University Institute of Legal Studies Panjab University , Chandigarh. (in partial completion of internal assessment .

5 year integrated law course)

Functions of a Bank

Submitted by : Gaganjot Kaur Roll No. 28/05 Section A

Introduction
Banks are regarded as the nerve centre of trade, industry and commerce of a country. Bank denotes an institution which deals in money and credit. A banker is regarded as a dealer of debt either may be own or of others. Commercial banks in India are divided as scheduled and non-scheduled banks. The former denotes a type of commercial banks which has a paidup capital of Rs. 5 Lakhs and more and the latter denotes a type of bank which has a paid-up capital of less than Rs. 5 Lakhs. Commercial banks were like joint stock companies as they raise capital from the general public. After nationalization commercial banks were classified as nationalized banks private sector banks. Commercial Banks have emerged as the single most important source of institutional credit. They are performing multifarious functions, some of which are not commercial in nature. So much so that in the light of services rendered by them even the same commercial bank is being considered a wrong nomenclature for the modern commercial banks. Such is the variety of functions performed and the services rendered by the banks that they can be described as departmental stores of financial services. Perhaps, it is not possible to make an all inclusive list of banks functions and services. As a tree gets its recognition by its fruits, a bank is known by its functions. The functions of a commercial bank may be classified into:

Primary Functions, Secondary Functions, Agency Functions, General Utility Functions and Resultative Functions.

Primary Functions of Bank

The two acid test functions of a commercial bank are : 1. Accepting deposits;
2. Lending or advancing loans.

These are treated as acid test functions because, unless an establishment satisfies the test of these two functions, it simply cannot be a bank or a banker. These functions are also known as Primary or Basic Functions of commercial banks, along with credit creation and cheque system of payment of fund.

1. Accepting deposits
The most important activity of a commercial bank is to mobilise deposits from the public. People who have surplus income and savings find it convenient to deposit the amounts with banks. Depending upon the nature of deposits, funds deposited with bank also earn interest. Thus, deposits with the bank grow along with the interest earned. If the rate of interest is higher, public are motivated to deposit more funds with the bank. There is also safety of funds deposited with the bank.

2. Grant of loans and advances

The second important function of a commercial bank is to grant loans and advances. Such loans and advances are given to members of the public and to the business community at a higher rate of interest than allowed by banks on various deposit accounts. The rate of interest charged on loans and advances varies depending upon the purpose, period and the mode of repayment. The difference between the rate of interest allowed on deposits and the rate charged on the Loans is the main source of a banks income.

i) Loans
A loan is granted for a specific time period. Generally, commercial banks grant short-term loans. But term loans, that is, loan for more than a year, may also be granted. The borrower may withdraw the entire amount in lumpsum or in instalments. However, interest is charged on the full amount of loan. Loans are generally granted against the security of certain assets. A loan may be repaid either in lumpsum or in instalments.

ii) Advances
An advance is a credit facility provided by the bank to its customers. It differs from loan in the sense that loans may be granted for longer period, but advances are normally granted for a short period of time. Further the purpose of granting advances is to meet the day to day requirements of business. The rate of interest charged on advances varies from bank to bank. Interest is charged only on the amount withdrawn and not on the sanctioned amount.

Modes of financial assistance adopted by commercial banks are : a) Cash Credit

Cash credit is an arrangement whereby the bank allows the borrower to draw amounts upto a specified limit. The amount is credited to the account of the customer. The customer can withdraw this amount as and when he requires. Interest is charged on the amount actually withdrawn. Cash Credit is granted as per agreed terms and conditions with the customers.

b) Overdraft
Overdraft is also a credit facility granted by bank. A customer who has a current account with the bank is allowed to withdraw more than the amount of credit balance in his account. It is a temporary arrangement. Overdraft facility with a specified limit is allowed either on the security of assets, or on personal security, or both.

c) Discounting of Bills
Banks provide short-term finance by discounting bills,that is, making payment of the amount before the due date of the bills after deducting a certain rate of discount. The party gets the funds without waiting for the date of maturity of the bills. In case any bill is dishonoured on the due date, the bank can recover the amount from the customer.

d) Money at call
It is the money lent for a very short period, generally varying from 1 to 14 days. Such advances are usually made to other banks and financial institutions only. Money at a call ensures liquidity. The amount invested and the interest earned depends upon the conditions prevailing in the money market. In the interbank market it enables banks to make adjustments according to their liquidity requirements.

e) Term Loans
This is a lumpsum loan advanced with a fixed maturity period of more than one year. Term loans are usually secured and provide medium to long term funds to the borrowers. The entire amount of the loan is chargeable to interest. Repayment is made either on maturity or in instalments. Sometimes to ensure the proper utilisation of the loan sanctioned it is released in instalments after examining the progress of the work for which it is sanctioned. Like overdraft it is not a continuing sort of arrangement. Each loan is a separate contract.

f) Credit to Government
the commercial banks provide indirect credit to the central government or state governments by investing in their securities. Investment in securities form an important part of the portfolio of a bank. It enables it to meet requirement of statutory liquidity ratio (SLR).

3.

Credit Creation

As a monetary institution credit creation is another distinct function performed by the commercial banks. In fact, this function is automatically performed while advancing credit or loans or by accepting deposits. Banks are able to create credit because the demand deposits i.e. a claim against the bank is accepted by the public in settlement of their debts. Thus, when a bank advances a loan or credit, it does not lend cash but opens an account in favour if the customer ans credits the amount to the account. It creates a claim against itself which is acceptable by the public for

settlement of debts. As these claims against the banks are accepted by the public for settling their debts, it is an important constituent of money supply. In this process the bank creates money. For this reason the banks are called manufacturers of money.

4. Cheque system of payment of funds

A cheque , a negotiable instrument, which in fact is a bill of exchange drawn upon a banker, is the most popular credit instrument used by the client to make payments. The cheque system was evolved in very early stages of banking and now it has become the main credit instrument in the banking world. Although a cheque is not a legal tender money, it serves as a medium of exchange in a limited way as it is a negotiable instrument.

Secondary functions of a Bank

Besides the primary functions of accepting deposits and lending money, banks perform a number of other functions which are called secondary functions. These are as follows a) Issuing letters of credit, travellers cheques, circular notes etc. b) Undertaking safe custody of valuables, important documents, and securities by providing safe deposit vaults or lockers; c) Providing customers with facilities of foreign exchange. d) Transferring money from one place to another; and from one branch to another branch of the bank. e) Standing guarantee on behalf of its customers, for making payments for purchase of goods, machinery, vehicles etc. f) Collecting and supplying business information; g) Issuing demand drafts and pay orders; and, h) Providing reports on the credit worthiness of customers.

Agency and General Utility Services provided by Modern Commercial Banks

The primary activities of commercial banks include acceptance of deposits from the public and lending money to businessmen and other members of society. Besides these two main activities, commercial banks also render a number of ancillary services. These services supplement the main activities of the banks. They are essentially non-banking in nature and broadly fall under two categories: i) Agency services, and ii) General utility services.

i) Agency Services
Agency services are those services which are rendered by commercial

banks as agents of their customers. They include : a) Collection and payment of cheques and bills on behalf of the customers; b) Collection of dividends, interest and rent, etc. on behalf of customers, if so instructed by them; c) Purchase and sale of shares and securities on behalf of customers; d) Payment of rent, interest, insurance premium, subscriptions etc. on behalf of customers, if so instructed; e) Acting as a trustee or executor; f) Acting as agents or correspondents on behalf of customers for other banks and financial institutions at home and abroad.

ii) General utility services

General utility services are those services which are rendered by commercial banks not only to the customers but also to the general public. These are available to the public on payment of a fee or charge. They include : a) Issuing letters of credit and travellers cheques; b) Underwriting of shares, debentures, etc.; c) Safe-keeping of valuables in safe deposit locker; d) Underwriting loans floated by government and public bodies. e) Supplying trade information and statistical data useful to customers; f) Acting as a referee regarding the financial status of customers; g) Undertaking foreign exchange business.

Resultative Functions of a Bank

As a result of the performance of above mentioned functions, the commercial banks perform other functions like: i) Mobilisation of savings of people. ii) Channelizing savings into productive channels. iii) Extension of financial services to rural areas. iv) Making credit to weaker sections of society.

Bibliography

R.N. Chaudhary, Banking Laws, Central Law Publications, First edition:2009. Dr. A.B. Kalkundrikar, Banking Law & Practice, Himalaya Publishing House, First Edition:1987.