Hope University College

Financial market and institution

Department of Accounting and Finance Section One(1)

Development of banking and the functions of commercial banks

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Table of Content

Content. Page

1, Introduction .....................................................................................................3

1.1 General objectives:............................................................................................3

1.2 Development of banking and the functions of commercial banks ..............4

1.3 Role of Development Bank...............................................................................4

1.4 Contribution of Development Bank to Capital Markets................................6

2. What is Commercial Bank?................................................................................6

2.1 Function of Commercial Bank. .......................................................................8

2.2 Types of Commercial Banks...........................................................................11

2.3 What is the main purpose of commercial banks?.........................................12

2.4 Conclusion and Recommendations ..............................................................13

References..........................................................................................................14

1, Introduction:

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Commercial banks have traditionally been located in buildings where customers come to use
teller window services and automated teller machines (ATMs) to do their routine banking. With
the rise in internet technology, most banks now allow their customers to do most of the same
services online that they could do in person including transfers, deposits, and bill payments.A
growing number of commercial banks operate exclusively online, where all transactions with the
commercial bank must be made electronically. Because these banks don't have any brick-and-
mortar locations, they can offer a wider range of products and services at a lower cost—or none
at all—to their customers. The financial system consists of many players like financial
institutions, financial markets, regulators, market participants and others having stake on it.
Money and Capital Markets operating within the financial system make possible the exchange of
current income for future income and the transformation of savings into investment which result
in increased production, employment, income, and living standards. Governments in developing
countries face increasing difficulties in funding public enterprises through government
allocations because of budget constraints due to low savings and population explosion. It has
also become increasingly difficult to expect an increase in the flow of foreign private and
government capital because of the recent debt crises experienced by some developing countries
as well as budgetary uncertainties in the developed countries themselves. Research has shown
that development of securities markets contributes to economic development through the
mobilization of savings and their channeling to the most productive enterprises.

1.1 Objectives:

The general objectives of this topic is to identity and study the economic usefulness of
Development Bank and Commercial Banks in the community of one country or as world. - To
explain the definition of development bank and commercial bank,
- To see the instructional factors that affect the development of stock market strategies, - To
identify describes the functions of development bank and commercial bank in least, - To
classifies and explain commercial banks types and their roles in countries as whole, - To To see
the current technological system factors that affect the establishment of development bank
and commercial bank to provide social services in tje countries, - To see how the
development bank and commercial bank could be used in promoting investment and job
creation.

1.2 Development of banking and the functions of commercial banks

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Development banks are specialized financial institutions. They provide medium and long-term
finance to the industrial and agricultural sector. They do term lending, investment in securities
and other activities. They even promote saving and investment habit in the public. The
Narasingham committees aid to perform only the promotional and refinancing role. Specialized
development financial institutions (DFIs) such as the IDBI, NABARD, NHB and SIDBI, etc., with
majority ownership of the Reserve Bank, were set up to meet the long-term financing
requirements of industry and agriculture.

OBJECTIVES

The objective of development banks in the growth of the economy are:

- Increasing capital formation that can contribute towards the growth of economic
development.

- Ensure that the investors and entrepreneurs are induced by careful allocation of material and
human resources.

- Development activities are undertaken.

Ensuring that industrial units are promoted in order to fill the gaps in the industry structure.
Healthy projects should have enough financial and technical services in order to make the
projects work.

Functions

For their financial and social development, the increment advances and investments to its
creating partner nations. They provide specialized assistance for the arranging and the usage of
improvement tasks and programs and for financial advisory services. For development, they
promote and encourages public and private capital.

They respond to demands for help with planning development approaches and plans of its
expanding nations.

1.3 Role of Development Banks

1, Providing Funds

The persons who have the capability of starting a business but does not have requisite help
approach to financial institutions for help. These institutions help a large number of persons for
taking up some industrial activity.

2. Promotional activities

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The promotional role of development banks is helpful in increasing the development of a
country. They create a new class of entrepreneurs and help the weaker sections of society to be
a part of industrial culture. With a view for a long term benefit to social development, banks
have new capital schemes which provide financial assistance to the novice entrepreneurs. They
help in covering the expense and manpower resources for undertaking the exercise of starting a
new unit.

3. Assistance of backward units

The development bank encourages rustic and provincial development. They give money to
beginning organizations in reverse zones. Likewise, they help organizations which are in the
venture in less-developed regions.

4. Employment generation

Financial institutions have helped both direct and indirect employment generation. They have
employed many people in their offices. These institutions help in creating employment by
financing new and existing industrial units.

5. Accelerating Industrialization

The setting up of more industrial units will generate direct and indirect employment, make
available goods and services in the country and help in increasing the standard of living.
Financial institutions provide requisite financial, managerial, technical help for setting up new
units.

6. Development of Housing Sector

Development banks provide funding for the development of the housing sector. It refinances
banks and financial institutions which provides credit to the housing sector. It promotes and
develops housing and financial institutions.

7. Agriculture and Rural Development

It organizes the working of all monetary establishments that give credit to farming and rural
development. Development banks like the National Bank for Agriculture and Rural
Development (NABARD) which give credit to the agriculture and furthermore for country
advancement exercises.

8. Improve Foreign Trade

It gives Overseas Buyers Credit to purchase Indian capital merchandise. Likewise, urges abroad
banks to give account to the purchasers in their nation to purchase capital products from India.

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9. Revival of Sick Units

Development banks help to resuscitate (fix) wiped out units. It encourages modernization,
rebuilding, and broadening of wiped out units by giving credit and different administrations.
The public authority of India (GOI) began the Industrial Investment Bank of India (IIBI) to help
wipe out units. IIBI is the principal credit and recreation foundation for a restoration of wiped
out units.

1.4 Contribution of Development Bank to Capital Markets

The development bank helps in the growth of capital markets. They invest in equity shares and
debentures and mutual funds of several companies listed in India. Industrial Finance
Corporation of India (IFCI): this is for providing medium and long term credit for the needs of
industrial units. Industrial Credit and Investment Corporation of India (ICICI): it promotes
private industry concerns in the country and was set up as a private sector development bank.
Industrial Development Bank of India (IDBI): the IDBI’s it organizes the activities of other
development banks and term-financing institutions

Industrial Reconstruction Bank of India (IRBI)’: it provides financial assistance as well as to

revive and revitalize sick industrial units in both of the sectors. Small Industries Development
Bank of India (SIDBI): With a view to ensuring a larger flow of financial and non-financial
assistance to the small-scale sector. State-Level Industrial Development Banks: (SFCs and
SIDCs): there is a combination of financing agencies and industrial development banks, focusing
on backward regions for the development of medium and small-scale industries in respective
states.

2. What is Commercial Bank?

A commercial bank is a kind of financial institution that carries all the operations related to
deposit and withdrawal of money for the general public, providing loans for investment, and
other such activities. These banks are profit-making institutions and do business only to make a
profit. The two primary characteristics of a commercial bank are lending and borrowing. The
bank receives the deposits and gives money to various projects to earn interest (profit). The
rate of interest that a bank offers to the depositors is known as the borrowing rate, while the
rate at which a bank lends money is known as the lending rate. The general role of commercial
banks is to provide financial services to the general public and business, ensuring economic and
social stability and sustainable growth of the economy. In this respect, credit creation is the
most significant function of commercial banks. While sanctioning a loan to a customer, they do
not provide cash to the borrower. Instead, they open a deposit account from which the

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borrower can withdraw. In other words, while sanctioning a loan, they automatically create
deposits.

History of banking

The name bank derives from the Italian word banco "desk/bench", used during the Italian
Renaissance era by Florentine bankers, who used to carry out their transactions on a desk
covered by a green tablecloth.[1] However, traces of banking activity can be found even in
ancient times.

In the United States, the term commercial bank was often used to distinguish it from an
investment bank due to differences in bank regulation. After the Great Depression, through the
Glass–Steagall Act, the U.S. Congress required that commercial banks only engage in banking
activities, whereas investment banks were limited to capital market activities. This separation
was mostly repealed in 1999 by the Gramm–Leach–Bliley Act.

It can also refer to a bank, or a division of a large bank, which deals with corporations or
large/middle-sized business to differentiate it from a retail bank and an investment bank.
Commercial banks play a part in economic growth and liquidity by catering to a multitude of
customers. Their clientele comprises individuals and small to mid-sized corporates. The
customers obtain low rates of interest on bank deposits but the bank loans funds at a higher
interest rate to earn a margin—also known as the spread. Recently, some of these banks
introduced investment banking divisions—Citibank and JPMorgan Chase. But banks like Ally
operate only on commercial aspects of the business. These banks mainly offer loan facilities and
accept deposits. But in addition to that, they provide saving accounts, merchant services,
commercial loans, global trade services, treasury services, lending services, current or checking
accounts, term deposits, consumer loans, mortgages, credit cards, debit cards, cash
management services, corporate loans, and online banking services.

In the contemporary digital era, most commercial banks function online—customers carry out
electronic banking transactions without visiting their bank’s branch office. As a result, operating
profit margins for “virtual” banks have increased. The Internet has brought down operating
expenses (OpEx)—banks do not have to maintain physical branches—ancillary charges on rent,
property taxes, and utilities have gone down.

Commercial banks include private sector banks and public sector banks.

2.1 Function of Commercial Bank:

Commercial banks are authorized to provide a variety of financial services which includes loans,
savings accounts, etc. The most important function of a bank is to collect deposits from the

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public and lend those deposits for the development of business, agriculture, trade and
commerce.

Bank of Calcutta is the oldest commercial bank in India. It was established in the year 1806. It
was later renamed the Bank of Bengal. Currently it is known as State Bank of India. The
functions of commercial banks are classified into two main divisions.

(a) Primary functions

The primary functions of a commercial bank are accepting deposits and also lending funds.
Deposits are savings, current, or time deposits. Also, a commercial bank lends funds to its
customers in the form of loans and advances, cash credit, overdraft and discounting of bills, etc.

1, Accepts deposit : The bank takes deposits in the form of saving, current, and fixed deposits.
The surplus balances collected from the firm and individuals are lent to the temporary
requirements of the commercial transactions.Commercial banks accept deposits from people,
businesses, and other entities in the form of:

• Savings deposits – The commercial bank accepts small deposits, from households or persons,
in order to encourage savings in the economy.

• Time deposits – The bank accepts deposits for a fixed time and carries a higher rate of
interest as compared to savings deposits.

• Current deposits – These accounts do not offer any interest. Further, most current accounts
offer overdrafts up to a pre-specified limit. The bank, therefore, undertakes the obligation of
paying all cheques against deposits subject to the availability of sufficient funds in the account.

2, Provides loan and advances : Another critical function of this bank is to offer loans and
advances to the entrepreneurs and business people, and collect interest. For every bank, it is
the primary source of making profits. In this process, a bank retains a small number of deposits
as a reserve and offers (lends) the remaining amount to the borrowers in demand loans,
overdraft, cash credit, short-run loans, and more such banks. Loans are advances that a bank
extends to his customers with or without security for a specified time and at an agreed rate of
interest. Further, the bank credits the loan amount in the customers’ account which he
withdraws as per his needs.

3, Credit cash: The function of credit creation is generated on the basis of credit and payment
intermediary. Commercial banks use the deposits they absorb to make loans. On the basis of
check circulation and transfer settlement, the loans are converted into derivative deposits. To a
certain extent, the derivative funds of several times the original deposits are increased, which
greatly improves the driving force of commercial banks to serve the economic development.

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When a customer is provided with credit or loan, they are not provided with liquid cash. First, a
bank account is opened for the customer and then the money is transferred to the account.
This process allows the bank to create money. Under the cash credit facility, the bank offers its
customers a facility to borrow cash up to a certain limit against the security of goods. Further,
an overdraft is an arrangement that a bank offers to customers wherein a temporary facility is
offered to overdraw from the current account without any security. The limit is pre-specified.
Additionally, banks also discount and purchase bills. In both of these cases, a bank credits the
amount of the bill in the customer’s account after deducting discounts and commissions.
Subsequently, this amount is recovered from the debtors on the maturity of the instrument.

4, Overdraft facility: It is an advance given to a customer by keeping the current account to

overdraw up to the given limit.

B, Secondary functions
The secondary functions of a commercial bank are acting as an agent to its customers and also
providing general utility services.

1, Bank as an Agent

A bank acts as an agent to its customers for various services like:

• Collecting bills, draft, cheques, etc.

• Paying the insurance premium, rent, loan installments, etc.

• Working as a representative of a customer for purchasing or redeeming securities, etc. in the

stock exchange.

• Acting as an executor, administrator, or trustee of the estate of a customer

• Also, preparing income tax returns, claiming tax refunds, etc.

2, General Utility Services

There are several general utility services that commercial banks offer like:

• Issuing traveler cheques

• Offering locker facilities for keeping valuables in safe custody

• Also, issuing debit cards and credit cards, etc.

3, Purchasing and selling of the securities: The bank offers you with the facility of selling and
buying the securities.

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4, Discounting bills of exchange: It is a written agreement acknowledging the amount of money
to be paid against the goods purchased at a given point of time in the future. The amount can
also be cleared before the quoted time through a discounting method of a commercial bank.

5, Locker facilities: A bank provides locker facilities to the customers to keep their valuables or
documents safely. The banks charge a minimum of an annual fee for this service.

6, Paying and gathering the credit : It uses different instruments like a promissory note,
cheques, and bill of exchange.

In most countries, commercial banks are heavily regulated and this is typically done by a
country's central bank. They will impose a number of conditions on the banks that they regulate
such as keeping bank reserves and to maintain minimum capital requirements. Commercial
banks generally provide a number of services to its clients; these can be split into core banking
services such as deposits, loans, and other services which are related to payment systems and
other financial services.

Core products and services

• Accepting money on various types of Deposit accounts

• Lending money by overdraft, and loans both secured and unsecured.

• Providing transaction accounts

• Cash management

• Treasury management

• Private equity financing

• Issuing Bank drafts and Bank cheques

• Processing payments via telegraphic transfer, EFTPOS, internet banking, or other payment
methods.

Other functions

Along with core products and services, commercial banks perform several secondary functions.
The secondary functions of commercial banks can be divided into agency functions and utility
functions.

Agency functions include:

• To collect and clear cheques, dividends, and interest warrant

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• To make payments of rent, insurance premium

• To deal in foreign exchange transactions

• To purchase and sell securities

• To act as the trustee, attorney, correspondent and executor

• To accept tax proceeds and tax returns

Utility functions include:

• To provide safe deposit boxes to customers

• To provide money transfer facility

• To issue traveler's cheques

• To act as referees

• To accept various bills for payment: phone bills, gas bills, water bills

• To provide various cards such as credit cards and debit cards

2.2 Types of Commercial Banks:

There are three different types of commercial banks.

Private bank –: The majority stake is owned by private shareholders (individuals or corporates).
They accept deposits and distribute loans to individual customers, small businesses, and
medium-sized businesses. It is a type of commercial banks where private individuals and
businesses own a majority of the share capital. All private banks are recorded as companies
with limited liability. Such as Housing Development Finance Corporation (HDFC) Bank,
Industrial Credit and Investment Corporation of India (ICICI) Bank, Yes Bank, and more such
banks.

Public bank –: For public banks, majority equity lies in the hands of the government.
Nationalized banks provide financial services to mass customers at affordable rates. It is a type
of bank that is nationalised, and the government holds a significant stake. For example, Bank of
Baroda, State Bank of India (SBI), Dena Bank, Corporation Bank, and Punjab National Bank.

Foreign bank –: As the name suggests, these financial institutions operate in foreign countries
but have head offices in the parent country. The bank’s foreign branches take deposits, extend
loans, engage in securities trading, and facilitate foreign exchange functions. These banks are
established in foreign countries and have branches in other countries. For instance, American

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Express Bank, Hong Kong and Shanghai Banking Corporation (HSBC), Standard & Chartered
Bank, Citibank, and more such banks.

2.3 What is the main purpose of commercial banks?

The main purpose of commercial banks is to provide financial services to the general public and
also provide loan facilities to the business which helps in ensuring economic stability and
growth of the economy. Therefore, we can say that credit creation is the most important
purpose of commercial banks.

Commercial banks offer consumers and small to mid-sized businesses with basic banking
services including deposit accounts and loans, make money from a variety of fees and by
earning interest income from loans, have traditionally been located in physical locations, but a
growing number now operate exclusively online, also they are important to the economy
because they create capital, credit, and liquidity in the market. Commercial banks are crucial to
the fractional reserve banking system, currently found in most developed countries. This allows
banks to extend new loans of up to (typically) 90% of the deposits they have on hand,
theoretically growing the economy by freeing capital for lending.commercial banks have
traditionally provided services to individuals and businesses, investment banking offers banking
services to large companies and institutional investors. They act as financial intermediaries,
providing their clients with underwriting services, merger and acquisition (M&A) strategies,
corporate reorganization services, and other types of brokerage services for institutional and
high-net-worth individuals (HNWIs).

While commercial banking clients include individual consumers and small businesses,
investment banking clients include governments, hedge funds, other financial institutions,
pension funds, and large companies.

2.4 Conclusion
Development banks are specialized financial institutions. They provide medium and long-term
finance to the industrial and agricultural sector. They do term lending, investment in securities
and other activities. They do term lending, investment in securities and other activities. They
even promote saving and investment habit in the public.The objective of development banks in
the growth of the economy are: Providing Funds, Promotional activities, Assistance of backward
units, Employment generation, Accelerating Industrialization, Development of Housing Sector,
Agriculture and Rural Development, Improve Foreign Trade, and Revival of Sick Units.

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Commercial Banks are profit-seeking financial institutions. They receive deposits from
customers at a lower rate of interest and offer business loans at a higher interest rate. They
serve individuals, small-scale businesses, and medium-sized businesses. Commercial finance
institutions offer various loans and advances—personal, mortgage, business, and auto loans.
The banks earn interest on these credit services, and it is always less than the interest rate
offered to the depositors. This margin between the interest rates acts as their source of
income. The functions of commercial banks are classified into two main divisions. Primary
functions and Secondary functions. Primary functions includes:- Accepts deposit (Saving
deposit, Time deposit and current deposit), Provides loan and advances, and credit cash. The
secondary functions of a commercial bank are acting as an agent to its customers and also
providing general utility services that includes: Bank as an Agent (Collecting bills, draft, cheques,
Paying the insurance premium, rent, loan installments, Working as a representative of a
customer for purchasing or redeeming securities, etc. in the stock exchange, Acting as an
executor, administrator, or trustee of the estate of a customer, Also, preparing income tax
returns, claiming tax refunds, etc.), General Utility Services( Issuing traveler cheques, Offering
locker facilities for keeping valuables in safe custody and Also, issuing debit cards and credit
cards, etc.), Purchasing and selling of the securities, Discounting bills of exchange, Locker
facilities and Paying and gathering the credits. The majority stake is owned by private
shareholders (individuals or corporates). They accept deposits and distribute loans to individual
customers, small businesses, and medium-sized businesses. There are three different types of
commercial banks:- Private Bank, Public Bank and Foreign Bank. The main purpose of
commercial banks is to provide financial services to the general public and also provide loan
facilities to the business which helps in ensuring economic stability and growth of the economy.

Reference:
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• Brunner, Allan D.; Decressin, Jörg; Hardy, Daniel C. L.; Kudela, Beata (2004-06-21). Germany's
Three-Pillar Banking System: Cross-Country Perspectives in Europe. International Monetary
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