Commercial Banks:

A commercial bank is a financial institution that accepts deposits from the

general public and provides investment loans for the purpose of making a profit. In fact,
commercial banks, as their name suggests, are profiting institutions, that is, they do
banking business to make a profit.
They usually finance trade and commerce with short-term loans. They charge high
interest rates from lenders but pay very low interest rates on their deposits, making the
difference between the two interest rates the main source of profit for banks.
Importance and functions of Commercial Banks:
Banking plays an important role in the financial life of a business, and the
importance of banks can be seen from the fact that they are considered the lifeblood of
the modern economic system. Although no wealth is generated by banks, their essential
activities facilitate the process of production, exchange and distribution of wealth.
Commercial banks have the power to provide a variety of financial services, including
loans, savings accounts, etc. Functions of commercial banking are of two main categories
i.e. Primary and Secondary.
Primary Functions of Commercial Banks:
Following are the primary functions of commercial banks:
1) Accepting deposits:
Commercial banks accept deposits from people, businesses and other entities in
this form saving deposits, Time deposits and current deposits.
2) Lending of Funds:
Another important activity is lending money to consumers in the form of loans
and advances, cash credit, overdrafts and bill rebates etc. Loans are advances
that a bank provides to its customers for a specified period of time and with
security at an agreed interest rate. In addition, the bank deposits the loan
amount into the customer's account, which it withdraws as needed.
Secondary Functions of Commercial Banks:
Following are the Secondary functions of commercial banks:
a) Bank as an Agent:
A bank acts as an agent to its customers for various services like:

 Collecting bills, draft, cheques, etc.

  Paying the insurance premium, rent, loan installments, etc.
 Working as a representative of a customer for purchasing or
redeeming securities, etc. in the stock exchange.
 Acting as an executor, administrator, or trustee of the estate of a
customer
 Also, preparing income tax returns, claiming tax refunds, etc.

b) General Utility Service:

There are several general utility services that commercial banks offer like:

 Issuing traveler cheques

 Offering locker facilities for keeping valuables in safe custody
 Also, issuing debit cards and credit cards, etc.

Principles of Commercial Banking:

 Principles of liquidity:
The principle of liquidity is very important for a commercial bank.
Liquidity refers to the liquidity of an asset that will soon be converted into
cash without any loss.

A commercial bank offers two types of deposits:

 Demand deposit which the bank has to pay on demand like a savings
account and
 Time deposits that have to be paid to the bank after the end of a certain
period.
 Principle of Efficiency:
The commercial bank should run its business efficiently. So that they
can succeed in the goal.
In this competitive market, there is no alternative but efficiency in
management. Therefore, the commercial bank has to train its employees
to increase its efficiency in management.

 Principle of Economy:

Commercial banks never fight for any pointless expenses. They strive
to maintain a sustainable economy that increases their annual profits.
Credit Creation:

The central bank is the main source of money supply in an economy

through circulation of currency. It ensures the availability of currency to meet the
transactional needs of the economy and to facilitate various economic activities such as
production, distribution and consumption.

For this purpose, however, the central bank needs to rely on the reserves of commercial
banks. These reserves of commercial banks are a secondary source of money supply in
the economy. The most important function of a commercial bank is to create credit.

Therefore, money provided by commercial banks is called credit money. Commercial

banks prepare credit by advancing loans and buying securities. They lend to
individuals and businesses from publicly accepted reserves. However, commercial
banks cannot use the full amount of public reserves for lending purposes. It is
necessary to keep a special amount with the central bank to provide cash to the
depositors. After having the required amount of reserves, commercial banks can lend
the rest of the public reserves.

According to Benham’s, “a bank may receive interest simply by permitting customers

to overdraw their accounts or by purchasing securities and paying for them with its
own cheques, thus increasing the total bank deposits.”

Example:
Suppose you deposit Rs. 10,000 in a bank A, which is the primary
deposit of the bank. The cash reserve requirement of the central bank is 10%. In such
a case, bank A would keep Rs. 1000 as reserve with the central bank and would use
remaining Rs. 9000 for lending purposes.

The bank lends Rs. 9000 to Mr. X by opening an account in his name, known as
demand deposit account. However, this is not actually paid out to Mr. X. The bank has
issued a check-book to Mr. X to withdraw money. Now, Mr. X writes a check of Rs.
9000 in favor of Mr. Y to settle his earlier debts.

The check is now deposited by Mr. Y in bank B. Suppose the cash reserve
requirement of the central bank for bank B is 5%. Thus, Rs. 450 (5% of 9000) will be
kept as reserve and the remaining balance, which is Rs. 8550, would be used for
lending purposes by bank B.
Thus, this process of deposits and credit creation continues till the reserves with
commercial banks reduce to zero.

Limitation of Credit Creation:

 Amount of Cash:

Affects the creation of credit by a commercial bank. higher the cash of

commercial banks in the form of public deposits more will be the
credit creation. However, the amount of cash to be held by
commercial banks is controlled by the central bank.

The central bank can increase or contract cash in commercial banks

by buying and selling government securities. Furthermore, the ability
to generate credit depends on the rate of increase or decrease in
reserve ratio of cash by the central bank.

 Reserve Ratio of Cash:

Refers to reserve ratio of cash that need to be kept with the central
bank by commercial banks. The main purpose of keeping this reserve
is to fulfill the transactions needs of depositors and to ensure safety
and liquidity of commercial banks. In case the ratio falls, the credit
creation would be more and vice versa.

 Leakages:

Imply the outflow of cash. The credit creation process may suffer
from leakages of cash.

 Types
1) Excess Reserves
2) Currency Drains

 Availability of Borrowers:

Affects credit creation through banks. Credit is created by lending to

borrowers in the form of loans. If there are no borrowers, then no
credit will be created.
  Availability of Securities:

Refers to securities against which banks lend. Therefore, the

availability of securities is essential for lending otherwise
credit will not be created. According to Crowther, “the bank does
not create money out of thin air; it transmutes other forms of wealth
into money.”

 Business Conditions:

This means that credit creation is affected by the cyclical nature of the
economy. For example, when the economy enters a recession, credit
creation will be smaller. This is because in the depressed phase,
traders do not prefer to invest in new projects. On the other hand, in
the prosperous phase, merchants turn to banks for loans, which lead to
credit creation.

Despite its limitations, we can conclude that credit creation through commercial
banks is an important source of revenue generation.

The Principle Features of Different Bank Accounts:

Fixed Account:
The account which is opened for a particular fixed period (time) by
depositing a particular amount is known as a Fixed Deposit Account.

Features:
i. Money can only be deposited once. Separate accounts are required for
more such deposits.
ii. A higher interest rate is paid on a fixed deposit. Interest rates vary
from bank to bank.
iii. Withdrawals are not allowed before maturity date. However, in an
emergency, banks allow the closing of the designated account before
the maturity date. In such cases, the bank deducts 1% (the rate of
deduction varies from bank to bank) from the interest payable till that
day.
iv. The depositor is given a fixed deposit receipt, which must be
presented to the depositor at maturity. The deposit can be renewed for
a longer period.
Current Account:
The current account includes deposits, withdrawals and contra
transactions. Such accounts are also called demand deposit accounts. Current accounts
can be opened in most commercial banks.

Features:
i. The current record gives experts the ability to easily guide their
business transactions.
ii. The specialists can pull back any sum whenever from their present
records. There are likewise no confinements on withdrawals.

iii. The bank gathers cash for its clients and credits the equivalent to
their accounts.

PLS (Prize Linked Saving) Saving Account:

It is a saving account available for general public, govt/semi govt
organizations, companies, business entities etc. who are eligible to open account as
per bank’s criteria.

Features:
i. The Account can be opened with an initial/minimum deposit as
stipulated by the Bank from time to time unless specifically
exempted.
ii. Calculation of profit is on monthly average balance method at
minimum savings rate.
iii. Payment of profit is on half yearly basis.
iv. SMS Alert facility is available subject to payment of annual charges
as per bank’s schedule of charges.

Rights & Duties of a Bank Customer:

Rights:
i. The Right to be informed:
As a bank customer, you have a right to disclosure of information
from your bank on goods and services the bank offers.

ii. The Right to choose:

 You have a right to select from the range of products and services
made available by your bank at competitive prices.

iii. The Right to safety:

This right requires a bank to guarantee all its customers a secure and
conducive banking environment devoid of threats to their safety and health.

iv. The Right to good service:

All customers have a right to value for their money which involves the
right to be treated with respect and dignity by banks and their
representatives.

v. The Right to equality:

This right requires that a customer is treated equally as other
customers regardless of differences in financial standing/deposit balance,
physical ability, age, gender, ethnicity, or creed.

vi. The Right to free monthly statement of account:

The provision of the Revised Guide to Bank Charges is that banks are
required to provide their customers free statement of account on a monthly
basis.
Duties:
i. Duty of knowledge and understanding:
This represents the cornerstone of your duties as a bank customer and
involves the search for relevant knowledge that should lead you to make
informed decisions and enhance your benefits.
ii. Duty of financial obligation:
This requires customers to repay credit facilities and pay mutually
agreed interest on loans and other financial services rendered by their banks
as and when due.
iii. Duty to protect instruments and information:
It is your duty as a bank customer to keep your cheque book, ATM
and all information relating to your account like PIN, passwords and codes
safe.
iv. Duty to provide factual information and not to mislead the bank:
As a bank customer, you should bear in mind that just as your bank is
required to provide you with truthful information about goods and services it
offers, you are also required to provide the bank with truthful information
about yourself.
v. Duty to report suspected fraud or error:
Where you suspect a fraud or compromise, whether in your accounts
or in respect of relevant information/transaction, you are duty-bound to
 promptly report your discovery to your bank and relevant authorities
accordingly.

Rights & Duties of a Banker:

Rights:
i. Right of general lien:
One of the important rights of the banker is the right of general lien. Lien
means the right of the creditor to retain the goods or securities owned by the
debtor until the debt due from him is repaid.

ii. Right of the set-off:

A banker possesses the right of set-off which enables him to combine
two accounts in the name of the same customer and to adjust the debit balance
in one account with the credit balance in the other.
The right of set-off can be exercised subject to the fulfillment of the
following conditions:

 The accounts must be in the same name in the same right.

 The right can be exercised in respects of debts due only not in
respects of future debts or contingent debts.
 The number of debts must be certain.
 The banker may exercise that right at his discretion.

iii. Banker’s right of appropriation:

If the customer has more than one account or he has taken more than one
loan from the banker, the banker has the right to appropriation these loans by
the accounts.

iv. Right to charge interest, incidental charges:

As a creditor, a banker has the implied right to charge interest on the
loans granted to the customer.
In the same way, incidental charges like service charges, processing fees,
appraisal charges, panel charges may be imposed by the banker to the
customer.
Deposit are repayable on the term and made by the customer but the
period of limitation for the refund of bank deposit is three years with effect
from the date a customer made a demand for his money.
Duties:
i.