CHAPTER 3 COMMERCIAL BANKS

Meaning: A commercial bank also called as business bank, is a type of financial institution and intermediary, that lends money and provides transactional, saving and money market accounts and accepts time deposits. Commercial banks are those banks which perform all kinds of banking functions such as accepting deposits, advancing loans, credit creation, and agency functions. They are also called joint stock banks because they are organised in the same manner as joint stock companies. Definition: According to the Indian Banking Company Act 1949, "A banking company means any company which transacts the business of banking . Banking means accepting for the purpose of lending of investment of deposits of money from the public, payable on demand or other wise and withdraw able by cheque, draft or otherwise."

Nature of Commercial Banks: Commercial banks are an organisation with financial transactions. It performs the twin task of accepting deposits from members of public and make advances to needy and worthy people form the society. When banks accept deposits its liabilities increase and it becomes a debtor, but when it makes advances its assets increases and it becomes a creditor. Its main aim is to earn profit. Banking transactions are socially and legally approved. It is responsible in maintaining the deposits of its account holders. Operated and established under the control of central bank of a nation.

Structure/classification of Commercial banks The commercial banks can be broadly classified under two heads: Scheduled Banks: Scheduled Banks refer to those banks which have been included in the Second Schedule of Reserve Bank of India Act, 1934. In India, scheduled commercial banks are of three types: (I) Public Sector Banks: These banks are owned and controlled by the government. The main objective of these banks is to provide service to the society, not to make profits. State Bank of India, Bank of India, Punjab National Bank, Canada Bank and Corporation Bank are some examples of public sector banks. (II) Private Sector Banks: These banks are owned and controlled by private businessmen. Their main objective is to earn profits. ICICI Bank, HDFC Bank, IDBI Bank is some examples of private sector banks. (III) Foreign Banks: These banks are owned and controlled by foreign promoters. Their number has grown rapidly since 1991, when the process of economic liberalization had started in India. Bank of America, American Express Bank, Standard Chartered Bank are examples of foreign banks.  Non-Scheduled Banks: Non-Scheduled banks refer to those banks which are not included in the Second Schedule of Reserve Bank of India Act, 1934.

Functions of Commercial Banks: Primary and Secondary Functions of Commercial Banks (1) Primary Function: 1. Accepting Deposits: It is the most important function of commercial banks. They accept deposits in several forms according to requirements of different sections of the society. The main kinds of deposits are: 1. Current Account Deposits or Demand Deposits: These deposits refer to those deposits which are repayable by the banks on demand. Such deposits are generally maintained by businessmen with the intention of making transactions with such deposits. They can be drawn upon by a cheque without any restriction. Banks do not pay any interest on these accounts. Rather, banks impose service charges for running these accounts.

Fixed Deposits or Time Deposits: Fixed deposits refer to those deposits, in which the amount is deposited with the bank for a fixed period of time. Such deposits do not enjoy cheque-able facility. These deposits carry a high rate of interest. Saving Deposits: These deposits combine features of both current account deposits and fixed deposits The depositors are given cheque facility to withdraw money from their account. But, some restrictions are imposed on number and amount of withdrawals, in order to discourage frequent use of saving deposits. They carry a rate of interest which is less than interest rate on fixed deposits. 2. Advancing of Loans: The public deposits are used by commercial banks for the purpose of granting loans to individuals and businesses. Overdraft: This is one of cash credit facility offered to current account holders. It is an arrangement with the bankers thereby the customer is allowed to draw money over and above the balance in his/her account. Cash Credit: Cash credit refers to a loan given to the borrower against his current assets like shares, stocks, bonds, etc. A credit limit is sanctioned and the amount is credited in his account. The borrower may withdraw any amount within his credit limit and interest is charged on the amount actually withdrawn.

Discounting bills: It is one of the primary operating of a bank where the bank purchases inland and foreign bills before these are due for payment by the drawer debtors, at discounted values i.e., values a little lower than the face value. Demand Loans: Demand loans refer to those loans which can be recalled on demand by the bank at any time. The entire sum of demand loan is credited to the account and interest is payable on the entire sum. Short-term Loans: They are given as personal loans against some collateral( corresponding)security. The money is credited to the account of borrower and the borrower can withdraw money from his account and interest is payable on the entire sum of loan granted. Credit creation: It appears when a bank sanctions a loan to a customer, it does not give cash to him, but a deposit account is opened in his name and the amount is credited to his account. He can withdraw the money whenever he needs.

(2) Secondary Functions: Agency Functions: Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients. Some of the agency functions are: Transfer of Funds Collection and Payment of Various Items Purchase and Sale of Foreign Exchange Purchase and Sale of Securities Income Tax Consultancy Trustee and Executor Letters of Reference General/Public utility functions: Bank customers are generally utilized by general public for some amount of fee. Locker Facility: Commercial banks provide facility of safety vaults or lockers to keep valuable articles of customers in safe custody. Traveller’s Cheques: Commercial banks issue traveller’s cheques to their customers to avoid risk of taking cash during their journey.

Difference between Demand deposit and Fixed deposit Letter of Credit: They also issue letters of credit to their customers to certify their creditworthiness. Underwriting Securities: Commercial banks also undertake the task of underwriting securities. As public has full faith in the creditworthiness of banks, public do not hesitate in buying the securities underwritten by banks. Collection of Statistics: Banks collect and publish statistics relating to trade, commerce and industry. Hence, they advice customers on financial matters. Commercial banks receive deposits from the public and use these deposits to give loans. However, loans offered are many times more than the deposits received by banks. This function of banks is known as ‘Money Creation’. Difference between Demand deposit and Fixed deposit DEMAND DEPOSIT FIXED DEPOSIT Demand deposit can be withdrawn by the depositor at anytime without notice. Fixed deposit can be withdrawn only after the expiry of the certain fixed time period. They are chequable i.e., demand deposits are withdrawn by cheques. They are non chequable. No interest is paid on these deposits rather bank collect the service charges High interest is paid on deposits These deposits constitute a part of money supply. They fall under the category of near money assets.

SOURCES AND APPLICATION OF FUNDS OF COMMERCIAL BANK: A commercial bank is a retail financial institution that helps community members open checking and savings accounts and manage money market accounts. It also provides customers with deposit, withdrawal and transfer services. Sources of Funds: Sources of funds are also called as assets and liabilities. There are different sources to rise short term and long term funds. Deposits: Deposits remain the main source of funds for a commercial bank. The money collected can go toward paying on interest-bearing accounts, completing customer withdrawals and other transactions. Demand classified into demand deposits, savings deposits, term deposits. Share capital: it is the owners fund and employed for the life time of the bank. In nationalized banks the share capital is contributed by central government. But in private banks, the share capital is introduced by public and private people. This source provides long term source of fund and liability of the investors is limited. Reserves and surplus: These are the retained earnings maintained in the bank out of surplus profit. Statutory reserves, capital reserves, share premium, revenue and other reserves and balance of profit. These are strictly provisioned as per RBI and banking regulation act guidelines as mandatory requirements. Borrowings: The bank can borrow funds from different sources on certain conditional basis. Two sources of borrowings are: a. Borrowings in India: RBI, Other banks, other institutions and agencies. b. Borrowings outside India: Secured borrowings and unsecured borrowings from overseas. Other liabilities and provisions: These are also called current liabilities. The banks maintain some of these temporary funds to adjust short term obligations. Bills payable, inter-office adjustments(net), interest accrued and other provisions.

Applications of funds/ Asset structure of commercial Banks. Cash and cash balance with RBI: It is a form of liquid asset kept in the form of cash in hand and balance kept at Reserve Bank of India. These are used to discharge the obligations arrived immediately. Cash in hand includes Foreign currency notes also. And balance with RBI represents balance in current and other accounts. Cash balance with other banks, Money at call and short notices: It is a form of liquid asset kept with other banks in current and other deposits accounts. Money at call and short notices are the deposits repayable within 15days or less than 15days notice notice lent in the interbank call money market. Investments: These include central and state government securities and government treasury bills. These securities should be shown at the book value in the balance sheet. Investment in India: Govt Securities, shares, debentures, bonds etc. Investment outside India Advances: These are the loans and advances given by the bank to the different customers in different schemes. (i) Bills purchased and discounted (ii) Cash credit, overdraft and loans payable on demand (iii) Term loans. (iv) Secured and Unsecured loan (v) Advances in India and outside India

5. Fixed Assets: These are the assets of the bank which are employed and the return on which earned for a long time.( Cost of the asset, additions made, deductions (sale), depreciation charged. 6. Other assets: current assets that are transacted for short time a. Interest accrued b. Tax paid in advance/TDS c. Stationery and stamps d. Non-banking assets acquired in satisfaction of claims e. Any other assets Investment policy of Commercial banks Liquidity Profitability Safety and Security Diversity Salability of Securities: Institution able to handle increased market demands, can maintain or improve profit margins while sales volume increases. Stability in the value of investments: fixed income securities that are insulated from interest rate movements. Principles of tax exemption of investments :

Liquidity: Honor claims of depositors(Ability) Conversion of non-cash assets into cash assets(easily and without cash). The bank cannot always have all its assets in the form of cash because it is an idle asset which does not fetch any return to the bank.(Money at call( Immediately repay on demand)and short notice( 14 days), bills discounted etc.,) Profitability: Interest, commission and discounting charges Banks has to earn profit to pay salaries, meet expenditures, pay deposit interest, dividends. Since cash is least profitable for the bank by keeping all the assets in the form of cash on hand.(Money at call, short notice, bills discounted, investments, loans and advances etc) by receiving interest. Safety and Security: Consider the three ‘C’s of credit character, capacity and the collateral of the borrower. Apart from liquidity and profitability the bank should look into the principles of safety of its funds for smooth working.

Diversity: Not keep all its eggs in the same basket Diversification of investment is necessary to avoid the dangerous consequences of investing in one or more channels. If the banks invest its funds in different types of securities or makes loans and advances to different objectives and enterprises, it shall ensure for itself a regular flow of income. Salability of securities: Invest in securities that can be easily marketed at a time of emergency. The bank cannot afford to invest its funds in very long term securities or those securities which are unsalable. (In govt or reputed corporations or debentures. Bank Liquidity: Liquidity for a bank means the ability of the bank to meet its financial obligations when they are demanded. LIQUIDITY VS PROFITABILITY In support of profitability Meet the demands of the depositors. Meet claims of the depositors. Installing confidence in the minds of the depositors. But cannot earn income to pay the expenses. Cash is an idle asset.

In support of Liquidity If the bank lends out all its fund, it will be left with no cash. Cash to honour the obligations of the depositors. Wind up of the bank Most profitable asset(loans and advances) ROLE OF COMMERCIAL BANKS IN INDIA: Trade development: The commercial banks provide capital, technical assistance and other facilities to businessman according to their need which leads to development in trade. Supports to Agricultural development: The provision of credit to agriculture sector has greatly helped in raising agriculture productivity and income of the farmers. Supports to Industrial development: The commercial banks generally provide short and medium term loans to entrepreneurs to invest in new enterprises and adopt new methods of production. Capital formation: means increase in the number of production units, technology, plant and machinery. Development of foreign trade: letter of credit is issued by the importer’s bank to the exporters to ensure the payment. The banks also arrange foreign exchange.

Development of transport Monetisation of economy: The commercial banks are opening branches in the rural and backward areas are reducing the exchange of goods through barter. Export promotion cells: In order to increase the export trade in the country the commercial banks have established export promotion cells. They provide information about general and economic conditions both inside and outside the country to its customers. Balanced development of different regions: commercial banks help in transferring surplus capital from developed regions to the less developed regions to meet their adequate business needs. Influencing economic activity: Influences of the availability of credit ( increase in the circulation of money) and the rate of interest (lowering the rate of interest).

The capital adequacy ratio, also known as capital to risk-weighted assets ratio, measures a bank's financial strength by using its capital and assets. It is used to protect depositors and promote the stability and efficiency of financial systems around the world. CRR is a cash reserve ratio where a certain percentage of the total bank deposits has to be kept in the current account with RBI which means banks do not have access to that much amount for any economic activity or commercial activity. Banks can’t lend the money to corporates or individual borrowers, banks can’t use that money for investment purposes. So, that CRR remains in current account and banks don’t earn anything on that. SLR, statutory liquidity ratio is the amount of money that is invested in certain specified securities predominantly central government and state government securities. A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest. In most cases, debt is classified as nonperforming when loan payments have not been made for a period of 90 days.