Banking: Commercial Banks

Commercial Bank

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Commercial banks are a primary unit of the banking system in india. Like all the other businesses, commercial banks also aim to earn high profits and to do so they offer a variety of services to there customers. Commercial bank can be described as a institution which performs the function of accepting deposits, granting loans and making investment with the aim of generating profit. Example are the state bank of india, Punjab National Bank, bank of baroda etc.

Function of commercial bank

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There function can be described in two types:
i- primary functions
ii- secondary functions

Primary functions

i. Accepting deposits
It is the most important function of a commercial bank. They accept deposits in several forms according to the needs of different sections in a society.

1. Current account deposits
2. Fixed deposits
3. Savings deposits

ii. Advancing loans
The deposits in the bank are not meant to be kept idle. After making certain reserves the balance left is given to borrowers and thus interest is charged from them.this is the main source of income of a bank.

1. Cash credit: it is refers to a loan given to a borrower against his current assets like shares,stocks,bond etc.
2. Demand loans: demand loans are the loans which can be recalled by thr bank any time.
3. Short term loans: they are given against a personal collateral security to the borrower.

Secondary functions

1. Overdraft facility: it refers to a facility in which a customer is allowed to withdraw money from his account upto a given limit.
2. Discounting bills of exchange It refers to a facility un which a bill holder is given discount on his bill by the bank before maturity time.
3. Agency function i. Tranfer of funds ii. Purchase and sales of foreign exchange iii. Collection and Payment of various items iv. Purchase and sales of securities v. Income tax consultancy

Money creation or credit creation

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It is one of the most important activities of a commercial banks. Through the process of Money creation, commerical banks are able to create credit, which is in far excess of thr initial or primary deposits. It is legally compulsory for a bank to keep a certain minimum fraction of their deposits as reserves. The fraction of money reserve is called the legal reserve ratio (LRR) or reserve deposit ratio or reserve ratio.

Money multiplier

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Money multiplier is the number bt which all the deposits can increase due to the change in deposits. It is inversely related to legal reserve ratio.

Money multiplier= 1/LRR

Money creation by commercial banks raises the national income

Commercial banks lends more money mainly to investors. The rise in investment in the economy leads to rise in national income through the effect of multiplier.