Elective Course I: ECO3 E01 - BANKING: THEORY AND PRACTICE

Module II
Commercial Banks and Specialised Financial
Institutions
Structure of Commercial Banks - Public Sector Banks - Private
Sector Banks - New Generation Banks - Foreign Banks - Functions Module II - Part 2
of Commercial Banks - Commercial Banks and Credit Creation -
Branch Expansion Programme and Policy - Deposit Mobilization ● Functions of Commercial banks
and Sectoral Allocation of Bank Credits - Priority Sector Lending - ● Commercial Banks and Credit
Social Banking - Lead Bank Scheme - Land Development Banks- Creation
Regional Rural Banks - Development Financial Institutions (IFCI,
18 January 2022 (Tuesday)
IDBI, IIBI, SIDBI) - Specialized Financial Institutions (EXIM Bank
- National Housing Bank - NABARD - MUDRA Bank) - Specialized
Investment Institutions (Pension Funds - Hedge Funds - Mutual
Funds - UTI) - Non Banking Financial Companies - Investment
Banks - Merchant Banks.
 FUNCTIONS OF COMMERCIAL BANKS
Primary Functions of CBs
1. Acceptance of Deposits:
Commercial Banks mobilize the deposits of the public both
from domestic as well as NRI customers as the custodian
of public money mainly in 3 types of deposits.

Fixed Deposits: These are ‘time deposits’ with a fixed

‘maturity’ and the interest rate varies with the length of
‘tenure’.

Demand Deposits: These are of two types:

1) Savings Deposits: Ideal for temporary saving with

a nominal interest rate and can be withdrawn as
and when need arises.

2) Current Deposits: These deposits with no interest

rate can be withdrawn at any time.

Recurring Deposits: It is a term deposit where people can

deposit a fixed amount every month and earn interest at
the rate applicable to these deposits.
 Primary Functions of Commercial Banks
2. Granting Loans and Advances:
3. Promote the Use of Cheques: CBs provide to their
a. Term Loans: Banks grant loans for a specific time period, in lump
sum/installments, purpose, against security of certain assets and repaid in customers a cheap medium of exchange like cheques. It is a convenient
instalments. instrument to settle debts and the most developed credit instrument in
b. Consumer Credit: These are short term credit facility provided to customers to the money market.
meet the day-to-day requirements of business.

c. Overdraft: Overdraft is an arrangement that a bank offers to customers 4. Financing Internal and Foreign Trade: CBs finances
wherein a temporary facility is offered to overdraw from the current account
without any security. internal and foreign trade through discounting of exchange bills. Banks
also gives short-term loans to traders on the security of commercial
e. Discounting Trade Bills: Banks discount and purchase bills and credits the
amount of the bill in the customer’s account after deducting discounts and papers. This discounting business greatly facilitates the movement of
commissions. This amount is recovered from the debtors on the maturity of the
instrument. internal and external trade.

f. Cash Credit: Under cash credit facility, the bank offers its customers a facility to
borrow cash up to a certain limit against the security of goods. 5. Remittance of Funds: CBs provide facilities to remit funds

from one place to another for their customers by issuing bank drafts,
g. Money at Call: Banks grant loans for a very short period (7 days) to dealers or
brokers in stock exchange markets against collateral securities like shares, mail transfers or telegraphic transfers on nominal commission charges.
debentures etc. repayable at short notice which is described as call money.
As compared to the postal money orders or other instruments, bank
h. Miscellaneous Advances: This includes advances/credit given to drafts have proved to be a much cheaper mode of transferring money
exporters/importers, self- employed, public sector, cooperative sector and weaker
sections of the community. and has helped the business community.
 Primary Functions of Commercial Banks
6. Creation of Credit Assumptions of Credit Creation
● CBs lend out the excess cash reserves as loans and advances.
● Presence of a well-developed banking system
● Instead of giving loan amount directly to the borrower, CBs open
● All transactions are settled through cheques
an account in his name as secondary or derivative deposit that
● CBs keep excess CRR as liquid cash
act as the basis of credit creation.
● CBs do not make any change in the credit policy.
● Since every loan creates a deposit, the excess cash reserve with
the bank acts as a credit multiplier. Limitations of Credit Creation
● Credit multiplier indicates the no. of times primary deposits
multiply. ❖ Credit creation depends on the volume of money in
● Credit multiplier is the reciprocal of cash reserve ratio. circulation.
● CBs are not only purveyors of money, but also manufacturers of ❖ High CRR reduces the credit creation capacity of CBs
money. ❖ Higher the amount of liquid cash with the public,
● Every loan creates an additional deposit and the borrower make lower is the credit creation.
the payment through cheque to the creditor who in turn deposit ❖ Periodical revision of CRR by Central Bank influence
the cheque in the bank which again creates an additional deposit. the capacity of CBs to create or contract credit.
This process is known as multiple credit creation.
 Secondary Functions of Commercial Banks
1. Agency Services 2. General Utility Services
★ Collection and payments of credit instruments ❖ Locker facility
★ Collection of dividends, interest, etc. on behalf
❖ Traveler’s cheque
of customers. Purchase and sale of shares and
❖ Credit cards
securities on behalf of customers.
★ Payment of rent, insurance premium, ❖ Letter of credit
subscriptions etc. on behalf of customers. ❖ Collection of statistics
★ Acting as a trustee or executor.
❖ Underwriting securities
★ Acting as agents on behalf of customers for
❖ Gift cheques
other financial institutions at home and
abroad. ❖ Merchant banking
❖ Acting as Referee