A commercial bank refers to a form of financial intermediary engaged in banking activities like checking accounts, money market accounts and savings accounts as well as accepting of time deposits.
A commercial bank is different from investment banks and retail banks. A commercial bank primarily deals with loans and deposits from large businesses and corporations. The functions of investment banks are limited to activities relating to the capital market. Retail banking refers to providing financial services directly to consumers. There are several banks which provide both commercial and retail services.
Commercial banks functions can be classified under two categories. These are:
• Primary functions
• Secondary functions inclusive of agency functions
a) Accepting of deposits: The primary role of a commercial bank is mobilizing public deposits. People having surplus income as well as savings find it easy depositing the amount with banks. Funds that are deposited earn interest which is based on the specific nature of the deposits. Higher rates of interest induce public to deposit greater funds with the particular bank. Fund deposits with banks are always safe and secured.
b) Granting of loans and advances: This is the second most vital role of a commercial bank. Loans and advances are offered to the general public and business communities with a higher interest rate as compared to the rate provided on different deposit accounts. The interest rates on the loans and advances vary according to the purpose, duration of the loan and the method of repayment.
Loans: Commercial banks grant loans for a specified time period. They generally grant short–term loans. However they also often grant term loans, which are loans for more than one year period. The borrower has the option of withdrawing the entire loan amount in installments or in lumpsum. However interest rate is applicable on the full loan amount. Commercial banks grant loans against security of assets (collateral). In the early days, commercial banks were not much into mortgage or real estate loans. With the change in banking policies and rules, commercial banks have taken an active role in home financing or providing mortgage loans.
Advances: This refers to providing credit facility to the customers. Advances are usually granted for a shorter time span and in order to meet daily expenses of a business. The interest rate differs with each bank and is charged not on the amount sanctioned, but on the withdrawn amount only (cash credit). Banks give advances in the form of:
• Cash credit
• Overdraft – This refers to allowing a customer to withdraw a higher amount than his credit balance.
• Bills discounting – This refers to the bank paying the amount prior to the bills due date, after deduction of a particular rate of discount.
Commercial banks are also engaged in secondary functions like providing safety deposit boxes to customers, issuing travelers checks, circular notes, as well as providing facilities for foreign exchange.
It is clear from this discussion that commercial banks indeed play a vital role in every economy.