A Bank is an organization which is licensed by government or law to receive and safeguard deposits from the public, sanction loans and to act as an intermediary in their financial transactions.
Banking institutions have been in operation since ancient history where funds were pooled and loans were sanctioned to farmers and small traders for an overall development of economic conditions in their respective areas or kingdoms.
The modern banking system had its roots in the aftermath of the Renaissance Europe. Thereafter, gradually the modern banking concepts and practices developed from the 18th century onwards resulting in the present banking system and practices.
Definition of Bank
A Bank can be defined as follows:
"An establishment authorized or licensed by a government to accept/ receive deposits, pay interest on those deposits, issue loans, act as an intermediary in all financial transactions, and provide other related financial services to its customers."
Functions of Banks
From the above definition, it is evident that Banks perform all types of financial transactions like receiving deposits from their customers, maintaining their accounts, safeguarding those deposits and allow withdrawals or payments from those deposits, pay interest on those deposits, collection or payment of cheques and bills on their behalf, provide debit or credit cards based on those accounts to enable easy transactions of funds from any corner of the world, etc.
Now, these functions of banks can be grouped into two distinct sub-groups. They are primary functions and secondary functions. Let us discuss both these types of functions.
Primary Functions of Banks
The primary functions are also known as the main banking functions. Banks (mainly commercial banks) perform many banking functions like accepting deposits and lending of loans and advances in various forms.
A) Accepting Deposits
i) Current Account Deposits:
These accounts are mainly suitable for business people who need to make daily transactions of depositing cash or cheques and to withdraw cash or make their bill payments through cheques and drafts. These accounts are also known as Demand Accounts, as the banks should pay these amounts immediately on demand by the depositors without any limit or restrictions. No interest is paid on these accounts. Some service charges are debited to the account depending upon the transactions.
ii) Savings Deposits:
Savings deposits are aimed at creating a habit of savings among people. These deposits provide an incentive of interest to the customers (4% to 5% normally) which are credited to their accounts quarterly. There is a ceiling on withdrawals, presently 3 times per month. Any extra withdrawal is charged with some fees.
iii) Fixed Deposits or Term Deposits:
Fixed Deposits are also known as Term Deposits because they are deposited for a particular period or term. These deposits carry higher interest rates depending upon the period of deposit and as per the prevailing rates of interests of those banks.
Deposits made for lesser periods will be paid lower interest rates and higher periods are paid higher rates. The present rates applicable are 4% to 8% approximately varying according to periods.
The minimum period of deposit is 7 days and maximum period is 10 years.
If you withdraw money before maturity period, penalty charges are imposed and the amount is deducted from your maturity balance calculated as on that day of withdrawal.
iv) Recurring Term Deposits:
These are known as Recurring Deposits and are generally treated as Term Deposits and carry the same interest rates and rules as governed under Fixed Deposits.
The only difference between Recurring Deposits and Fixed Term Deposits is that in Recurring Deposits, you enjoy the facility of depositing monthly denominations of the deposits instead of a lump sum deposit.
These deposits are suitable for those who want to save money, but can not afford a one time deposit.
The minimum deposit accepted is Rs.1,000 and thereafter, you can deposit in denominations of Rs.100 and above every month till maturity.
The tenure of deposits ranges from 12 months to 10 years. The interest is calculated monthly or quarterly according to the denominations deposited and the amount will be paid on maturity of the entire period.
If you are unable to deposit an installment timely, you will be charged penalty charges from the due date to the next deposit date.
B) Lending of Loans and Advances
Banks lend various types of loans and advances to facilitate their customers. The main types of these loans and advances are classified into three types.
i) Cash Credit:
Cash Credit is a type of loan sanctioned generally to business people against their stocks, shares, bonds and other securities. It is allowed to current account holders as well as outsiders also. A fixed amount of credit limit is sanctioned after evaluating the security provided. The interest is charged on the amounts withdrawn, calculated by the number of days those particular balances are outstanding. The customers can enhance their credit limits by providing further securities.
ii) Overdraft:
Overdraft facilities are provided to existing current account holders on their request up to a certain fixed limit after providing some personal guarantee or security. It is generally provided after assessing his creditworthiness and repayment capacity. It can be availed both for personal accounts and business accounts. Interest is charged on the overdraft amounts.
iii) Loans and Term Loans:
Term loans or simply loans are sanctioned by banks to customers either for a short-term or comparatively longer terms to facilitate their various needs against some security or lien.
Some of these loans are as follows to list a few.
a) Home Loans
b) Car Loan or Vehicle Loan
c) Educational Loan
d) Personal Loan (for short term needs of customers like meeting marriage expenses, hospital or medical expenses, etc.)
These loans and advances are credited to their account after approval and the customers can withdraw the money according to their needs. Interest is calculated on the whole amount credited and the loan amount is refundable in equal EMIs (including interest amount) which is calculated according to the rates of interest prevailing at the time of sanction of the loan.
Secondary Functions of Banks
Secondary functions of Banks are, generally, not performed by all banks. These may not be considered as essential functions of most commercial banks. So, they are known as Secondary Functions. These functions include many services provided by banks to facilitate customers and keep them around their banks.
The secondary functions of banks are classified into two types known as Agency Functions and Utility Functions.
The Banks charge their commission or bank charges for providing each one of these secondary functions.
1) Agency Functions of Banks
a) Discounting of Bills
Banks allow advances to their customers to facilitate their need for funds against bills of exchange drawn by them or of which they are the beneficiaries. The payments are made after deducting some charges. The bank will later collect the payment from the drawee of the bill or from the party that accepted the bill by presenting it after the maturity of the period.
b) Transfer of Funds
Banks transfer funds of their customers from one account to another, from one branch to another or to other banks both within the country or abroad at the request of customers in the form of demand drafts or mail transfers for which they charge some commission and bank charges.
c) Collection or Payment of Bills, etc.
Banks can also collect or pay your bills according to your instructions. This includes collection and payment of salaries, pensions, utility bills, interest amounts, insurance premiums, taxes, dividends, etc. Banks charge their charges for this service.
d) Portfolio Services
The banks can also provide the services of acting as your agent in the sales and purchase of stocks, bonds, and debentures,etc.
e) Other agency functions
Banks can also act as the trustees, executors and income-tax consultants of your deposits, deeds, wills and funds.
2) General Utility Functions
The banks offer some more general public services to facilitate their customers which are known as general utility functions.
a) Locker Facilities
Lockers are allowed to customers for safeguarding their valuable possessions like gold ornaments, title-deeds or documents, etc. by keeping them in the bank lockers.
b) Issue of Letter of Credit
Banks provide their customers with a letter of credit certifying their creditworthiness to facilitate their needs.
c) Issue of Traveller's cheques
Traveller cheques are also issued by banks to facilitate people on their journeys so that they need not carry huge cash balances with them while on a journey.
d) Underwriting of Securities
Banks undertake the function of underwriting or certifying the securities of their customers to facilitate the sales of those securities.
e) Purchase and Sale of Foreign Exchange
Banks are authorised to deal in the foreign exchange transactions by RBI. So, they provide the services of dealing with the purchases and sales of foreign exchange on behalf of their customers.
f) Collection of statistics and preparation of project reports
Banks collect statistics from markets regarding trade and commerce and thereby can provide the required information to their clients. They also prepare the project reports for their clients.
g) Social welfare programmes
Banks also indulge in activities of public awareness, public welfare, and literacy programmes as a service to the nation.
Banking institutions have been in operation since ancient history where funds were pooled and loans were sanctioned to farmers and small traders for an overall development of economic conditions in their respective areas or kingdoms.
The modern banking system had its roots in the aftermath of the Renaissance Europe. Thereafter, gradually the modern banking concepts and practices developed from the 18th century onwards resulting in the present banking system and practices.
Definition of Bank
A Bank can be defined as follows:
"An establishment authorized or licensed by a government to accept/ receive deposits, pay interest on those deposits, issue loans, act as an intermediary in all financial transactions, and provide other related financial services to its customers."
Functions of Banks
From the above definition, it is evident that Banks perform all types of financial transactions like receiving deposits from their customers, maintaining their accounts, safeguarding those deposits and allow withdrawals or payments from those deposits, pay interest on those deposits, collection or payment of cheques and bills on their behalf, provide debit or credit cards based on those accounts to enable easy transactions of funds from any corner of the world, etc.
Now, these functions of banks can be grouped into two distinct sub-groups. They are primary functions and secondary functions. Let us discuss both these types of functions.
Primary Functions of Banks
The primary functions are also known as the main banking functions. Banks (mainly commercial banks) perform many banking functions like accepting deposits and lending of loans and advances in various forms.
A) Accepting Deposits
i) Current Account Deposits:
These accounts are mainly suitable for business people who need to make daily transactions of depositing cash or cheques and to withdraw cash or make their bill payments through cheques and drafts. These accounts are also known as Demand Accounts, as the banks should pay these amounts immediately on demand by the depositors without any limit or restrictions. No interest is paid on these accounts. Some service charges are debited to the account depending upon the transactions.
ii) Savings Deposits:
Savings deposits are aimed at creating a habit of savings among people. These deposits provide an incentive of interest to the customers (4% to 5% normally) which are credited to their accounts quarterly. There is a ceiling on withdrawals, presently 3 times per month. Any extra withdrawal is charged with some fees.
iii) Fixed Deposits or Term Deposits:
Fixed Deposits are also known as Term Deposits because they are deposited for a particular period or term. These deposits carry higher interest rates depending upon the period of deposit and as per the prevailing rates of interests of those banks.
Deposits made for lesser periods will be paid lower interest rates and higher periods are paid higher rates. The present rates applicable are 4% to 8% approximately varying according to periods.
The minimum period of deposit is 7 days and maximum period is 10 years.
If you withdraw money before maturity period, penalty charges are imposed and the amount is deducted from your maturity balance calculated as on that day of withdrawal.
iv) Recurring Term Deposits:
These are known as Recurring Deposits and are generally treated as Term Deposits and carry the same interest rates and rules as governed under Fixed Deposits.
The only difference between Recurring Deposits and Fixed Term Deposits is that in Recurring Deposits, you enjoy the facility of depositing monthly denominations of the deposits instead of a lump sum deposit.
These deposits are suitable for those who want to save money, but can not afford a one time deposit.
The minimum deposit accepted is Rs.1,000 and thereafter, you can deposit in denominations of Rs.100 and above every month till maturity.
The tenure of deposits ranges from 12 months to 10 years. The interest is calculated monthly or quarterly according to the denominations deposited and the amount will be paid on maturity of the entire period.
If you are unable to deposit an installment timely, you will be charged penalty charges from the due date to the next deposit date.
B) Lending of Loans and Advances
Banks lend various types of loans and advances to facilitate their customers. The main types of these loans and advances are classified into three types.
i) Cash Credit:
Cash Credit is a type of loan sanctioned generally to business people against their stocks, shares, bonds and other securities. It is allowed to current account holders as well as outsiders also. A fixed amount of credit limit is sanctioned after evaluating the security provided. The interest is charged on the amounts withdrawn, calculated by the number of days those particular balances are outstanding. The customers can enhance their credit limits by providing further securities.
ii) Overdraft:
Overdraft facilities are provided to existing current account holders on their request up to a certain fixed limit after providing some personal guarantee or security. It is generally provided after assessing his creditworthiness and repayment capacity. It can be availed both for personal accounts and business accounts. Interest is charged on the overdraft amounts.
iii) Loans and Term Loans:
Term loans or simply loans are sanctioned by banks to customers either for a short-term or comparatively longer terms to facilitate their various needs against some security or lien.
Some of these loans are as follows to list a few.
a) Home Loans
b) Car Loan or Vehicle Loan
c) Educational Loan
d) Personal Loan (for short term needs of customers like meeting marriage expenses, hospital or medical expenses, etc.)
These loans and advances are credited to their account after approval and the customers can withdraw the money according to their needs. Interest is calculated on the whole amount credited and the loan amount is refundable in equal EMIs (including interest amount) which is calculated according to the rates of interest prevailing at the time of sanction of the loan.
Secondary Functions of Banks
Secondary functions of Banks are, generally, not performed by all banks. These may not be considered as essential functions of most commercial banks. So, they are known as Secondary Functions. These functions include many services provided by banks to facilitate customers and keep them around their banks.
The secondary functions of banks are classified into two types known as Agency Functions and Utility Functions.
The Banks charge their commission or bank charges for providing each one of these secondary functions.
1) Agency Functions of Banks
a) Discounting of Bills
Banks allow advances to their customers to facilitate their need for funds against bills of exchange drawn by them or of which they are the beneficiaries. The payments are made after deducting some charges. The bank will later collect the payment from the drawee of the bill or from the party that accepted the bill by presenting it after the maturity of the period.
b) Transfer of Funds
Banks transfer funds of their customers from one account to another, from one branch to another or to other banks both within the country or abroad at the request of customers in the form of demand drafts or mail transfers for which they charge some commission and bank charges.
c) Collection or Payment of Bills, etc.
Banks can also collect or pay your bills according to your instructions. This includes collection and payment of salaries, pensions, utility bills, interest amounts, insurance premiums, taxes, dividends, etc. Banks charge their charges for this service.
d) Portfolio Services
The banks can also provide the services of acting as your agent in the sales and purchase of stocks, bonds, and debentures,etc.
e) Other agency functions
Banks can also act as the trustees, executors and income-tax consultants of your deposits, deeds, wills and funds.
2) General Utility Functions
The banks offer some more general public services to facilitate their customers which are known as general utility functions.
a) Locker Facilities
Lockers are allowed to customers for safeguarding their valuable possessions like gold ornaments, title-deeds or documents, etc. by keeping them in the bank lockers.
b) Issue of Letter of Credit
Banks provide their customers with a letter of credit certifying their creditworthiness to facilitate their needs.
c) Issue of Traveller's cheques
Traveller cheques are also issued by banks to facilitate people on their journeys so that they need not carry huge cash balances with them while on a journey.
d) Underwriting of Securities
Banks undertake the function of underwriting or certifying the securities of their customers to facilitate the sales of those securities.
e) Purchase and Sale of Foreign Exchange
Banks are authorised to deal in the foreign exchange transactions by RBI. So, they provide the services of dealing with the purchases and sales of foreign exchange on behalf of their customers.
f) Collection of statistics and preparation of project reports
Banks collect statistics from markets regarding trade and commerce and thereby can provide the required information to their clients. They also prepare the project reports for their clients.
g) Social welfare programmes
Banks also indulge in activities of public awareness, public welfare, and literacy programmes as a service to the nation.
