader immediate cash.

3. Credit creation. By the very act of granting a loan the bank creates a fresh deposit in the borrower's account, so the banking system as a whole multiplies the community's deposits far beyond the cash originally paid in. This function is important enough to be treated separately below.

B. Secondary (agency) functions — services the bank performs on behalf of its customers, usually for a small commission:

• Collecting and paying cheques, bills and other instruments.
• Collecting dividends, interest and rent, and paying insurance premia, taxes and other recurring dues on standing instructions.
• Buying and selling securities on the customer's behalf.
• Acting as trustee, executor or attorney where the customer so appoints it.
• Remitting funds from one place to another by draft or electronic transfer.

C. General utility functions — services offered to the public at large using the bank's facilities:

• Issuing bank drafts, pay orders and travellers' cheques. …