Functions of a bank can be classified into.
(A) Main functions and
(B) Optional functions
(A) Main functions:
1. To accept/collect deposits:
- A person who has some unused money and wishes to deposit it in a bank can go to bank and deposit it.
- The biggest responsibility of the bank is to maintain the trust of the customer i. e. the person who deposits the money.
Bank accepts four types of deposits:
- Deposits in saving account
- Deposits in current account
- Deposits in recurring account
- Deposits Fixed term account
2. To lend money:
- Bank accepts deposits from various people. The deposited money remains with bank on which the bank pays some interest to the depositors.
- On the other hand people go to banks to borrow money in forms of loans. The bank lends the money to the borrowers at higher rates of interest. Thus, the bank earns profit from the difference of rate of interests.
The bank lends money in following ways:
(a) Through loans:
- Bank provides short term and long term loans to borrowers. In some cases it asks for hypothecation where as in some it doesn’t.
- Bank provides loan to individuals, businessman, industrialists, etc.
- Bank offers home loans, car loan, education loan, cash credit, machinery loan, gold loan, personal loan, etc.
(b) Through overdraft and cash credit:
Overdraft:
As per rule, one cannot withdraw more than the amount present i.e. deposited in one’s account. When a current account holder is allowed to withdraw more money than present in his account for a short duration it is said that the bank has lent him money through overdraft facility.
Cash credit:
- A cash credit is a drawing account for drawing money within a specific credit limit approved by the bank against some security.
- Overdraft and cash credit are similar except that for withdrawing under cash- credit one needs to provide some security like raw-material, finished goods, etc. as hypothecation.
3. To invest:
- A bank cannot make profit if it is unable to lend the deposits and invest its capital in a substantial manner. One of the important tasks of the bank is to thoroughly calculate and invest its money at some secure options.
- As per RBI’s rule a bank need to invest some percentage of its total deposit in government guarantees (securities) on which the bank earns a low interest. The reason for investing in such government guarantees is that bank can easily withdraw its investment in case of emergencies or some unforeseen events. As a result a bank majorly invests in government securities or other capital units.
4. To carry out inter-banking transactions (call money):
- In day to day transactions it is quite likely that each bank faces a shortage of money even for as short as 24 hours or even lesser.
- In such cases the bank may borrow money from another bank at an interest rate which is determined by the shortage of money or say demand or supply pattern in the market.
- The borrowing and lending banks do not come is direct contact with each other for this transaction. It is done by an agency appointed by the Central Bank
- This money is known as ‘Call money’ and its rate of interest is called ‘Call money rate’.
(B) Optional functions of bank:
1. Look after the financial transactions of the customers:
A bank mainly has two customers
(a) A depositor and
(b) A borrower.
It is the bank’s duty to see that both of his customers can perform their financial transactions properly.
- When a customer writes a cheque in favor of another person, the bank pays ‘ th’at person the money on behalf of the person who wrote the cheque.
- Similarly, when a person receives a cheque and goes to bank the bank collects money from the account of person who has written the cheque and pays the money to the person who brought the cheque.
- Bank also facilitates payments of electricity bill, telephone bill, insurance premium, transfer of money from one account to another, etc.
2. Carry out foreign exchange (forex) transactions:
- The financial transactions related to import-export business can only be done through banks.
- Those banks that have got permission from central bank to provide Forex services can facilitate people to exchange foreign currencies in bank, send and receive documents related to foreign trade, etc.
3. To issue Letter of Credit (L/C):
- A letter of credit is a document from a bank guaranteeing that the seller will receive full payment at specified time if all the delivery conditions are fulfilled by the seller. These letters are generally needed in international transactions where buyers and sellers are unknown to each other.
- The bank collects certain deposit or some guarantee of similar amount from the person before issuing such letter. The bank earns commission by providing this service.
4. Issuing Traveller’s Cheque (TC):
- A traveller’s cheque is a medium of exchange that can be used instead of currency. It is very useful when a person is travelling within country or even abroad. Since the traveller carries cheques he is safe from the danger of hard cash getting robbed or stolen.
- Before leaving for a tour the person can deposit certain amount at the bank, get his signature verified and receive traveller’s cheques in the amount he asks to the bank. The person can then withdraw money using these cheques from outstation or foreign banks by doing the same sign before the bank as he did in the bank which issued him traveller’s cheques.
- These cheques are very reliable and transferable too. However, their use has decreased after ATM facility became popular worldwide.
5. Issuing demand draft (DD):
- Demand draft (DD) is a cheque written by a bank (issuing bank) to another bank/branch asking it to pay money to the person/organization whose name is mentioned on it. Demand daft is a very secure medium for sending money to a person or an institute.
- The person who wishes to send money fills a form in the bank requesting it to issue the draft for the details mentioned in the form. Based on this the bank prepares a demand draft and mentions the receiver’s name on it and passes the order to its branch or associate bank to make the payment to the receiver. If the bank issues a draft that can be encashed only in the same branch then it is called pay-order.
- The sender of the DD needs to pay certain commission to the banks for this service.
6. Provide information related to the financial credit of its customer:
The bank frequently transacts with its customers and hence is well aware about their financial soundness.
- A firm or an institute who wishes to undergo credit transactions with a person can obtain the information on his financial soundness from his bank. This helps the institute to check the reliability and financial capability of the person.
- The certificate that the bank provides regarding the financial soundness of the customer is called solvency certificate.
7. To provide service as an under-writer (i.e. guarantor):
- When a new company enters the capital market and collects funds through shares it is afraid if it will be able to collect at least a minimum subscription to start the business.
- In such situations it requests the bank to become a guarantor or say under-writer that in case if it cannot raise sufficient money from the market the bank will fulfill the deficit by investing in the company.
8. Providing services like ATM, Demat, safe-deposit vault, etc. Bank provides several services like ATM cards, credit and debit cards, safe deposit vaults, Demat services, etc.
