Understanding Banking Business and Functions [Part-I]

Functions of Banks

The core functions commercial banks can be segregated into three main segments viz. Financial Intermediation, Payment System and Financial Services. Apart from these, various other functions of banks are as follows:

  • Banks work as trustees for certain requirements of the businesses, governments and public.
  • They issue Letter of credit for the purpose of facilitating trade.
  • They help in the disbursement of the pension to pensioners.
  • Enable Government to Government (G2G), Government to Corporate (G2C) transactions.
  • Banks liaison with local government departments and government treasury.

Financial Intermediation

The key business of the banks is to accept different types of deposits from the public and then lend these funds to the borrowers. This is called Financial intermediation. In terms of the banks, the deposits represent the “liabilities” of the banks while loans advanced and investments made by banks represent their “assets”.

Acceptance of Deposits

Banks are called custodians of public money and mobilization of the deposits from the public is the most important function of the commercial banks.  There are mainly two types of deposits viz. Time deposits (Term Deposits) and Demand Deposits. As custodians of public money, the banks provide security to the money and valuables of the general public.  In India, the bank deposits are covered under the deposit insurance scheme provided by DICGC. For security of valuables banks provide locker facilities.

Loans and Advances

There are various types of loans or advances, which can be divided on the basis of different sets of criteria. More information about various types of lending operations in India, click here.

Payment System

Payment refers to the transfer of an item of value from one party to another in exchange for goods or services or both; or to fulfill a legal obligation. In any economy, the banks are core to the payment systems. Banks not only enable transfer of money but also its mobilization. The basic method of financial transactions is by negotiable instruments such as cheques and drafts. In modern times, the electronic banking, wire transfers, real time settlements, internet banking etc. are various modes of financial transactions. Banks also enable the internal remittances, foreign exchange transactions, telegraphic transfers of money.

Financial Services provided by Banks

Apart from the above, Banks impart various financial services such as investment banking, insurance-related services, government-related business, foreign exchange businesses, wealth management services, etc. Banks also provide agency services to their customers which includes:

  • Collection and payment of cheques and bills on behalf of customers.
  • Collection of dividends, interest, rent etc. on behalf of customers, if so instructed by them.
  • Purchase and sale of shares and securities on behalf of customers.
  • Payment of rent, interest, insurance premium, subscriptions, on behalf of customers, if so instructed.
  • Acting as a trustee or executor.

Deposits and Accounts

Time deposits and demand deposits

Banks are called custodians of public money and mobilization of the deposits from the public is the most important function of the commercial banks.  Mainly, there are two types of deposits viz. Time Deposits and Demand Deposits. When money is deposited for a fixed period, before which it cannot be withdrawn; such deposits are called “Time deposits” or “Term deposits”. The most common example of Time deposits is “Fixed Deposit“. On the other hand, if money deposited can be withdrawn by the customer (depositor / account holder) at any time without any advanced notice to banks; it is called demand deposit. Most common example of demand deposit is our Saving Banks Account, Current Bank Accounts etc. We can withdraw the funds in these accounts on demand.

Different types of time deposits

On the basis of their nature, time deposits may be of three types as follows:

  • Fixed deposits: A fixed rate of interest is paid at fixed, regular intervals
  • Re-investment deposits: Interest is compounded quarterly and paid on maturity, along with the principal amount of the deposit. In the Flexi Deposits amount in savings deposit accounts beyond a fixed limit is automatically converted into term-deposits.
  • Recurring deposits: Fixed amount is deposited at regular intervals for a fixed term and the repayment of principal and accumulated interest is made at the end of the term. These deposits are usually targeted at persons who are salaried or receive other regular income. A Recurring Deposit can usually be opened for any period from 6 months to 120 months.

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