Primary Functions — Lending Money

Accepting deposits is only half of a bank's core function — a bank then lends out a large part of those deposits (keeping a prudent reserve, per RBI's cash reserve and liquidity rules) to earn interest, which is how the bank itself makes a profit and how the wider economy gets access to credit for trade and industry. Banks lend money mainly through the following forms:

• Loans. A specific sum is sanctioned and paid to the borrower in a lump sum (or in agreed instalments), for a fixed period, usually against security/collateral. Interest is charged on the full sanctioned amount from the date of disbursement, regardless of how much the borrower has actually used, and is usually repaid in equated instalments.
• Cash Credit. The bank sanctions a certain credit limit against the security of stock/goods/receivables, and the borrower can withdraw up to that limit as and when needed, repaying and re-drawing repeatedly within the sanctioned limit. Interest is charged only on the amount actually withdrawn (outstanding balance), not on the full sanctioned limit — this makes it a popular working-capital facility for traders and manufacturers.
• Overdraft. A facility mainly attached to a Current Account, allowing the account holder to withdraw more than the balance actually standing in the account, up to a pre-approved limit, for a short period. Like cash credit, interest is charged only on the amount actually overdrawn, not on the full sanctioned limit.
• Discounting of Bills of Exchange. A trader holding a bill of exchange that will mature (be paid) at a future date can get it "discounted" by the bank immediately — the bank pays the trader the bill's value minus a discount (effectively the bank's interest for the remaining period) and itself collects the full amount from the party liable to pay when the bill matures. This gives the trader immediate cash without waiting for the bill's maturity date.