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Chapter 4 Service Sector and Business
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4.2.2 Banks and Their Functions Finance is the most important section of business that makes all the other functions run smoothly. No function can work efficiently unless adequate finance is available on time. Management of finance is a specialized activity. It includes raising finance, keeping custody, proper utilization and maintaining optimum flow of finance in business. Banks are specialists in handling finance.
Definition The term ‘bank’ is derived from the word ‘banko’ or ‘banck’ which means a bench or table which European money lenders or money changers used to exhibit coins of different countries for the purpose of changing or lending. Banker is no only a money lender. He lends what he has borrowed from others. Thus banking is the business of borrowing money for interest for the purpose of lending it at a higher rate. According to the India Banking Regulation Act, 1949 banking means, ‘’ accepting deposits of money from the public for the purpose of lending or investment”.
Functions of Commercial Banks Bank is the financial institution enabling the fuller utilization of surplus money in the society by making them available to those who need them. In this sense it is the heart of the circulatory system of finance in the society. Following are the important functions of commercial banks.
i. Acceptance of deposits As a financial intermediary, commercial banks have two basic functions of accepting deposits and lending money. Deposits are accepted into current accounts, savings accounts or fixed deposit accounts depending on how fast the depositor wants his money back. Current accounts are mainly operated by business people. Money in these accounts can be withdrawn without notice. Banks pay almost no interest on current account deposits. Savings bank accounts are operated for promoting small savings among public. Banks place certain restrictions on withdrawal of funds from savings bank accounts. Banks usually pay interest of 2 or 3 percent per annum on savings bank accounts. Fixed deposits, as the name indicates are deposited for a fixed period. Banks can safely utilize this money for the purpose of lending because the depositor would not ask his money back before the end of the fixed period. Banks pay highest rate of interest on fixed deposits.
ii. Lending of Money Lending of money is the second important function of commercial banks. The profit of the bank comes from lending the money at a higher rate than the rate paid to its depositors. Banks usually operate four different channels of lending money namely, loans, cash credits, overdrafts and discounting of bills of exchange. Loans are a lump sum amount advanced by a bank. This amount will be credited to the customers account immediately on approval of the loan. The bank start charging interest from the day the loan is granted. Cash credits and overdrafts are facilities granted. They are essentially same, but cash credits are granted to any account holder but overdraft facility is granted only to businesses on the current accounts only. The bank does not start charging interest from the day these facilities are granted. Interest is charged only on the overdrawn money on daily basis. Discounting of bills of exchange is almost like a purchase of bill of exchange by a commercial bank from its customer. Bank takes possession of the bill and pays the amount after deducting its discount. On due date of the bill, bank sends them to the acceptor of the bill and collects its money.
iii. Credit creation Commercial banks can lend money more than the actual deposits they have because of the mechanism of credit creation. When a bank grants a loan to a customer it is unlikely that the customer drains out the last rupee in the account. The customer starts issuing the cheque on the basis of loan. Banks estimate the actual cash requirement on a loan and the remaining surplus beyond this amount is used for granting loans.
iv. Collection of cheques and bills Banks provide a very important service by collecting cheques and bills of exchange for the customers. If the cheque is drawn on the same bank, the bank will transfer the money from one account to the other. If a customer deposits a cheque drawn on another bank, the bank will send it for collection and credit the customers account as soon as the money is received.
v. Personal services Commercial banks provide several personal services to the customers. Bank undertakes to pay insurance premium and similar regular payments on behalf of the customer. It also collects revenues from customer’s investments such as shares, debentures and deposits.
vi. Buying and selling of shares and debentures Banks act as agents for their customers in buying and selling shares, debentures and other securities. They distribute application forms, collect applications and receive correspondence on behalf of customers. They also provide valuable advice to customers about the market conditions and future trends.
vii. Custodial services Commercial banks provide the facility of safe deposit lockers for keeping safe custody of ornaments, precious stones, gold, silver, valuable documents and other valuable items.
viii. Issue of Letters of Credit, Traveller’s Cheques Letter of credit is an essential document in foreign trade. This is a guarantee letter issued by a bank confirming that the bank shall make payment to the supplier of goods at the completion of the transaction stated in the letter. Travellers cheques are cheques issued by a bank that can be cashed at anywhere in the country. This is a safe way of carrying cash because these cheques can be cashed only by the authorized person whose signature appears on the cheque.
Ix Credit information Banks provide credit information about its customers to other banks upon request. This is gives makes credit transactions relatively safer.
x. Electronic Baking Electronic banking is a new addition to the baking business in recent years. Most of the banks have switched over to electronic banking in a very large scale. As a first step there has been large scale computerization in banking. Secondly the branches are electronically linked. At present a customer having account in one branch can access his account, deposit or withdraw funds through any branch. Electronic banking also include automated teller machines, electronic fund transfer, issue of credit cards and the recent addition – internet banking.
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