Page 11 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice

Notes Self Assessment

Fill in the blanks:
4. A bank provides easy payment and ………………………. facility to its customers in the
form of cheques, drafts, ATM’s, ETF.

5. A bank is a financial institution which does ……………….. activities of selling
………………… services.
6. A bank provides advance money in the form of loans to needy persons for …………………..
& development of business.

1.3 Functions of Commercial Banks

The functions of commercial banks are divided into two categories:

(i) Primary functions, and (ii) Secondary functions including agency functions.

1.3.1 Primary Functions

The primary functions of a commercial bank include:
(a) Accepting deposits; and
(b) Granting loans and advances;

(a) Accepting Deposits: The most important activity of a commercial bank is to mobilize
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.

Example: 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.
(b) 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
bank’s 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 lump-sum or in installments.
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 lump-sum or in
installments.
(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

6 LOVELY PROFESSIONAL UNIVERSITY