Economics · Ch 4 — Banking and Monetary Policy
Commercial Banks: Meaning and Functions
Commercial Banks: Meaning and Functions
A commercial bank is a financial institution licensed to accept deposits from the public and to grant loans and advances for the purpose of earning profit. Commercial banks act as intermediaries between savers and borrowers, and their smooth functioning is central to any modern economy — the Gujarat Std-12 Economics syllabus places this chapter right after the study of money and inflation for exactly this reason: banks are the institutions through which the money supply actually moves.
Primary Functions
Commercial banks perform two broad primary functions:
1. Accepting Deposits — Banks mobilise the savings of the public through different kinds of accounts:
| Type of Deposit | Nature | Interest | Withdrawal |
|---|---|---|---|
| Savings Deposit | For small, regular savers | Low rate of interest | Limited withdrawals permitted |
| Current Deposit | Mainly for businesses/traders | Usually no interest | Withdrawable any number of times, on demand |
| Fixed (Time) Deposit | Deposited for a fixed period | Highest rate of interest | Withdrawable only after maturity (premature withdrawal attracts penalty) |
| Recurring Deposit | Fixed sum deposited every month | Interest close to fixed deposits | Lump sum paid at the end of the agreed period |
2. Granting Loans and Advances — Banks lend the deposited funds (retaining only a fraction as reserve) in several forms: term loans, cash credit, overdraft facilities, and discounting of bills of exchange. This lending activity is precisely what allows banks to create credit, covered in the next section.
Secondary (Agency and General Utility) Functions
Besides the two primary functions, commercial banks also perform:
- Agency functions — collecting cheques, dividends and interest on behalf of customers; making payments of insurance premia, rent and bills on standing instructions; acting as a trustee or executor.
- General utility functions — issuing letters of credit and travellers' cheques, providing safe-deposit lockers, underwriting shares and debentures, and providing foreign-exchange facilities.
A bank that failed to perform its lending function well would still be safe, but it would fail the economy's need for credit — which is why the scale at which a bank can safely lend, discussed next, matters so much to policymakers.
A financial institution that accepts deposits from the public and lends money to individuals and businesses, in order to earn a profit.
A short-term loan arrangement in which a borrower is allowed to withdraw up to a sanctioned limit against a pledge of goods or securities, paying interest only on the amount actually utilised.