Primary functions consist of accepting deposits, lending money and investment of funds.
Bank receives idle savings of people in the form of deposits. It borrows money in the form of deposits. These deposits may be of any of the following types:
Current or demand deposit
In the case of current deposits money can be deposited and withdrawn at any time. Money can be withdrawn only by means of cheques. Usually a bank does not allow any interest on this kind of deposit because, bank cannot utilize these short term deposits. This type of deposits is generally opened by business people for their convenience. Current account holders should keep a minimum balance of Rs. 2000, to keep the account running.
Fixed or time deposits
These deposits are made for a fixed period. These can be withdrawn only after the expiry of the fixed period for which the deposits have been made. The bank gives higher rate of interest on this deposit. The rate of interest depends upon the duration of deposit. The longer the period the higher will be the rate of interest. For the evidence of the deposit, the banker issues a ‘Fixed Deposit Receipt’.
As the name suggests, this deposit is meant for promotion of savings and thrift among the people. In the case of savings deposits there are certain restrictions on the number of withdrawals or on the amount that can be withdrawn per week. A minimum balance of Rs. 100 should be maintained and if cheque book facility is allowed, the minimum balance should be Rs. 1000. On the savings deposit, the rate of interest is less than that on the fixed deposit.
This is one form of savings deposit. In this type of deposit, at the end of every week or month, a fixed amount is deposited regularly. The amount can be withdrawn only after the expiry of the specified period. This deposit works on the maxim ‘little drops of water make a big ocean’. It may be opened for monthly installments in sums of Rs. 100 or in multiples of Rs. 100 with a maximum of Rs. 1000.
Lending constitutes the second function f a commercial bank. Out of the deposits received, a bank lends money to the traders and businessmen. Money is lent usually for short periods only. A commercial bank lends in any one of the following ways:
In case of loan, the banker advances a lump sum for a certain period at an agreed rate of interest. The amount granted as loan is first credited in the borrower’s account. He can withdraw this amount at any time. The interest is charged for the full amount sanctioned whether he withdraws the money from this account or not. Loan is granted with or without security.
Cash credit is an arrangement by which the customer is allowed to borrow money up to a certain limit. The customer can withdraw the amount as and when required. Interest is charged only for the amount withdrawn and not for the whole amount as in the case of loan.
overdraft is an arrangement between a banker and his customer by which the customer is allowed to withdraw over and above the credit balance in the current account up to an agreed limit. The interest is charged only for the amount sanctioned. This is a temporary financial assistance. It is given either on personal security or on the security of assets.
Discounting of bills
Bank grants advances to their customers by discounting bills of exchange or pronote. In other words, money is lent on the security of bill of exchange or pronote. The amount after deducting the interest (discount) from the amount of the bill is credited in the account of the customer. Thus in this form of lending, the interest is received by the banker in advance. Bank, sometimes, purchases the bills instead of discounting them.
Investment of funds
Another function is investing the funds in some securities. While making investment a bank is required to observe three principles, namely liquidity, profitability and safety. A bank invests its funds in government securities issued by central government as well as state government. It also invests in other approved securities like the units of UTI, shares of GIC and LIC, securities of State Electricity Board etc.
It is a unique function of Commercial Banks. When a bank advances loan to its customer if doesn’t lend cash but opens an account in the borrowers name and credits the amount of loan to that account. Thus, whenever a bank grants loan, it creates an equal amount of bank deposits. Creation of deposits is called Credit Creation. In simple words we can define Credit creation as multiple expansions of deposits. Creation of such deposits will results an increase in the stock deposits. Creation of such deposits will results an increase in the stock of money in an economy.