Q.Explain the functions of commercial banks with an example of each.

• Acceptance of deposits — through current, savings and fixed accounts (e.g., a fixed deposit earns higher interest than a savings account).
• Lending of funds — as overdrafts, cash credits, discounting of bills, term loans and consumer credit (e.g., a term loan to a factory).
• Cheque facility — collecting customers' cheques; bearer (encashed at the counter) and crossed (deposited into the payee's account).
• Remittance of funds — transferring money via bank drafts, pay orders or mail transfers (e.g., a draft sent to another city).
• Allied services — bill payments, locker facilities, underwriting, buying/selling shares, paying insurance premiums, collecting dividends.

Why banks perform these functions

A bank is both a borrower (paying interest on deposits) and a lender (earning interest on loans); the margin between the two is its profit. Deposits are therefore the basis of a bank's lending. Its functions divide into primary (basic) functions and agency or general-utility services.

• Acceptance of deposits — deposits are the basis of a bank's lending. They are taken through three main accounts:
  • Current account — withdrawable up to the balance at any time without prior notice (used by businesses).
  • Savings account — meant to encourage saving; interest is paid at RBI-decided rates, with some restrictions on the amount and number of withdrawals.
  • Fixed (time) deposit — carries a higher rate of interest than a savings account; premature withdrawal is allowed but a part of the interest is forfeited. Example: a customer places money in a fixed deposit for two years to earn a higher rate than a savings account.
• Lending of funds — the bank lends the money received as deposits in the form of overdrafts, cash credits, discounting of trade bills, term loans, consumer credit and other advances, greatly supporting trade, industry and transport. Example: a manufacturer takes a term loan to buy new machinery.
• Cheque facility — banks collect customers' cheques drawn on other banks. The cheque is the most developed credit instrument and a convenient, inexpensive medium for withdrawing deposits. There are two kinds:
  • Bearer cheque — encashable immediately at the bank counter.
  • Crossed cheque — can only be deposited into the payee's account. Example: a trader deposits a crossed cheque received from a customer into his own account.
• Remittance of funds — because branches are interconnected, banks transfer funds from one place to another using bank drafts, pay orders or mail transfers on nominal commission; the payee presents the draft at the drawee bank and collects the amount. Example: a person buys a bank draft to send money to a supplier in another city.
• Allied services — banks also provide bill payments, locker facilities and underwriting services, buy and sell shares and debentures on instructions, and perform personal services such as paying insurance premiums and collecting dividends. Example: a customer authorises the bank to pay his insurance premium and collect dividends on his shares.