A General Study on the Functions of Commercial Banks Dr. Saeed T.V. Department of Islamic Studies, Yobe State University, Damaturu, Nigeria Abstract- Commercial banks provide many functions and services like accepting deposits, giving loans, mortgage function, etc. Its services are divergent forms of investment banking system in its norms and activities of brokerage, security services, etc. The modern banks perform a variety of functions. the commercial and other types of banks introduce a lot of functions and services rendered to the public people, its customers, businessmen and tradesmen. But, these banks are resorted to pursue with the imposition of interest rates in its various operations. It is because; the banks are being operated to make profit for the sake of the banks. Anyhow, it is not allowed as far as a Muslim is concerned to approach such operations of the bank and live along with the interest rates. Although accepting deposit and providing loans are the two basic functions of commercial banks, the other functions are used into its appropriate places due to the necessity of conditions. This study will lighten on the major functions of the commercial banks in a general approach. I. INTRODUCTION The banking system is very common in the present world. There are different kinds of the banks working in all parts. Every bank has some particular rules and regulations. At the same time all commercial banks have some general rules which are used widely in their activities. The functions of commercial banks are based on these rules. This research is an enquiry on the functions of commercial banks. Every commercial bank has primary functions and secondary functions. These functions will illustrate a clear picture on banking services and the basic ways of banking system. II. PRIMARY FUNCTIONS Primary banking functions of the commercial banks include the followings: 1. Acceptance of deposits 2. Advancing loans 3. Creation of credit 4. Financing domestic and foreign trade 5. Remittance of funds A. Acceptance of Deposits As the commercial banks are in the enterprise of borrowing money, accepting deposits is main function to absorb the required and excess amount of money to pursue and make profit by itself 1. There are mainly three types of deposits the banks absorb. They are: (a) Current Deposits (b) Savings Deposits, and (c) Fixed Deposits. (a) Current Deposits: the deposit amounts in the current deposits are necessarily payable on demand which its customers can withdraw with no restriction usually by cheques 2. The main feature of this type of deposit is 1 N. Emmanuel Roussakis, Commercial Banking in an Era of Deregulation (West Port: Greenwood Publishing Group, 1997), 7 2 Vinay Dutta & Kanhaiya Singh, Commercial Bank Management.(New Delhi: Tata McGraw-Hill Education (India) Private Ltd, 2013), 482 596 Dr. Saeed T.V.
that there is no imposition of interest rate in this. But, the customer is required to deposit a minimum balance prescribed by the bank and keep it undrawn. The bank imposes certain incidental charge on the customer for the services on them. As it gives much importance to paying on demand, it is also known as demand deposit. These deposits are kept by businessmen and industrialists who receive and make large payments through banks. The bank levies certain incidental charges on the customer for the services rendered by it. (b) Savings Deposits: This is meant mainly for professional men and middle class people to help them deposit their small savings. Mainly, this type of deposit is used by a large numbers of small depositors as they are able to deposit from their regular incomes into this, take back the amount of money on demand as they wish and also earn interest on the balance left in the account 3. It can be opened without any introduction. Money can be deposited at any time but it is allowed to a bounded extent of amount as prescribed the central banks. So, this restriction provides valid information that this type of account couldn t be opened by big trading firms and large business firms. Similarly, institutions such as government departments and government bodies, local authorities, etc. cannot take membership in savings bank accounts. 4 Besides, there is a legitimate bounded ambit on the withdrawal from this deposit as the customer needs to provide a prior notice to withdraw a certain amount more than the normal stipulated amount. Unlike current deposit, interest is levied on this type of deposit lower than that of fixed deposit 5. (c) Fixed Deposits: These deposits are also known as time deposits 6. This kind of deposits is for a fixed term from few days to few years. As its term is fixed, in regular condition, no withdrawal could be possible before the completion of tenure at any way. If he is dire exigent, then he can borrow another type of money on the security of this account along with giving a higher rate of interest to the bank. The customers are attracted to this by acquirement of high amount of interest. In India, they are accepted between three months and ten years. Unlike current deposits, the savings and fixed deposit are non-transaction deposits of a bank 7. B. Advancing Loans The another major function of a commercial bank is to give loans and advance to all kinds of its customers primarily to businessmen, investors and other needed people against personal security or other movable or immovable things 8.Really, the bank can make deposit by itself and provide advances and loans in excess of its original deposited amounts. After getting enough confidence of economically self-reliance, the bank gives its customers to draw cheques. Therefore, the loan becomes a deposit to the credit of the customers. That is why, it is said that the the loan creates the deposit 9. The banks use mainly seven methods to provide advance and loans. They are: 1. Bank overdraft 2. Cash Credit 3. Discounting of bills 4. Loans 5. Money at Call 6. Consumer Credit 7. Miscellaneous Advances (a) Bank Overdraft: Overdraft facility has a slight similarity with cash credit facility. This is allowed to only current account holders who used to transact their account through cheques. It is a fluctuating account in 3 Abhijit Rot, Commercial Banking In India: A Beginner s Module, (Bombay: national stock exchange of India limited), 20 4 5 Somashekar, Banks and Banking. 5 6 7 Roussakis, Commercial Banking in an Era of Deregulation,7 8 Rajesh R. & Sivagnanasithi T, Banking Theory: Law And Practice ( New Delhi: Tata McGraw-Hill Publishing Company Ltd, 2007), 83 9 Dr. Rajan Mishra, Industrial Economics and Management Principles (New Delhi: Laxmi Publication Ltd, 2008), 179-180 597 Dr. Saeed T.V.
which the balance sometimes may be in credit and at other times in debit. Overdraft facilities are allowed in current accounts only 10. It is a short term facility which prolongs up to normally 12 months and is able to renew this account on yearly basis 11. This facility is repayable on demand by the bank at any time. Overdraft facility is possible after a written agreement with the bank by which a current account holder is allowed to withdraw a specified amount above the credit balance in his account. Exempli gratia, if the current account holder has a credit balance of Rs.40, 000 and an overdraft limit of Rs. 50,000 is sanctioned to the party, he can draw cheques up to Rs. 90,000. Unlike in the case of loans, here is no imposition of other restricted parameters on withdrawing the amount many times. In fact, as customer is allowed to withdraw as his will many times, the debit balance at any time wouldn t exceed the agreed limit. Sometimes, banks also insist on either a promissory note from the borrower or personal security to ensure safety of funds. The security may be in the forms of government paper, life insurance policy etc. Interest is charged on actual amount withdrawn by the customer 12. The interest rate on overdraft is higher than that of the rate on loan. (b) Cash Credit: A cash credit is essentially a drawing account against credit granted by the bank and is operated in the same way as a current account in which an overdraft limit has been sanctioned. It is granted on a bond of credit or certain other securities. 13 The principal advantages of a cash credit account to a borrower are that, unlike the party borrowing on a fixed loan basis, he may operate the account within the stipulated limit as and when required and can save interest by reducing the debit balance whenever he is in a position to do so. The rate of interest is charged only on the amount of money he actually withdrawn from his credit account and not on the amount placed to the credit of his account 14. The borrower can also provide alternative securities from time to time in conformity with the terms of the advance and according to his own requirements as it is also given against the security of book-debts. If good turnover occurred both in the account and in the goods, and there are no adverse factors, a cash credit limit is allowed to continue for years together. Therefore, a periodical review would be necessary in this system 15. (c) Discounting Bills of Exchange: It is another major kind of bank credit. Banks purchase inland and the foreign bills before they are being responsible of being paid by debtors at discounted value that is; its values are lower than face value 16. This is known as discounting of bills 17. It is really a short term financing mode. Bills of exchange are negotiable instruments. The bank s discount is generally the interest in the full amount for the unexpired bill. Such bills are the way investment for the banks and make possible for commercial transactions both in internal and external trade. Because, the banks provide a very liquid asset which could be convert into cash. The banks have the right debiting its customers unless the bill regularly paid 18. The commercial banks can rediscount the discounted bills with the central banks when they want money. These bills are safe and secured 19. Of course, the banks recover the full amount of these bills from the persons liable to make payment. So, the discounting of bills is a major function of commercial banks. (d) Loan: A loan is a financial transaction in which bank agrees to give its client a certain amount of money with the expectation of total repayment which is comprised of fixed interest rate as per the agreement 20. 10 Gaurav Akrani, Different Forms of Advances by Commercial Banks - Loan Types,<http://kalyancity.blogspot.com/2010/09/different-forms-of-advances-by.html> 11 Over drafts, <http://www.moneysense.gov.sg/understanding-financial-products/credit-and-loans/types-ofloans/overdraft.aspx> 12 Advancing Loans, <http://hema-economics.wikispaces.com/advancing+loans> 13 14 Somashekar, Banks and banking, 5 15 Gaurav Akrani, Different Forms of Advances by Commercial Banks - Loan Types,<http://kalyancity.blogspot.com/2010/09/different-forms-of-advances-by.html> 16 Then the value would be the face value minus interest at current rate of interest for the period of the bill and the bank gives the current rate of the bill to holder. 17 Advancing Loans, <http://hema-economics.wikispaces.com/advancing+loans> 18 Rajesh & Sivagnanasithi. Banking Theory: Law and Practice, 83 19 Somashekar, Banks and banking, 6 20 What is a Loan, <http://www.wisegeek.com/what-is-a-loan.htm> (accessed on 1 December 2013) 598 Dr. Saeed T.V.
Generally, the loan is for a fixed period half a year or full year. The given loan is taken as the credit in the loaner s account, which could be taken back in lump sum or partly by direct, or by cheques. Along with this, a procedure of charging interest rate also occurs imposing on the full loan amount that would be lower than the interest rate of cash credit. Likewise, as it is customary, the loan is given against the security of property or personal security. Its return also would be in lump sum or partly as each bank possesses its own procedures. Therefore, a bank is free to grant loan depending on its own resources as this is very ubiquitous in every nook and cranny of the world. The loan can be provided in two forms 21. They are: 1. Demand Loan 2. Term Loan 1) Demand Loan Demand loan means the loan given paid on the basis of demand from the bank s customers. In this type, the bank gives to its debtor the full loan sum wither in lump sum directly in cash or by depositing it into his bank accounts. Along with this, the banks absorb interest rate, service charges, insurance etc. after legitimating of new orders. Hence, the customer has to return the full amount of loan directly by lump sum or by installations. The interest rate is fixed on monthly basis and the security received on the loan would be personal or in the mode of shares, government papers, commercial papers, etc. 22 2) Term loans Medium and long term loans are called Term loans. Term loans are, normally, provided for more than three years and repayment of such loans is spread over a longer period as pre-agreed decision. The repayment is generally made in suitable installments of fixed amount. These loans are repayable over a period of 5 years and maximum up to 15 years. The main objective behind the term loan is setting up of new business activity, renovation, and modernization, expansion of existing units, purchase of plant and machinery, vehicles, land for setting up a factory, construction of factory building or purchase of other immovable assets. The security measures against this type of loan would be in large level, that is, against the mortgage of land, plant and machinery, building and other securities. The normal rate of interest incurred in such loans is generally quite high 23. C. Creation of Credit Credit creation is a main function of a commercial bank. There is an exposed secret in credit creation of banks that the banks give away a large part of deposits to the borrowers and keep smaller parts of deposits to the customers on demand. Despite, the customers have trust in the operations of bank that their deposits are secured and could be withdrawn on demand. Making capital out of this trust, banks are confident to broaden the area of loans by much more time than the amount of demand deposits possessed by them. This phenomena of the commercial banks to broaden their demand deposits as a multiple of their excess cash reserve is called creation of credit. It constitutes the major component of money supply in the economy. Commercial banks operate credit creation as divergent from other financial institutions. Other financial enterprises transfer money from the lenders to the borrowers 24. Commercial banks while performing the same function, they create credit or bank money also. Professor Sayers says, "Banks are not merely purveyors of money, but in an important sense, they are the manufacturers of money". 25 In the milieu of receiving deposits from the people and providing loan on its basis creates the immediate possibility of credit creation as in this case, the money 21 Advancing Loans, <http://hema-economics.wikispaces.com/advancing+loans> 22 Gaurav Akrani, Different Forms of Advances by Commercial Banks - Loan Types,<http://kalyancity.blogspot.com/2010/09/different-forms-of-advances-by.html> 23 Advancing Loans, <http://hema-economics.wikispaces.com/advancing+loans> 24 http://www.yourarticlelibrary.com/commercial-banks/credit-creation-the-most-important-functions-of-a-commercialbanks/11011/ 25 Mohammed Julfekar Haider, Credit Creation of a Bank; Limitations of a Bank, <http://www.indiastudychannel.com/resources/108889-credit-creation-limitations-bank.aspx> (accessed on 3 January 2014) 599 Dr. Saeed T.V.
could not be withdrawn immediate after the deposit. After receiving the deposits, the banks keep a certain amount from it as reserves which are known as cash reserve ratio and this paves the bank the way to grant loans to the needy persons. Thus, every deposit creates a loan which is kept against some security to the public. But the bank does not give the loan amount directly as the bank opens a bank account in the name of the borrower and deposits the amount in that account. Thus, every loan creates a deposit. The loan amount can be withdrawn through cheques. D. Financing Domestic and Foreign Trade The commercial banks are very keen objective is to acquire ultimate profit by pursuing various kinds of enterprises. So, the commercial banks are very interested to finance on trading and market related operations be it domestic and foreign enterprises. The financing of banks on trade would be mainly via discounting of exchange bills. Likewise, the banks provide loans to the traders largely on foreign related trades against the security of commercial papers. E. Remittance of Funds The other major function of commercial banks is remittance of bank funds and transfer of its money to the needy persons in native places or in other alienated places. One of the major aims of the customers of bank is the transfer of money via banking facilities as it is very simple and reliable. As the commercial banks have a lot of branches in various nook and crannies of the world, they facilitate on ample level for remittance of funds for its customers from one place to another. The commercial banks provide many facilities to remit fund like issuing bank drafts, mail or telegraphic transfers by issuing service charges. The bank drafts have gained more popularity than postal money orders and other elements due to the cheaper cost and simple process of its operation. 26 II. SECONDARY FUNCTIONS The secondary functions of commercial banks are those functions which are not its supreme objectives. The secondary banking functions of the commercial banks include: 1. Agency Services 2. General Utility Services 27 A. Agency Services The commercial banks perform many services behaving like agents. Such functions are known as agent functions. Such functions are either bank-centered or customer-centered. Almost all the agency services of a bank are very need of the people that is why it got enough popularity. The major agency services introduced by the commercial banks are as follows: Purchase and Sale of Securities: Banks purchase and sell various securities like shares, stocks, bonds, debentures on behalf of their customers. i) Transaction with credit elements: the commercial banks get and acquire various credit elements and in other forms, it grant to its customers like the provision of cheques, bills of exchange, promissory notes, other commercial papers, etc. ii) Acts as agent: in some contexts, the banks behave the manners of an agent of its customers as they attain the customers driving license, passports, etc iii) Income-tax Consultancy: the banks are very diligent to employ income tax experts to make income tax returns for their customers to easily get the refund of income tax. 26 Shivani Pachori, Secondary Functions Performed by the Commercial Banks in India, <http://www.shareyouressays.com/117049/secondary-functions-performed-by-the-commercial-banks-in-india> (accessed on 3 November 2013) 27 600 Dr. Saeed T.V.
iv) Acts as Trustee and Executor: banks are sharp in implementing their customers wills and promises provided in their life-time after their death. These wills will have been made in the presence of him and the bank by signing the pertained documents and agreements. v) Collection of Dividends on Shares: Banks accumulate dividends and interest on shares and debentures of their customers and credit them to their accounts. B. General Utility Services Besides these agency services, the banks provide many general utility services for the people in various forms. These kinds of general services are aimed at the public attraction and increasing its feasibility. The main general utility services provided by the banks are as follows: i) Locker Facility: all banks have introduced the locker facility. By the locker facility a person could keep his valuable assets like gold and silver, ornaments, necessary and precious documents by putting it in lockers made by the banks. These assets are out and out safe and could take back at their will by making some incremental charges. ii) Credit Cards: Banks issue credit cards which ill access the customers to refund any amount from the ATMs when he want. This helps him to assure no loss for his money as it is safe in the account of banks. Also, the account holders have no risk of carrying cash in money in their hands. iii) Underwriting Securities: Banks underwrite the shares and debentures issued by the Government, public or private companies. iv) Accepting Bills of Exchange on Behalf of Customers: by accepting the bills of exchange on behalf of customers, it facilitates the customers to import goods and conduct marketing with foreign traders. 28 v) III. SOURCES OF BANK S INCOME A bank is a gorgeous business enterprise which is busy operating the transactions of depositing and loan giving. As it is yielded before many financial risky exertions, it needs a stable and consistent source of income to substantiate the procedures of banking with no anomaly in its normal operations. As the bank is also engaged in borrowing and lending, it can be equipped with enough income only if it borrows in small level and lends at higher rate. The proportion of difference between the two instruments decides the money attainted by the bank along with the amount of profit. Likewise, bank issues many commissions, various levels of interest rate on various enterprises, service charges, increments and other fee on various financial operations of a bank. Actually, such instruments become the significant sources of income for the bank. Here, as a result of examining the details on the banks wealth absorption, four types of main sources of its income are elaborated as follows: 1. Interest on Loans: the main source of income is the interest which the banks charge on the loans provided by it to businessmen, traders, and the customers. The extra yields of money on the loans which the banks absorb through many procedures become a lion s share of the banks major source of income. Various banks, according to its status, charge different levels of interest rates on loans. The interest rates also depend upon the tenure of the loan. When the repayment exceeds the expiry date, then the interest rate may become same as the original amount of the loan. 2. Interest on Investments: on the contrary of loan-giving from the deposits, the banks also invest the money acquired through the current deposits and the fixed deposits in the prescribed shares of Central bank and other governmental enterprise which fetches a high interest reserves and frequent dividends and excess shares to its assets. 3. Discounts: the commercial banks invest a certain amount of its wealth asset in the bills of exchange by discounting them. The banks buy the bills of exchange at discount along with getting its full amount at the date of maturity. Really, discount is a kind of interest on the sum provided for the further period of the bill. However, the interest rate on the bills is smaller than the interest rate of loans for being highly liquid assets. 28 601 Dr. Saeed T.V.
4. Increments, Brokerage, Commission, etc.: for many financial operations and transactions, banks charge various types of commissions, increments, service fee, brokerage charge, etc. which become a great portion of the banks yield as it comes through various procedures. This also changes according to the status of the banks. Likewise, banks are used to get cheques, rents, dividends, etc., accept bills of exchange, impose drafts and letters of credit and collect pensions and salaries for the sake of their customers. For it, the banks also earn commissions in various levels as well as it is customary on locker rents, shares of joint stock companies. The banks also act as the intermediaries of foreign banks and foreign exchanges by which it acquires a huge amount of increment charges. 29 IV. CONCLUSION The commercial banks functions cannot be explained in a short study. Here the major functions have been discussed. The banking system always needed for more updates and latest version of technology and the accuracy in services. The bank achieves the success when it practices the rules on ground. The people never compromise with the low level of service. The bank receive more deposits and funds from the people on the basis of the guaranty and trust provided from the side of banks. The People also should have to maintain good enough knowledge on the functions of the bank. ACKNOWLEDGEMENT I am grateful to Professor Yakubu Mukhtar, Vice Chancellor, Yobe State University, Damaturu, Nigeria for providing the research facilities. Again a special thank goes to Mr. Muhammad Fazal K., research scholar in the Department of Economics, Central University, Gujarat, India who supported with enough data and helped me to conduct this research. REFERENCE Nupur Singh, 8 main Objectives of Regional Rural Banks. <http://www.preservearticles.com/2012033129452/8- main-objectives-of-regional-rural-banks.html> (accessed on 1 January 2014) Shivani Pachori, Secondary Functions Performed by the Commercial Banks in India, <http://www.shareyouressays.com/117049/secondary-functions-performed-by-the-commercial-banks-in-india> (accessed on 3 November 2013) http://www.yourarticlelibrary.com/commercial-banks/credit-creation-the-most-important-functions-of-acommercial-banks/11011/ Mohammed Julfekar Haider, Credit Creation of a Bank; Limitations of a Bank, <http://www.indiastudychannel.com/resources/108889-credit-creation-limitations-bank.aspx> (accessed on 3 January 2014) Roussakis, Commercial Banking in an Era of Deregulation,7 Rajesh R. & Sivagnanasithi T, Banking Theory: Law And Practice ( New Delhi: Tata McGraw-Hill Publishing Company Ltd, 2007), 83 Dr. Rajan Mishra, Industrial Economics and Management Principles (New Delhi: Laxmi Publication Ltd, 2008), 179-180 29 602 Dr. Saeed T.V.