Functions of Commercial Banks
Commercial banks play a central and indispensable role in modern economic systems. They serve as key financial institutions that connect savers and borrowers, facilitate transactions, and support economic development. By accepting deposits from the public and lending those funds to individuals, businesses, and governments, commercial banks act as financial intermediaries. Their operations contribute directly to economic stability, capital formation, employment generation, and national growth.
The major functions of commercial banks can be broadly classified into deposit acceptance, lending, payment facilitation, credit creation, agency services, utility services, and development-oriented functions. Each of these functions is discussed in detail below, along with relevant examples.
1. Accepting Deposits:
Accepting deposits from the public is the primary and fundamental function of commercial banks. People deposit money in banks mainly for safety, liquidity, and interest income. Deposits also enable banks to mobilize savings, which later become the main source of funds for lending activities.
Types of Deposits:
a) Savings Deposits: Savings accounts are designed for individuals who wish to save money while maintaining easy access to their funds. These accounts usually earn moderate interest and encourage regular saving habits.
Example: A university student deposits part of their monthly allowance into a savings account to build future savings.
b) Current Deposits: Current accounts are mainly used by business organizations, traders, and institutions that require frequent deposits and withdrawals. These accounts generally do not earn interest but provide high liquidity and transaction flexibility.
Example: A shop owner uses a current account to deposit daily sales revenue and make supplier payments.
c) Fixed Deposits: Fixed deposit accounts involve depositing a lump sum amount for a specific period at a higher rate of interest. Premature withdrawal usually results in reduced interest.
Example: A customer deposits Tk 50,000 for one year in a fixed deposit scheme to earn higher interest.
d) Recurring Deposits: Recurring deposit schemes allow customers to deposit a fixed amount regularly, usually every month. This is particularly suitable for salaried individuals and small savers.
Example: A salaried employee deposits Tk 2,000 every month in a recurring deposit to save for future expenses.
Deposits not only benefit customers but also provide banks with the financial resources needed for lending and investment.
2. Granting Loans and Advances:
Granting loans and advances is the second most important function of commercial banks. Through lending, banks supply credit to various sectors of the economy, supporting consumption, production, and investment.
Types of Loans and Advances:
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- a) Personal Loans: These loans are provided to individuals for personal needs such as education, medical treatment, marriage, or emergencies.
- b) Business Loans: Banks offer loans to businesses for working capital, purchasing machinery, or expanding operations.
- c) Housing Loans: Housing or home loans help individuals purchase, construct, or renovate residential properties.
- d) Overdraft and Cash Credit: These are short-term credit facilities mainly provided to businesses to meet day-to-day financial needs.
Example: A manufacturing company takes a bank loan to expand production facilities, leading to increased employment and economic activity.
By granting loans, banks promote entrepreneurship, industrial growth, and overall economic development.
3. Facilitating Payment and Money Transfer:
Commercial banks play a crucial role in facilitating safe, fast, and efficient payment systems. These services reduce the need for physical cash and promote cashless transactions.
Major Payment and Transfer Services
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- Cheque clearing and collection
- Demand drafts and pay orders
- Online and internet banking
- Mobile banking applications
- Debit and credit card services
- Electronic fund transfers (EFT/BEFTN)
- Real-Time Gross Settlement (RTGS)
- International remittance services
Example: A parent transfers tuition fees to their child studying in another city through online banking or mobile financial services.
These services enhance convenience, transparency, and security in financial transactions.
4. Credit Creation:
Credit creation is a unique and significant function of commercial banks. Banks create credit by extending loans based on deposited funds, thereby increasing the overall money supply in the economy.
Mechanism of Credit Creation: When a bank grants a loan, it does not usually pay cash. Instead, it credits the borrower’s account. This newly credited amount becomes purchasing power, even though no new physical money is issued.
Example: If a bank provides a loan of Tk 100,000, that amount becomes available for spending and circulation, contributing to economic activity.
Through credit creation, banks stimulate investment, production, and economic growth, while also supporting monetary circulation.
5. Agency Functions:
Commercial banks act as agents of their customers by performing various services on their behalf. These services save time and reduce administrative burdens for individuals and organizations.
Major Agency Functions
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- Collection of cheques, dividends, and interest
- Payment of utility bills such as electricity, gas, and water
- Disbursement of salaries and pensions
- Execution of standing instructions (rent, insurance premiums, loan installments)
- Acting as trustees, executors, or administrators
Example: An organization uses a bank to distribute monthly salaries directly to employees’ accounts.
6. General Utility Services:
In addition to core banking functions, commercial banks provide various utility and support services that improve customer convenience and financial planning.
Common Utility Services
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- Safe deposit lockers for storing valuables
- Foreign exchange services
- ATM and 24/7 cash withdrawal facilities
- Online banking platforms for account management
- Issuance of letters of credit and bank guarantees
- Financial consultancy and advisory services
Example: A traveler exchanges local currency for foreign currency at a bank before traveling abroad.
7. Promoting Economic Development:
Commercial banks play a vital role in national economic development by mobilizing savings, financing investments, and supporting priority sectors.
Contributions to Economic Development
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- Financing industrial and infrastructure projects
- Supporting small and medium enterprises (SMEs)
- Encouraging savings and capital formation
- Providing credit to agriculture, education, and healthcare
- Promoting financial inclusion through rural and digital banking
Example: A bank provides a loan to a small entrepreneur, enabling business expansion and local employment generation.
Commercial banks are far more than institutions that accept deposits and provide loans. They are the backbone of the financial system, supporting individual financial needs and driving national economic growth. By accepting deposits, granting credit, facilitating payments, creating credit, and offering a wide range of financial and utility services, commercial banks ensure a stable, efficient, and inclusive financial environment. Their role as financial intermediaries makes them essential to promoting savings, investment, employment, and long-term economic development.