Definition: Commercial banks are ones that receive deposits and advance loans and play an important role in the creation of credit money.
They help businessmen promote their business. They work for traders, manufacturers, wholesales, retailers, importers, and exporters. The bank’s main functions are receiving deposits and advancing loans.
Kinds of Commercial Bank
Commercial banks are divided into two types:
1. Scheduled banks
2. Non scheduled banks
Scheduled Banks: These are the banks which are the members of the central bank. They are referred to as scheduled banks since their names appear in the schedule, list, or register of the central bank.
Once they become the scheduled bank they enjoy the following facilities and services from the central bank
1. Rediscounting of the bill of exchange
2. Clearing house
3. Lender of last report
4. Advisory services
However, such banks have to discharge certain liabilities to the central bank.
1. Maintaining cash reserve at the central bank as a mandatory requirement
2. Following credit control policy of the central bank
Because of their being member of the central bank, the scheduled commercial banks enjoy a strong market and financial goodwill which attracts huge amount of deposits from industrialists, traders, and the public at large. They also borrow from these banks with confidence and at better conditions than non-scheduled banks.
Not only local commercial banks, but also foreign banks are required to become the scheduled banks to be able to work in that country.
Non-Scheduled Banks: Non- Scheduled banks are not the members of the central bank, and hence they cannot get all those facilities and services that are allowed to scheduled banks from the central bank. They also do not enjoy the public confidence. In practice, such banks do not exist.
Functions of Commercial Banks
Functions of commercial banks can be divided into two categories:
1. Primary functions
2. Secondary functions
Primary Functions: Primary functions can further be subdivided into the following:
1. Receiving deposits
2. Advancing loans
1. Receiving Deposits: This is the function of the formation of capital. Capital is formed by receiving deposits from the accountholders (depositors). Small savers, salaried people, traders, manufacturers and other deposits their money with the bank under the head of savings current, or fixed deposit accounts and earn interest income. Commercial banks play an important role in the mobilization of savings.
2. Advancing Loans: The commercial bank finances the needs of businessmen in meeting their day to day business requirements. The bank advances loans on an interest rate which is much higher than that allowed on various kinds of deposits. This difference of interest earned and paid is the main source of the bank income. The loans may be secured or unsecured and is mostly for short-term period. Businessmen borrow from the commercial bank to finance the purchase of merchandise, pay salaries, retire bills, pay off accounts payables, discharge other liabilities, and buy various current assets.
Secondary Functions: Secondary functions are of two types:
a. Public utility services
b. Agency services
A. Public Utility Services
Under this category, the performs the following functions:
1. Accepting and discounting bills of exchange
2. Transfer money
3. Creation of credit money
4. Underwriting of shares
5. Issuing letter of credit (L/C)
6. Providing lockers services
7. Credit Cards
8 ATM Cards
The following are the details:
1. Accepting and Discounting Bills of Exchange: Bills of exchange is a negotiable credit instrument used in home and foreign trade. Through it the buyer of goods is allowed a specified period, generally three months for payment. The bank accepts the bill on behalf of the debtor and discounts it for the creditor. Discounting the bill refers to pay the cash at a discount before the bill becomes matured (due). Discounting process benefits all the parties involved in it viz, the banker, the drawer, and the drawee.
2. Transfer of Money: Commercial banks play a significant role in transferring money from one person, company, city, or country to another. This service is reliable, quick, safe, and inexpensive. On the other hand, if this service is performed by post office, it would be costly, time consuming, and risky. Now, in the business world, money is transferred mostly by banks using cheques, pay orders, drafts.
3. Creation of Credit Money: When banks receive deposits and advance loans out of these deposits, credit money is created. The whole banking system in a country makes way to the creation of credit money. To keep it in limit the central bank regulates it by requiring all commercial scheduled banks to deposit with it a certain percentage of their deposits.
4. Underwriting of Shares: Underwriting refers to purchasing the whole issue or shares or bonds from the principal company and reselling it to the public. By this underwriting the bank receives commission from the issuing company which becomes free from this painstaking job of selling shares to the public.
The bank also takes the responsibility to sell the new issues without underwriting them.
5. Issuing Letter of Credit (L/C): Letter of credit is an open letter from a bank requesting the seller to send the goods to the buyer and promises to pay the sum by itself. An L/C is a reliable guarantee for the exporter or seller from the bank. This instrument is used in home and foreign trade and once it is issued the importer can receive the goods. Banks also issue travelers cheques being kinds of L/C to the tourists and travelers.
6. Locker Services: Bank offers lockers for the safe custody of jewellery, currency, documents and other precious items.
7. Credit Cards: Through credit cards commercial banks provide a facility to their clients to buy goods and services. It is a card issued by a bank or a financial institution that allows credit on short term basis to the cardholder. It is issued to those who are credit worthy. The credit (or loan) allowed is unsecured but backed by the market goodwill of the cardholder.
8. Debit Cards: It is a new concept in a banking business. This card is issued to the bank’s accountholders who have sufficient balance with the bank. Instead of drawing money from their accounts they make direct purchases with their cards and the amount spend is recovered from their account balance. For this service, the bank charges some fee which is deducted from the account. Cash can also be withdrawn from ATM.
9. ATM (Auto Teller Machines): An automated teller machine is an electronic means of transferring funds. It is an electronic machine that replaces a human and provides needed cash to the credit cardholder, or a bank accountholder. The machines provide information about current balances of the account holder. All these functions are provided after the identification of the receiver or depositor of cash. Identification is made by personal identification number (PIN) which is entered on the machine at the time of making a transaction. ATMs are installed at or near the bank entrance. Other places include big stores, supermarkets, petrol pumps, drugstores. In Pakistan, the machines are installed at the bank gates. (For further details see chapter 9)
B. Agency Services
Commercial banks act as attorney for their clients. They buy and sell shares and bonds, receive and pay utility bills, premiums, dividends, rents and interest for their clients. Cheques are used on most of transactions with the bank. The details are as under:
1. Accepting Cheques & Bills: Businessmen receive cheques in payment from other parties. These cheques may be drawn on other banks than theirs. They deposit these cheques with their banks and get the payment. This is very valuable service that the bank performs for its clients.
In addition, the bank also receives payments against electricity, gas, phone bills from consumers. It also receives and pays premiums, dividends, interests, and rents on behalf of its clients.
2. Dealings in Shares & Bonds: On the instructions of its clients, the bank buys and sells shares and bonds on the stock exchange.