Primary Functions of Banks

Banks perform a variety of functions in the economy, which are broadly classified into primary (basic) functions and secondary (supporting) functions. The primary functions constitute the core activities that define the very existence of a bank, while secondary functions are additional services that enhance financial convenience and support economic development. Among these, the primary functions are fundamental because they distinguish banks from other financial institutions and directly contribute to credit creation and economic circulation of money.

Accepting Deposits

Accepting deposits is the first and foremost primary function of a commercial bank. Banks accept money from the public and provide a secure and reliable place for safeguarding savings. When individuals or institutions deposit money in a bank, the bank guarantees the safety of those funds and assures repayment either on demand or after a specified period. In most cases, banks also pay interest on deposits, which encourages the habit of saving among the public.
Deposits serve a dual purpose. For depositors, they provide safety, liquidity, and often a return in the form of interest. For banks, deposits form the principal source of funds used for lending and investment activities. To maintain public confidence and meet withdrawal demands, banks are legally required to keep a certain proportion of deposits as reserves, either as cash in hand or with the central banking authority.
Banks offer different types of deposit accounts to meet the varying needs of customers:

• Saving Deposits: These accounts are primarily meant for individuals and households to save money. They allow frequent deposits and withdrawals, subject to certain conditions, and pay interest at a modest rate. The objective is to promote regular saving while maintaining liquidity for depositors.
• Fixed Deposits (Term Deposits): Under this type, money is deposited for a fixed and predetermined period, such as one year or five years. Withdrawals before maturity usually attract penalties. In return for locking in funds, banks offer a higher rate of interest compared to savings accounts. Fixed deposits are suitable for individuals seeking stable returns without immediate liquidity needs.
• Current Deposits: These accounts are mainly operated by business firms, traders, and institutions. They permit unlimited deposits and withdrawals and facilitate day-to-day transactions. Generally, no interest is paid on current deposits, and banks may charge service fees. Their key advantage lies in high liquidity and transactional convenience, often supported by facilities such as chequebooks and overdrafts.
• Recurring Deposits: This form of deposit allows customers to deposit a fixed amount regularly, usually every month, over a specified period. Recurring deposits help inculcate disciplined saving habits and provide returns similar to fixed deposits upon maturity.

Through deposit acceptance, banks mobilise idle savings from the public and convert them into a productive financial resource. The assurance of safety and easy withdrawal makes bank deposits one of the most trusted forms of holding wealth.

Granting Loans and Advances

Granting loans and advances is the second primary function of banks and represents the core income-generating activity of the banking system. After retaining a portion of deposits as mandatory reserves, banks lend the remaining funds to individuals, businesses, and governments. By extending credit, banks facilitate investment, consumption, and production, thereby playing a crucial role in economic development.
Banks provide credit in several forms, depending on the needs of borrowers:

• Term Loans: These are loans granted for a fixed period and are commonly used for purposes such as purchasing homes, vehicles, education, or business expansion. The borrower receives a lump sum amount and repays it along with interest through instalments over the agreed term.
• Overdrafts: An overdraft is a facility under which a current account holder is permitted to withdraw more money than the available balance in the account, up to a sanctioned limit. It is a short-term credit arrangement, and interest is charged only on the overdrawn amount for the period it is used. Overdrafts are particularly useful for businesses to meet temporary cash shortages.
• Cash Credit: This is a form of short-term loan generally granted to businesses against the security of inventory, receivables, or other assets. The borrower is allowed to withdraw funds up to an approved limit, and interest is charged only on the amount actually utilised. Cash credit is widely used to finance working capital requirements.
• Advances and Bills Discounting: Banks also provide advances by discounting bills of exchange or promissory notes. When a seller sells goods on credit and holds a bill payable at a future date, the bank can discount the bill by paying the seller an immediate amount, less a discount. The bank then collects the full value of the bill from the buyer on maturity. This facility ensures liquidity for traders and smooth functioning of commercial transactions.

Banks charge interest on loans and advances at rates higher than those offered on deposits. The difference between lending rates and deposit rates, known as the interest margin or spread, constitutes the main source of bank profit. This spread covers operating costs, risk, and profit. In addition to interest income, banks may also earn fees related to loan processing and account maintenance, but interest income remains fundamental.
By granting loans, banks channel funds from surplus units (savers) to deficit units (borrowers). This recycling of money promotes productive investment, supports entrepreneurship, enables consumption of durable goods, and assists governments in financing development projects. As a result, lending activity lies at the heart of a bank’s contribution to economic growth.