BANKING FUNCTIONS OF BANKS COMMERCIAL & CENTRAL BANK MONETARY POLICY OF RBI

(DEWETT 417/431)

BANKS
Banks are like reservoirs They collect the savings of some people and give them to others who use them productively. In the process, they earn a commission, out of which they pay interest to those who save and deposits fund with them A bank is an institution in which those people who have spare cash deposit it and those who need funds borrow from it

TYPES OF BANKS
COMMERCIAL BANKS EXCHANGE BANKS INDUSTRIAL BANKS AGRICULTURAL OR CO-OPERATIVE BANKS SAVINGS BANK CENTRAL BANK EACH TYPE SPECIALIZE IN A PARTICULAR KIND OF BUSINESS

COMMERCIAL BANKS
Their business mainly consists of receiving deposits and giving loans and financing trade of a country. They provide a short term credit i.e , lend money for short periods.

EXCHANGE BANKS
Exchange banks finance mostly the foreign trade of a country. Their main function is to discount, accept and collect foreign bills of exchange. They also buy and sell foreign currencies and help businessmen to convert their money into any foreign money they need. In addition, they carry on ordinary banking business also.

INDUSTRIAL BANKS.
Industries require capital for a long period for buying machinery and equipment. Industrial banks provide capital for a long period for buying machinery and equipment. Industrial banks provide this type of block capital. They also receive deposits for longer periods. They are thus in a position to advance long term loans.

INDUSTRIAL BANKS
Examples of industrial banks: Industrial Finance Corporation of India (IFCA)-1948- By Central Government State Financial Corporations State owned Industrial Credit &Investment Corporation of India (ICCI) National Industrial Development Corporation (NIDC) Industrial Development Bank of India (IDBI)

AGRICULTURAL or Co-operative Banks

Provide funds to farmers. Long-term capital is provided by Land Mortgage Banks, nowadays called landdevelopment banks, while short-term loans are given by co-operative societies or cooperative banks. Long term loans are provided for purchasing lands and machineries while short term loans help them in purchasing implements, fertilizers, seeds etc.

SAVINGS BANKS
Collect small savings. Commercial banks too run savings departments to mobilize the savings of people of small means. Post Office Savings Banks in India are doing the same functions.

CENTRAL BANKS
Central Banks exists in almost all countries and it is owned and controlled by the government of the country. In India, Reserve Bank of India (RBI) is functioning as Central Bank

COMMERCIAL BANKS
FUNCTIONS OF COMMERCIAL BANKS 1. ACCEPTING DEPOSITS 2. GIVING LOANS 3. CREDIT CREATION 4. UTILITY FUNCTION

ACCEPTING DEPOSITS
To receive deposit and to advance loans are the two main functions of all commercial banks They borrow to lend. They borrow in the form of deposits and lend in various forms of advances.

 DEPOSITS
CURRENT DEPOSITS OR DEMAND DEPOSITS Payable on demand without any notice. No interest is paid because bank cannot utilize as it is short term. A little commission is paid For services rendered by Bank. A small interest is Paid to people who keep Large balance

FIXED DEPOSIT OR SAVINGS BANK DEPOSIT. Midway between current TIME DEPOSIT and fixed deposit. There is These deposits can be a limit for number of withdrawn only after the withdrawal and amount. expiry of the period. The rate of interest is less Interest is paid depending than that on the upon the time period Fixed Deposit and amount

GIVING LOANS
After collecting money by way of deposits , a bank invests it or lends it out. Money is lent to businessmen and traders usually for short periods only. This is because the bank must keep itself ready to meet the demands of the depositors, who have deposited money for short periods.

Giving loans- Money is advanced by the banks in any one of the following ways: BY ALLOWING AN OVERDRAFT BY CREATING A DEPOSIT DISCOUNTING BILLS REMITTING FUNDS

ALLOWING OVERDRAFT
Customers of standing are given the right to withdraw their accounts. In other words, they can get more than they have deposited, but they have to pay interest on the extra amount which has to be repaid within a short period. The amount of permissible over-draft varies with the financial position of the borrower.

BY CREATING A DEPOSIT CASH CREDIT

Is another way of lending by bank. When a person wants a loan from a bank, he has to satisfy the manager about his ability to repay Bank may demand security (tangible or personal) The loan is advanced after scrutiny. The borrower opens a current a/c with the bank , if he has no a/c (contd)

BY CREATING A DEPOSIT CASH CREDIT

The borrower rarely wants to draw the whole amount of his loan. Once the a/c is started , it is exactly as if that sum had been deposited by him. This is how a deposit is created by the bank That is why, it is said every loans creates a deposit A cheque book is given to the borrower with the right to draw cheques up to the full amount of the loan, but interest is charged on the whole sum even though only a part is withdrawn. After the period, for which the money has been borrowed, is over, the borrower returns the amount with interest to the bank. Banks make their profits thus.

DISCOUNTING BILLS
The banks purchase the bills through bill brokers and discount companies or discount them directly for the merchants. The banks immediately pay cash for the bill after deducting the discount (interest), and wait for the bill to mature when they get back its full value. The investment in bills is considered quite safe, because a bill bears the security of two businessmen, the drawee as well as the drawer. This is a best investment by the banks

REMITTING FUNDS
Banks remit funds for their customers through bank draft to any place where they have branches or agencies. This is the cheapest way of sending money . It is quite safe. Funds can be remitted to foreign countries.

MISCELLANEOUS FUNCTIONS SAFE CUSTODY AGENCY FUNCTIONS REFERENCES LETTERS OF CREDIT

SAFE CUSTODY
Ornaments, valuable documents can be kept in safe custody with a bank, in its strong room fitted with lockers, on payment of small sum per year

AGENCY FUNCTION
Dividends Insurance premium Bills payments

LETTERS OF CREDIT
In order to help the travelers, the banks issue letters of credit traveler's cheques. A man going on a tour takes him a letter of credit from his bank. It is mentioned there that he can be paid sums up to a certain limit. He shows this letter to banks in other places which make the payment to him and debit the bank which has issued the letter of credit.

UTILITY OF BANKS
An efficient banking system is absolutely necessary for a country for economic progress. The banking system can be useful in the following ways, in addition to what has been mentioned in the functions of banks THE BANKS CREATE INSTRUMENTS OF CREDIT THE BANKS INCREASE THE MOBILITY OF CAPITAL THEY ENCOURAGE THE HABIT OF THRIFT ACCUMULATION OF LARGE CAPITAL

CREDIT CREATION
A unique function of the bank is to create credit . Credit creation is the natural outcome of the process of advancing loan. When a bank advances a loan to its customer, it does not lend cash but opens an account in the borrowers name and credit the amount of loan to this account. Thus whenever a bank grants loan, it creates an equal amount of bank deposit. Creation of such deposits is called credit creation which results in a net increase in the money stock of the economy. Banks have the ability to create credit many times more than their deposit and this ability of multiple credit creation depends upon the cash reserve ratio of the banks.

BANKS AND ECONOMIC DEVELOPMENT

A sound banking system mobilizes the small and scattered savings of the community, and makes them available for investment in productive enterprise. In this connection, the banks perform two important functions They mobilize deposits by offering attractive rates of interest, thus converting savings, which otherwise would have remained inert, into active capital. They distribute these savings through loans among enterprises which are connected with economic development. In this way, they promote the development of agriculture, trade and industry.

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BANKS AND ECONOMIC DEVELOPMENT

Difficult to think how could small savings be stimulated or even possible in the absence of banks. It is also difficult to see who would distribute these savings among entrepreneurs. In India, the period of economic development has coincided with phenomenal increase in bank deposits and bank offices. Thus the banks have come to play a dominant and useful role in promoting economic development by mobilizing the financial resources of society.

CENTRAL BANKING
DEWETT 426/431

CENTRAL BANK
It is essential for every country to have a central bank The banking system of a country without central bank at the top is like a human body without head

FUNCTIONS OF CENTRAL BANK

MONOPOLY OF NOTE ISSUE GOVERNMENT BANBER BANKERS BANK LENDER OF LAST RESORT CONTROL OF CREDIT MAINTENANCE OF EXCHANGE RATE CUSTODIAN OF NATIONAL RESERVE PROVISION OF CLEARING HOUSE FACILITIES DEVELOPMENTAL FUNCTIONS

MONOPOLY OF NOTE ISSUE

Note issue is the sole privilege of the central bank In India, the Reserve Bank of India (RBI) which is the central bank is required to keep a minimum reserve of Rs 200 crores, of which not less than Rs 115 crores must be gold.

BANKERS BANK
All banks in the country are bound either by law or convention to keep a certain proportion of their total deposits as reserve with central bank. They also keep their spare cash with central bank on which they draw as and when needed. Under the Banking Regulation Act of 1949, the RBI has been empowered with the right to supervise and control the activities of various scheduled commercial banks. These powers are related to give licensing, branch expansion, management of banks, inspection, liquidity of assets.

LENDER OF LAST RESORT

The other banks in the country depend upon the Central Bank in times of emergency. This may be in the form of a loan on the security or rediscount of bills of exchange. In India, the scheduled banks have to keep in deposit as reserve as reserve with Reserve Bank of India not less than 3% of their total deposit liabilities.

CONTROL OF CREDIT
The most important function of a Central Bank is to control the credit. The central bank ensures price stability and avoids inflationary and deflationary tendencies by raising or lowering bank rate, by purchase or sale of securities in the open market

MAINTAINING EXCHANGE RATE

A stable exchange rate is necessary to maintain or promote a countrys foreign trade and to encourage foreign investments, which is necessary for economic growth. In order to maintain a stable rate of exchange, central bank buys and sells foreign currencies at rates fixed by it.

CUSTODIAN OF NATIONAL RESERVE

It is central bank which serves as the custodian of nations reserves of gold and international currency

PROVISION OF CLEARING HOUSE FACILITIES

Performs the duty of a Clearing House for cheques. It settles the account of commercial banks and enables them to settle their dues. Central bank does not come in competition with other banks. That is why it does not pay interest on the money kept with it. It is a government owned and whatever be the profits , they go to government treasury.

DEVELOPMENT FUNCTION
RBI concentrates on the economic development of under developed countries. The main task of central banks in such countries is to bring about a rapid expansion of banking facilities and also to make adequate funds available to finance development programs.

CONTROL OF CREDIT
OBJECTIVES OF CREDIT CONTROL 1. To safe guard its gold reserve against internal and external drains 2. To maintain stability of internal prices 3. To achieve stability of foreign exchange rate 4. To eliminate fluctuations in production and employment and 5. To assist in economic growth

METHODS OF CREDIT CONTROL

1.Quantitative 2.qualitative

QUANTITATIVE CONTROLS
1. MANIPULATION OF BANK RATE 2. OPEN MARKET OPERATIONS 3. VARYING RESERVE REQUIREMENTS 4. CREDIT RATIONING

QUALITATIVE CONTROLS
VARYING MARGIN REQUIREMENTS FOR CERTAIN BANK ADVANCES REGULATION OF CONSUMER CREDIT FOR REGULATING VOLUME OF INSTALMENT CREDIT BUYING ISSUING DIRECTIVES TO RESTRICT BANK ADVANCE

BANK RATE OF INTEREST

Bank rates and other rates in the market have a close relationship. Let us see how central bank can control credit by manipulating bank rate. If central bank want to control credit, it will raise the bank rate? Borrowing then will be discouraged Those who hold stock with borrowed money will unload their stock due to high interest payable and consequently they will pay back the loan. Thus raising interest will contract the credit. Conversely a fall in bank rate will lower interest rate which will stimulate industrial activity, and expand credit

OPEN MARKET OPERATIONS

Means purchase or sale of securities/ bills by central bank SAY SALE BY CENTRAL BANK it receives payment in the form of cheque on a commercial bank and cash is reduced in the commercial bank to this extend. With reduction in cash the commercial banks have to reduce lending SAY PURCHASE BY CENTRAL BANKS It pays through cheque and the cash balance in the central bank lying in the account of commercial bank will be increased. This will increse the lending

VARYING RESERVE REQUIREMENTS

The central bank can vary reserve ratio when it wants to control credit. In 1960, the RBI required scheduled banks to maintain with it additional reserve equivalent to 25% of their increase in Deposits and later increased to 50%. The raising of reserve requirements is an anti- inflationary measure

CREDIT RATIONING
The credit is rationed by limiting the amount available to each applicant

DIRECT ACTION
Direct action like refusal on the part of central bank to rediscount for banks whose credit policy is not in accordance with the wishes of central bank or whose borrowing from central bank are excessive in relation to their capital and reserve.