According to Indian Banking Regulation Act, 1949, commercial banking involves, “the accepting for the purpose of lending or investment, the deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, and order or otherwise.”
All these definitions lay emphasis on acceptance of chequable deposits from public and their use in lending and investing as the main features of the activities of a commercial bank. A close look at activities of a commercial bank would reveal that the definitions given so far focus on two core functions of a traditional commercial bank.
They are accepting chequable deposits from public and lending or investing them. Many non-bank financial institutions also perform them but a modern commercial bank does much more than that. A comprehensive definition, as said earlier, is difficult but a workable definition that may spell the changing character of a commercial bank is very much called for.
One such definition is attempted here. A commercial bank is an institution characterised for accepting chequable deposits, lending or investing them, and, more so, performing a host of other financial, commercial and agential services for their customers.
It, therefore, becomes essential to enumerate the functions of a modern commercial bank to provide an idea of what a commercial bank actually does. Here is the list of these functions:
1. Accepting Deposits:
Commercial banks accept three types of deposits:
(a) Fixed or Term Deposits: Money in fixed deposit accounts is accepted for a fixed period, varying from a few months to a few years. Money so deposited can’t be withdrawn before the expiry of the term. Interest offered by banks on such deposits is higher than that offered on other deposits.
In fact, the longer the period of the fixed deposit, the higher the rate of interest offered by a commercial bank. A variant of the term deposits is the recurring deposit in which deposits of specified amounts are made at regular intervals with an objective of raising a desired sum of money at the end of the period.
(b) Current Account Deposits: These deposits are often made and maintained by business houses. They qualify for unrestricted withdrawals, up to the limit of the deposit, through cheques. No interest accrues on such deposits. Periodic statements of transactions are provided by the banks for the benefit of the depositors.
(c) Savings Account Deposits: Such deposits qualify for interest but don’t enjoy unrestricted withdrawal facility. This however does not imply that they are non-chequable. Withdrawals can be made through cheques or through withdrawal-slips but under certain restrictions that vary from bank to bank.
Some banks permit two or three withdrawals per week while others permit more. Depositors are required to maintain a certain minimum balance in the accounts to continue to enjoy the benefits of these deposits. In monetary analysis, deposits were classified as demand deposits and time deposits.
The fixed or the term deposits are classified as the time deposits while current and savings account fall into the category of demand deposits.
2. Advancing Loans:
The deposits received by the banks are not allowed to remain idle as the vault cash. Banks have to pay interest on time and savings deposits for which, and also for raising funds to meet their own expenditures on running their establishments, they resort to lending or investing the deposits. For this, commercial banks grant various types of loans and advances to individuals and business houses. Some of these are introduced below:
(a) Cash Credit: It refers to the credit limit granted to a borrower on the basis of his creditworthiness determined by his assets such as listed shares, bonds and securities, fixed deposit certificates, LIC policies, goods-in-trade, inventory stocks, movable assets such as vehicles, and immovable assets such as land, building, etc.
Usually paper assets such as securities and bills receivable of legal authenticity are pledged, movable assets such as vehicles are hypothecated and immovable assets are mortgaged to the bank by the borrowers for availing of such facility.
The amount granted is credited in the borrower’s account from which the borrower keeps withdrawing as and when need arises. He can even make deposits in the cash credit account. Bank charges interest only on that portion of the credit limit which is actually utilized and the charge is only for that period over which it is utilized.
The tenure of such facility is 1 year subject to its renewal year after year by the bank. Interest charged is higher when the facility is availed against goods-in-trade or inventory stocks or movable or immovable assets than when it is availed against securities.
This is so due to higher liquidity possessed by these securities. Some multinational banks such as ABN Amro Bank and Standard Chartered Bank have started granting Clean Cash Credit facility to borrowers of repute without any security.
Interest charged on such credit facility is even higher than that charged on cash credit availed against movable and immovable assets.
(b) Demand Loans: Such loans are granted against the security of financial assets, goods, or personal credit worthiness. Entire loan amount is credited to the loan account of the borrower and is chargeable to interest.
It can be recalled by the bank at any point of time. The borrowers are usually the security brokers whose credit requirements vary from day to day. Bankers use the term ‘money at call’ or ‘call money’ for these loans in their balance sheets. In liquidity, such loans rank next only to cash in-hand.
(c) Short-term Loans: Such loans are meant for short periods. They include personal loans (granted as unsecured loans for a period not exceeding 5yrs) and working capital loans (granted as secured loans for short periods).
In respect of such loans entire loan amount is credited to the loan account of the borrower and is chargeable to interest. In case of personal loans, repayment is made through Equated Monthly Installments (EMIs) spread over the period of loan; but in respect of the working capital loans, repayment may be made through a single installment at the end.
(d) Discounting Bills of Exchange: The most common way of extending credit to the business houses is through discounting their bills of exchange. The tenure of the loan is the period of maturity of the document and the amount of loan is equal to the discounted value of the bill of exchange, discounted at standard rates.
A bill of exchange is a document that acknowledges an amount of money owed by the issuer in consideration of the consignment of goods received. On receipt of the bill of exchange, the supplier of the goods may present the same before his bank for immediate encashment. The bank deducts its commission from the present value of the document and releases the rest.
At the maturity of the bill, it is presented before its issuer for its encashment. Cost of such loans has two parts—first, the discounting bank’s commission and second, the excess of the face value over the present value of the bill at the time of discounting.
(e) Long Term Loans: Such loans are fully secured loans. The period of such loans is long, extending up to 25 years depending on the borrower’s preference. Repayment is spread over the entire period of loan and is usually made through EMIs. Home loans provide an example.
(f) Overdrafts: An overdraft refers to a temporary credit facility granted to a current account holder for a period of 3 months at the maximum. It is usually done against the pledge of paper-assets such as listed shares and debentures, or even against the assignment by the borrower of the LIC policies or the fixed deposit certificates to the bank.
The borrower can draw from the account up to the overdraft-limit granted to him, over and above the current account balance. Interest is charged on the credit used by the borrower but it is lower than that charged on the clean cash credit or the cash credit availed against movable and immovable assets.
In common man’s language, the terms cash credit and overdraft are used inter-changeably but the two are not the same, as is clear from the discussions above. The main points of difference relate to, first, the tenure, which is 3 months in case of an overdraft and 1 year in case of a cash credit and, second, the existence of a current account with the lending bank, which is just in case of overdraft but not so in case of cash credit.
3. Investment of Funds:
Commercial banks invest idle funds in government securities and in securities approved under the Indian Banking Regulation Act, 1949. Investment in such securities is mandatory for them under the Statutory Liquidity Ratio (SLR) requirement. Commercial banks have a tendency to overinvest in these securities despite lower returns. This they do mainly for high liquidity possessed by these securities. They can always avail of loans against them from RBI or can even sell them in open market whenever they need cash.
4. Agency Functions of the Commercial Banks:
Commercial banks act as agents of their customers in following matters:
(à) Remittance of Funds: Commercial banks help their customers in sending money from one place to another through drafts, mail and telegraphic transfers at nominal charges.
(b) Collection of Funds: Commercial banks help their customers in collection of funds through cheques, drafts, hundis and bills.
(c) Sale and Purchase of Shares: Commercial banks help their customers by undertaking sale and purchase of shares on behalf of their customers.
(d) Collection of Dividends: Commercial banks help their customers by collecting dividends and interests accruing on their shares and debentures.
(e) Payments of Bills: Commercial banks help their customers by making payments of their bills and insurance premia.
(f) Execution and Trusteeship of Will: Commercial banks act as executors and trustees of the customer’s will.
(g) Tax Consultancy: Commercial banks undertake to act as income tax consultants to their customers as also to make tax payments on behalf of them.
(h) Collection of Documents: Commercial banks collect documents showing despatch of consignments through air and sea passages. This is convenient not only to the customers but also to the bank. For example, collection of documents of loading the consignments if entrusted to the bank helps the bank as well as the customers at the time of discounting the letters of credit.
(i) Sale and Purchase of Foreign Exchange: Commercial banks undertake to buy and sell foreign exchange for their customers.
(j) Safe Custody of Valuables: Commercial banks provide lockers for safe custody of customer’s valuables.
(k) Purchase of Movable and Immovable Assets: Commercial banks represent their customers in sale-purchase of assets so that the authenticity of title deeds and their transfer may be ascertained to avoid the chances of cheating in the deal.
(I) Underwriting Activities: Commercial banks act as underwriters of share capital issued by the customer companies. An underwriter is usually a business house of high repute or a commercial bank prepared to buy the unsold portion of the new issue of the share capital.
From the discussions above, it is clear that commercial banks not only deal in money matters but also render a number of services in the interest of their customers. A modern business can’t run without the cooperation of their commercial banks.