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Yes, commercial banks issue credit cards to eligible customers based on their creditworthiness.
How do commercial banks make money?
Commercial banks make a profit through interest on loans, charges from products and services, and investment in the stock market.
How are commercial banks regulated?
Commercial banks are regulated by central banks and financial regulatory authorities to maintain stability and compliance with legislation.
What is the significance of commercial banks in the economy?
Commercial banks help boost the economy by offering funds for investments, supporting enterprises, and allowing efficient financial transactions.
Are commercial banks safe?
Yes, commercial banks are generally safe as they are insured by government agencies, protecting deposits up to a certain limit.
Functions of Commercial Banks, Meaning, Types and Importance
Learn the meaning, primary & secondary functions, importance, and types of commercial banks. Explore how these financial institutions drive economic growth and stability.
Izhar Ahmad16 Dec, 2024
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Commercial banks assist us with numerous banking operations, such as managing our savings accounts, depositing and withdrawing cash, and so on, so we see that these banks are constantly at our disposal. These are commercial banks that exist solely to serve the general public.
Commercial banks perform many additional functions in addition to those listed above. What exactly are these functions? What is the significance of these banks? Our review of Commercial Bank functions will address all of these concerns.
What is Commercial Bank?
A Commercial bank is a form of financial organization that regulates all actions relating to money deposits and withdrawals for the common public, as well as investment loans and other similar operations. They are profit-making enterprises that do business only for profit.
Lending and borrowing represent the two essential qualities of a commercial bank. The bank collects deposits and disperses funds among different activities to produce interest. One of the rates is the interest that a bank offers depositors, which is the borrowing rate. The other interest rate is the one a bank lends money, which is the lending rate.
Functions of Commercial Banks
Commercial banks have two main categories of functions. These functions are vital for the functioning of the economy and form the core activities of these financial institutions.
Primary Functions of Commercial Banks
Accepts deposits:
The bank accepts savings, current, and fixed deposits as deposits. Surplus balances obtained from firms and individuals are lent to meet the short-term needs of commercial activities.
Loans and advances:
Another important role of this bank is to provide loans and advances to entrepreneurs and business persons while collecting interest. It is the principal source of earnings for every bank. In this method, a bank holds a limited number of deposits as a reserve and gives (lends) the remainder to borrowers in the form of demand loans, overdrafts, cash credit, short-term loans, and other products.
Credit cash:
When a customer receives credit or a loan, they do not receive liquid cash. The customer's bank account is opened first, and then the funds are sent to the account. This procedure enables the bank to generate money.
Secondary functions of Commercial Banks
Discounting bills of exchange:
A written agreement confirming the amount of money to be paid against items acquired at a future date. The sum can potentially be cleared before the given period by using a commercial bank's discounting process.
Overdraft facility:
An overdraft facility allows a customer to overdraw their current account up to a certain limit.
Buying and selling securities:
The bank provides you with the option of selling and buying securities.
Locker facilities:
A bank provides customers with lockers in which to store valuables or papers. For this service, banks charge a minimum of an annual fee.
Paying and collecting credit:
It employs various tools such as promissory notes, cheques, and bills of exchange.
Importance of Commercial Banks
Commercial banks serve an essential role in the financial system, particularly assisting in economic stability and prosperity. Their importance can be summed up as follows:
Resource Mobilization
Commercial banks act as intermediaries between savers and borrowers, efficiently channeling resources where they are most needed:
Collecting Deposits:
By encouraging savings through accounts like fixed deposits, savings accounts, and recurring deposits, banks mobilize funds from individuals and businesses.
Redirecting Resources:
These collected funds are then allocated to productive sectors of the economy, such as agriculture, manufacturing, and infrastructure development. This resource mobilization fosters economic activity and increases national productivity.
For instance, the funds deposited by small savers in a bank can be used to finance large-scale projects like building roads, factories, or hospitals, thereby contributing to economic growth.
Credit Facilitation
The ability to provide loans and credit is one of the most critical functions of commercial banks. They offer financial support to individuals, businesses, and even governments:
Supporting Entrepreneurship:
By extending credit to startups and small businesses, commercial banks enable entrepreneurs to launch and grow their ventures.
Investment in Businesses:
Established businesses rely on bank loans for expansion, purchasing machinery, or upgrading technology.
Consumer Loans:
Banks also provide personal loans, home loans, and vehicle loans, which boost consumer spending and drive demand in the economy.
The credit services provided by banks not only generate revenue for the banks through interest rates but also stimulate overall economic development.
Transaction Efficiency
Commercial banks simplify and accelerate financial transactions, making the process more efficient for individuals and businesses:
Modern Banking Services:
With advancements like online banking, mobile banking, and electronic fund transfers, banks have revolutionized the way money is handled.
Convenience:
Debit and credit cards allow for seamless purchases, while cheque clearing services and automated payment systems enhance operational efficiency.
Real-Time Transfers:
Through systems like NEFT, RTGS, and IMPS, customers can transfer funds securely and instantly, saving time and effort.
These services reduce reliance on cash transactions, increase transparency, and improve the overall efficiency of the financial system.
Safe Custody
Banks provide a secure environment for safeguarding money and other valuables:
Deposits Safety:
Funds stored in banks are protected by regulatory frameworks, ensuring depositors' money remains secure even in times of economic instability.
Locker Facilities:
Commercial banks offer locker services for the safe storage of important documents, jewelry, and other valuables.
Insurance Cover:
Deposits are often insured up to a certain limit by government or regulatory agencies, further enhancing customer trust.
This trust encourages more people to store their savings in banks rather than keeping them at home, thereby increasing overall financial security.
Risk Diversification
Commercial banks play a significant role in managing and mitigating risks in the economy:
Lending Across Sectors:
Banks diversify their loan portfolios by lending to various industries such as agriculture, manufacturing, real estate, and services. This reduces the impact of sector-specific downturns.
Financial Stability:
By spreading risks, banks ensure their solvency, which is crucial for maintaining stability in the financial ecosystem.
Support During Crises:
In times of economic distress, commercial banks can assist by providing critical funds and liquidity to struggling sectors, helping them recover.
For example, during economic slowdowns, banks can offer restructured loans or reduce interest rates to alleviate financial stress on businesses and individuals.
Monetary Policy Implementation
Commercial banks are instrumental in helping central banks implement monetary policies effectively:
Money Supply Regulation:
Central banks influence money supply and interest rates through commercial banks. For instance, by adjusting the repo rate, central banks can encourage or discourage lending by commercial banks.
Credit Control:
Commercial banks follow guidelines set by central banks to manage inflation or deflation by controlling credit flow in the economy.
Economic Stabilization:
During periods of inflation, banks may raise interest rates to reduce borrowing, while during recessions, lower rates can stimulate borrowing and investment.
By acting as intermediaries for central banks, commercial banks play a pivotal role in ensuring economic stability.
Economic Growth
Commercial banks contribute significantly to national development by funding essential activities:
Business Expansion:
By providing capital for businesses to grow and innovate, banks drive economic progress.
Employment Generation:
Loans extended to industries and startups create job opportunities across various sectors.
Infrastructure Development:
Banks finance infrastructure projects like roads, railways, and power plants, which are crucial for economic development.
In essence, the financial support provided by commercial banks is a key driver of economic growth, enabling societies to prosper and achieve higher standards of living.
Types of Commercial Banks
There exist three distinct categories of commercial banks, each with unique ownership structures and operational scopes:
Private Banks:
These sort of banks are ones where the main ownership is by private persons and enterprises. Private banks are companies with limited liability. These include HDFC Bank, ICICI Bank, and Yes Bank.
Public Banks:
Public banks, on the other hand, are nationalized institutions where the government holds a significant stake. Notable examples of public banks include the Bank of Baroda, State Bank of India (SBI), Dena Bank, Corporation Bank, and Punjab National Bank. Some of the public banks are the Bank of Baroda, State Bank of India (SBI), Dena Bank, Corporation Bank, and Punjab National Bank
Foreign Banks:
The third category is made up of foreign banks that have opened branches in foreign countries. However, they are global in nature and their clients are distributed all over the planet. American Express Bank, Hong Kong and Shanghai Banking Corporation (HSBC), Standard Chartered Bank, and Citibank are examples of overseas banks.
Commercial banks play a fundamental role in financial intermediation and economic growth. By connecting savers and borrowers, they ensure efficient resource allocation. Understanding their functions and importance helps appreciate their contribution to the economy.
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