Students, by studying this chapter, will be familiar with
various commercial banks which play vital roles in the current world-economy.
They will know about major and distinct aims and functions of commercial banks,
their role in building the society, support in import and export, transfer of
funds and development of agriculture and industry.
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Commercial Banks
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After we have studied this chapter, we will know about
*Objectives and
functions of commercial banks.
*Sources of income
and funds of commercial banks.
Introduction to Commercial Banks
We generally mean commercial banks by the word ‘bank’.
Commercial banking system has come through a lot of modernization and
specialization through ages. Usually commercial banks collect money from people
that are surplus after meeting their essential requirements and lend it to the
borrowers. A commercial bank is a profit oriented organization that makes
profit by making deposit, transaction and lending of money.
So ‘The type of organizations which make transaction of
money or service exchangeable through money, are called commercial bank.’
Objectives of Commercial Banks
Although commercial banks are mainly established for making
profit, they have some other objectives. Objectives of commercial banks are
discussed below:
1. Making Profit:
Commercial banks are established with the fundamental objective of making
profit.
2. Medium of
Exchange: Commercial banks introduce cheques, bills of exchange etc. as
mediums of exchange.
3. Capital Formation:
Collecting surplus money from the people and formation of capital is one of the
main objectives of commercial banks.
4. Welfare of People:
Public welfare is an indirect objective of commercial banks.
5. Assisting in
Regulation of Loans: Participating and assisting the central bank in
formation of loan policy and loan regulation is one of the objectives of
commercial banks.
6. Assisting in
Planning and Implementation: Another purpose of commercial banks is to
assist the central bank in proper development planning and implementation.
7. Proper Distribution
of Wealth: Ensuring proper distribution of wealth by developing all sectors
of economy in an equal pace through using monetary assets is another major goal
of commercial banks.
8. Employment
Generation: A purpose of commercial banks is to create opportunities for
new employment by increasing economic activities.
9. Mitigating Gap
between Rich and Poor: Through collecting deposit and offering loans,
commercial banks enable participation of all class of people in economic
activities, which help mitigate economic gaps between rich and poor classes of
the society.
10. Forming a
Saving-tendency: Another purpose of commercial banks is to create a saving
tendency among people.
11. Security:
Ensuring security of money, valuable ornaments of people is one of the purposes
of commercial banks.
12. Economic Stability: Another purpose of commercial
banks is to ensure economic stability by meeting the demand of funds in
the market through providing loans and by working in line with the central
bank’s loan policy.
13. Development of Trade and Industries: An important
purpose of commercial banks is to develop trade and industries by
providing all-out support in import and export.
14. Improving Standard of Living: Improving standard
of living by ensuring overall economic development is also a goal of
commercial banks.
Functions of Commercial Banks
As a monetary organization, banks provide various kinds of
service in industrial, commercial, social and economic development of a
country. We can divide the functions of banks into two categories:
A) Main Functions
B) Special and Other Functions.
A) Main Functions
1. Acceptance of Deposit and Advancing of interest: One
of the main functions of commercial banks is to accept surplus money of
the clients in various types of deposits, such as current, savings and fixed
deposit. A bank pays interests to the holders of fixed and savings accounts on
their deposited amounts in certain rates. No interest is allowed for the
current accounts but various other facilities are offered to them.
2. Granting Loans and Charging Interests: Banks offer
loans to the borrowers from the deposited money of their clients in
various terms. Granting loan is an important function of a bank. Because by
providing loans, a bank facilitates productive economic activities on one hand,
and on the other hand, the amount of interest received from the borrowers is
its main source of income. A bank charges higher rate of interest to its
borrowers than the rate of interest it offers to the clients. The extra amount
received from the borrowers is a bank’s operational income.
3. Creation of Loan Deposit: When a bank sanctions a
loan to the customer, a deposit account is opened in his name and the
amount is credited to his account. Then, the amount of money withdrawn by the
borrower is debited from that account. In this way banks create deposits by
sanctioning loans.
4. Creating Medium of Exchange: Banks use cheque,
bill of exchange, certificate, bank draft, pay order, debit card, credit
card etc. as payment mechanism and medium of financial transaction.
5. Creation of Capital: Banks create capital by
accumulating all separate savings of people through different accounts.
6. Issue Notes: Notes are usually not issued by
commercial banks but by central bank. But commercial banks issue notes
in indirect forms. Thus, sometimes bank cheques serve as a medium of exchange
as an alternative to notes issued by the government.
7. Service as Trustee: Commercial banks serve as
trustee of properties of their customers and issue solvency certificates
to them.
8. Assistance in Import and Export: An importer needs
to convert local currency into foreign currency while an exporter needs
to convert foreign to local currency, which is one of the functions of banks.
Moreover, banks arrange for payment to the exporters on behalf of the importers
through letter of credits (LC) in international business. Letter of Credit
plays an important role in international trade by creating financial and
business connections between importers and exporters. Providing operative
assistance and suggestions in import and export related functions are
representative jobs of commercial banks.
9. Service as a Government Treasury: Central bank or
any other selected bank serves as the treasury of the government.
10. Change Bill of Exchange, Bill of Transport etc.: Banks
change bills of exchange, bills of transport etc. in favor of its
clients.
Special and Other Functions
1. Investment of Capital: Besides accepting loans,
banks invest capital in industrial plants and commercial organizations,
which help increase gross national production and capital mobilization.
2. Role in Economic Growth: Banks help a country’s
overall economic growth, especially development of trade, commerce,
transportation, communication, housing and education etc.
3. Money Transfer: Banks transfer money inside and
outside the country through their mediums of exchange.
4. Security of Money: Banks ensure security of public
money by keeping deposits. Besides, clients can also protect ornaments,
documents of their properties in banks by using locker service.
5. Guidance: Offering various types of business
guidance when sought by the clients and management of their properties,
for example, collecting house rents are also included in the functions of
banks.
6. Employment Generation: As a monetary organization,
banks help in employment generation and indirectly create new
employments by supplying loans in a country’s economy.
7. Loan Regulation: As the regulator, central bank
regulates supply of money and loans by expanding and contracting loans
given by the commercial banks. This is vital for ensuring economic stability
and regulating inflation of money.
8. Agricultural Development: Banks facilitate
agricultural development by offering loans and other assistance in this
sector.
9. Industrial Development: Banks assist industrial
plants by offering long-term loans.
10. Regional Development: Regional development is
also supported by banks as they have network of branches in different
areas of the country.
Sources of Funds of Commercial Banks
Commercial banks usually collect funds from the following
sources, some of which are external
sources and some of which are internal
sources.
1. Paid Capital: First and foremost source of banks
is paid capital. The capital is provided by the owners
for Joint
Stock Company, and in cases of joint capital company, capital is formed by
issuing shares.
2. Reserve fund: At the time of declaring dividend, a
certain portion of the profit is set aside every year which is called
reserve fund. This is fund is used as capital in future.
3. Deposits: Public deposits are a powerful source of
funds to a commercial bank. There are three types of bank deposits (i)
current deposits (ii) saving deposits and (iii) time deposits, which the
clients do not withdraw all at once. So, the bank can earn more capital by
using this money as loans or business investment.
4. Borrowing: Commercial banks in times of emergency
borrow loans from the central bank or from other commercial banks of the
country. They can also raise funds by issuing security bonds, credit certificates
etc.
Sources of Income of Commercial Banks
Commercial banks earn money through different businesses,
which are detailed below
1. Interest on Loans: Commercial banks lend money to
the industrialists, traders or consumers, and charge interest on the
loans. This is their main source of their income.
2. Investment: Commercial banks earn profit by
investing in profitable sectors like shares,
issuing letters of credit, government security etc.
3. Bill Discount: Commercial banks also earn money by
making discounted payment of bills of exchange in advance.
4. Commission Received
from Bank draft, Travellers cheque etc.: Commercial banks earn a big amount
of money by charging commissions on bank drafts, traveller’s cheques etc.
5. Correspondence:
Commercial banks also earn money through charges received by offering various
correspondence services for the clients at their request.
6. Rent of Lockers:
People can use lockers of commercial banks for safekeeping of their valuable
documents, ornaments etc. by paying certain charges, which is also a source of
income of the commercial banks.
7. Agency Service: Commercial
banks perform numerous agency services on behalf of their clients, such as
collection and payment of cheques or bills etc. Commercial banks charge
commission for such services which earn income for them.
8. Brokerage in
Purchase or Trade of Shares: Banks also earn through brokerage in
purchasing or trading shares.
9. Foreign Exchange:
Commercial banks earn profit by acting as brokers in foreign exchange, too.
10. Import-Export:
Commercial banks earn income through commission or service charges for the role
it plays in international trade and transactions.
11. Letter of Credit:
Banks charge commissions for issuing letters of credit on behalf of
importers.
12. Trustee:
Banks also charge commissions for performing services as trustee.
Expenditures of Commercial Banks
Commercial banks make following expenditure in operating its
business:
1. Giving interest to the clients on their deposits
2. Giving interest to the central bank on the borrowed
amount
3. Giving interest to commercial banks for the received
loans
4. Payment of salaries and allowances to the employees
5. Allowances of directors and managers
6. Auditor’s charges
7. Charges for cases or other legal measures for collecting
unrecovered loans
8. Rent for offices and warehouses
9. Tariffs and taxes
10. Insurance Premium
11. Charges for making correspondence through post office,
telephone, telex, fax, swift etc.
12. Advertisement cost
13. Training charges of the employees
More
topics about Banking and Finance…
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