UNIT 2 COMMERCIAL BANKING

BANK:A bank is a financial institution which deals in money. It means that a bank receives money in the form of deposits from the public and lends money for development of trade & commerce. BANKER:Dr. H.L. Hart (Native of England) defines the term banker as one who is in the ordinary of his business honours cheques drawn upon him by persons from & for whom he receives money on current account. BANKING:According to Section 5 (1) (b) of the Banking Regulation Act of 1949, the term banking is defined as Accepting for the purpose of lending or investment of deposits of money from the public repayable on demand or otherwise & withdrawable by cheques, drafts, orders or otherwise. BANKING COMPANY:Section 5(1) (c) of the Banking Regulation Act of 1949, defines the term banking company as Any company which transacts the business of banking in India. COMMERCIAL BANKING:It refers to that banking which is concerned with the acceptance of deposits from the public repayable on demand or after the expiry of certain period & the granting of mainly short term credit to trade, commerce & industry through a network of branches throughtout the country. FUNCTION OF COOMMERCIAL BANKING:The function of commercial banking can be broadly classified into two categories, viz., A. Principal/Primary/Basic/Fundamental function. B. Subsidiary/Secondary/Supplementary/Ancillary function. A. Primary functions:The primary functions of commercial banks are called traditional functions or core functions. They are the following:1) Acceptance of deposits from the public. 2) Lending of funds. 3) Investment of funds on securities. 4) Creation of credit/money. 5) Use of cheque system. 6) Remittance of funds.

I. Acceptance of deposits source of funds:Accepting deposits is one of primary function of a commercial bank. Banks receive deposits from individuals, households, & corporate & non-corporate customers, government & other agencies & thus, they mobilize the savings in the country for productive purposes. Commercial banks offer different varieties of deposits to suit to the requirements of different categories of customers. Deposits serve as the major source of supply of funds to the commercial banks. The different sources of supply of funds to the commercial banks are:i) Deposits of various kinds. ii) Borrowings from the Reserve Bank of India. iii) Borrowings from other financial institutions. iv) Borrowings from fellow bankers. v) Borrowings from abroad. Types of deposits: current account deposits/active a/c or running a/c:Current accounts form the most important type of bank account. They are generally opened by trading & industrial concerns, public authorities, etc., which have frequent banking transactions involving huge amounts. They can be opened with a minimum of Rs.5000. proper & satisfactory introduction is necessary for opening current account. Current accounts are active or running accounts which are continuously in operation. In current accounts, customers can deposit any amount of money & any number of times. Similarly, they can withdraw from current accounts any amount & as many times as they want, as long as they have funds to their credit. Deposits into current accounts are made by filling in payin-slips & withdrawals from the current accounts are made by issuing cheques. Current deposits are repayable on demand. It is for this reason, they are also called demand deposits or demand liabilities. So, banks are required to keep the major portion of current deposits in liquid form. As such; they are not able to earn much income from the utilization of current deposits. Further they have to incur heavy expenses for the maintenance of current accounts, as a large number of transactions are to br\e recorded in the account of each customer. For these reasons, generally, no interest is offers on current deposits; instead incidental charges are claimed by the banks from the customers for the work & expenses involved in the maintenance of current accounts. Savings Bank Account Deposits:Savings bank accounts are opened by middle & low income groups who wish to save a part of their current incomes for their future needs & earn fair interest on their deposits. They can be opened with a minimum of deposit of Rs.250 when they are to be operated without cheques & with Rs.1000 or more, when they are to br\e operated by cheques. Proper & satisfactory introduction is necessary for opening savings bank accounts. In savings bank accounts, customers can deposits any amount of money& any number of times. But, as these accounts are intended to promote

the habit of saving among the depositors, these are restrictions on the number as well as the amount of withdrawals from these accounts. Money is deposited into these accounts by filling in pay-in-slips. Withdrawals are made from these accounts either by cheques or by special withdrawal forms accompanied by pass books. As savings bank accounts are opened by customers with a view to earning interests on their deposits & as there is an opportunity for the banks to utilize the savings bank deposits profitably on account of restrictions on withdrawals, fair interest is offered by banks on savings bank deposits. At present 3% interest per annum is allowed by banks in India on savings bank account deposits. Fixed Deposit Accounts:Fixed deposits also form one of the most important types of bank accounts. They are opened by small investors in order to earn good & steady income. No introduction is necessary for opening the fixed deposit accounts, as they are not operated by cheques. In case of fixed deposit accounts, fixed amounts are deposited by the customers for fixed periods at fixed rate of interest. The period of deposits generally varies from three months to five years. The fixed deposits can be withdrawn not on demand, but only after the expiry of fixed periods. It is for this reason they are also called Time Deposits. The fixed deposits are withdrawn by the surrender of Fixed Deposit Receipt given by the banker at the time of depositing money. The banks can employ these funds profitably without any fear of withdrawals by the depositors during the course of fixed periods. That is why, the rate of interest offered by banks on fixed deposit accounts is higher than that offered on other types of deposits. Generally, the longer the period of deposits, the higher the rate of interest & vice versa. Recurring Deposit Accounts or Cumulative Deposit Accounts:Recurring deposit accounts are variants of saving bank accounts. They have become vary popular in recent years. They are meant for people who have regular monthly incomes. They are intended to encourage the habit of saving among the depositors on a regular basis. In the case of a recurring deposit account, the depositor deposits a fixed sum of money every month for an agreed period & at the end of the specified period, he gets back the amount deposited together with the interest accrued thereon. The amounts that are deposited into recurring deposit accounts every month are in the multiplies of Rs.5 or 10 with a maximum of Rs.1000. The period for which a recurring deposit account is opened varies from one year to ten years. As there is a regular deposit of money into a recurring deposits account & as there is no withdrawal from the account before the wxpiry of the fixed period, there is an opportunity for the banker to employ the recurring deposits profitably. So, he is able to offer high interest on the recurring deposits. The rate of interest offered by a banker on the recurring deposits is almost equal to that allowed on the fixed deposits. In the case of a recurring deposit account, pass book is the means through which deposits & withdrawals are made. The pass book is to be presented to

the bank every month when deposit is made so as to enable the banker to record the deposit therein. Again, at the end of the agreed period, the pas book is to be given to the banker for obtaining the repayment of the accumulated amount. II. Lending of funds:Lending of funds constitutes the main business of commercial banks. The major portion of the funds of commercial banks is employed by way of advances, as advances from the primary source of profits for banks. Banks lends funds to the public by way of a) Loans. b) Overdraft. c) Cash credit. d) Discounting of bills. Loans:A loan is a financial arrangement under which an advance is granted by a bank to a borrower on a separate account called the loan account. When a loan is sanctioned to a borrower, the entire amount of loan is debited to the loan account of the borrower at once in lumpsum, either in cash or by transfer to the credit of his savings bank account or current account or current account if any. A loan is granted for short term, medium term & long term periods also. The repayment of loan is made in lumpsum or instalments also. A loan is granted either against collateral securities or the personal securities of the borrower. In the case of a loan interest is charged on the entire amount f loan sanctioned, irrespective of the amount actually withdrawn by the borrower. Loans are given to against the personal securities of the borrower. But usually & particularly where the amount involved is heavy, tangible securities in the form of government securities, shares, debentures, fixed deposit receipts. Life insurance policies, documents of title to goods are taken. Cash credit:A cash credit is a financial arrangement under which a borrower is allowed an advance under a separate account called cash credit account upto a specified limit called the cash credit limit. In the case of a cash credit, the borrower need not withdraw the entire amount at once in one lumpsum. He can withdraw the amount in instalments as & when he needs. A cash credit is usually more permanent financial arrangement than an overdraft. It can continue even for years together & is usually granted against the hypothecation or pledge of agricultural or industrial products. Sometimes, it is given against guarantees. It is rarely given against the personal securities of the borrower. Interest is charged quarterly or half yearly & is calculated on the daily debit balance for the actual period of utilization. The cash credit arrangement is the most popular method of borrowing in India & about 70% of the total bank credit is in the form of cash credits. The popularity of cash credit is because if two reasons viz.,

a) The borrower is required to pay interest on the actual amount utilized by him for the actual period of utilization. b) It is a permanent financial arrangement. Though cash credit arrangement is popular with the borrowers, it is disadvantage to the banker, because A) he can charge interest only on the actual amount withdrawn by the borrower. B) he is required to keep at the disposal of the borrower, the entire amount of cash credit sanctioned. Therefore, to compensate the banker there is a provision for charging commitment charge. On the unutilized portion of the cash credit limit. Overdrafts:An overdraft is a financial arrangement under which a current account holder is permitted by the bank to overdraw his account ie., to draw more than the amount standing to his credit upto an agreed limit against the collateral or personal securities of the borrower. In the case of an overdraft, interest is charged quarterly or half yearly & is calculated on the daily debit balances for the actual period of utilization. It is advantageous to the borrower, as interest is charged only on the amount actually withdrawn by him. But, it is disadvantageous to the banker because, he can charge interest only on the amount actually overdrawn by the customer & he is required to keep at the disposal of the borrower, the full amount of the overdraft sanctioned. Therefore, to protect the interest of the banker, generally there is a provision for charging commitment charge. On the unutilized portion of the credit limit. Discounting of Bills of exchange:It is an arrangement under which a bank takes a bill of exchange maturing with in a short period of 60 days or 90 days from an approved customer & pays him or credit his current account immediately with the present value i\of the bill ie., the face value of the bill minus discount charges. Then on the due date of the, the bank receives the face value of the bill from the acceptor of the bill. The bill discounted may be documentary bill ( ie., a bill of exchange accompanied by documents of title to goods) or a clean bill (ie., a bill of exchange not accompanied by documents of title to goods.) The interest for this financial accommodation is called the discount & is charge on the face value of the bill for the unexpired period of the bill ie., from the date on which the bill is discounted to the date on which the bill matures. III. Investment of funds on securities:Investment of funds on securities is one of the important functions of commercial banks. They invest a considerable amount of their funds in government & industrial securities. In India commercial banks are required by statute to invest a major portion of their funds in government & other approved securities. While investing its funds on securities, commercial banks are required to keep in mind certain principles which are called Sound Commercial Banking Principles or Investment Norms. The various sound commercial banking principles are:-

1. Principles of safety or securities:A Commercial banks is the custodian of depositary money. So, it is required to safeguard the money of the depositors entrusted to it. That means while investing the funds of depositors in its hands, a commercial bank should see that the safety of investments is not sacrificed for the sake of profitability. It has to ensure that the funds invested will back on time to meet the depositors claims. To ensure safety of funds invested, a bank has to take in to account the repaying capacity of the borrowers. To assess the repaying capacity, a bank has to take into account 3 cs i.e., capacity, capital & collateral security offered by the borrowers. 2. Principle of Liquidity:The deposits accepted by a commercial bank are repayable either on demand or after the expiry of a fixed period. That means, to meet the claims of the depositors on demand or due dates, a commercial bank is required to maintain adequate liquidity of its funds i.e., keeping sufficient funds in hands or with the central bank. So, liquidity is another sound commercial banking principle. 3. Principle of profitability:Like any other business, commercial banking also is a business. So, like other business enterprise, a commercial bank also must make sufficient profits. Even public sector commercial banks must aim at reasonable profits. Unless reasonable profits are earned by a commercial bank to maintain the viability of the banking business, sooner or later it has to become sick & has to even disappear. So, profitability is one of the sound principles of commercial banking. 4. Principle of Social responsibility or social good:In a country like India, where there is a socialisation of credit every commercial bank(public or private) has to take into account a new principle called the principle of social good. The principle of social good is the outcome of the concept of social responsibility. The principle of social good suggest that the commercial bank which deals in others money are expected to make effective use of public deposits for promoting maximum social good to the society. In fact, the performance of commercial banks is judged by their contribution to the achievement of eco-economic objectives & to the economic development of the country as per the national policies & national priorities determined by the government. 5. Principle of productivity:This is another important principle suggested by banking experts. According to them, the bank should invest its funds in such a way as to secure for itself an adequate & permanent income. The objective of the bank is to earn maximum profits & its income must accrue from productive investments. If the assets are productive the income to the bank will also be stable. This principle implies that under no circumstance, the bank should advance funds for speculative purposes (i.e., antisocial )