what is a commercial bank essay

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How Do Commercial Banks Work, and Why Do They Matter?

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

What Is a Commercial Bank?

The term commercial bank refers to a financial institution that accepts deposits and offers different banking and financial products. Commercial banks provide these services to people and businesses. Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.

Key Takeaways

Commercial banks offer basic banking services, including deposit accounts and loans, to consumers and businesses.
These financial institutions make money from a variety of fees and by earning interest income from loans.
Commercial banks have traditionally been located in physical locations, but a growing number now operate exclusively online.
Commercial banks are important to the economy because they create capital, credit, and liquidity in the market.

Yurle Villegas / Investopedia

How Commercial Banks Work

Commercial banks provide basic banking services and products to the general public, both individual consumers and businesses. The following table highlights some of the key services commercial banks provide to their retail customers:

Business banking services also include bank accounts, investments, and lending products. Commercial banks also provide their business clients with merchant services, which allows companies to accept payments electronically from their customers.

These financial institutions have traditionally been located in buildings where customers come to use teller window services and automated teller machines (ATMs) to do their routine banking. With the rise in internet technology, most banks now allow their customers to do most of the same services online that they could do in person, including transfers , deposits, and bill payments .

The money that customers deposit at commercial banks is insured by the Federal Deposit Insurance Corporation (FDIC) , including cash in savings accounts and CDs. Customers have the option to withdraw money upon demand, and the balances are fully insured up to $250,000. Therefore, banks do not have to pay much for this money.

A growing number of commercial banks operate exclusively online, where all transactions with the commercial bank must be made electronically. Because these banks don’t have any brick-and-mortar locations, they can offer a wider range of products and services at a lower cost—or none at all—to their customers.

How Commercial Banks Make Money

Banks make money by imposing service charges on their customers. These fees vary based on the products, ranging from account fees (monthly maintenance charges, minimum balance fees, overdraft fees, and non-sufficient funds [NSF] charges), safe deposit box fees, and late fees . Many loan products also contain fees in addition to interest charges.

Banks also make money from the interest they earn when they lend money to their clients. The funds they lend come from customer deposits. However, the interest rate paid by banks on the money they borrow is less than the rate charged on the money they lend. For example, a bank may offer savings account customers an annual interest rate of 0.25%, while charging mortgage clients 4.75% in interest annually.

Many banks pay their customers no interest (or very little) at all on checking account balances and offer interest rates for savings accounts that are well below U.S. Treasury bond (T-bond) rates.

Commercial Banks and Lending

Consumer lending makes up the bulk of North American bank lending. Some of the most significant categories include residential mortgages, automobile lending, and credit cards.

Residential Mortgages

Mortgages make up by far the largest share. Mortgages are used to buy properties, and the homes themselves are often the security that collateralizes the loan. Mortgages are typically written for 30-year repayment periods, and interest rates may be fixed , adjustable , or variable .

Although a variety of more exotic mortgage products were offered during the U.S. housing bubble of the 2000s, many of the riskier products, including pick-a-payment mortgages and negative amortization loans , are much less common now.

Automobile lending is another significant category of secured lending for many banks. Compared to mortgage lending, auto loans are typically for shorter terms and higher rates. Banks face extensive competition in auto lending from other financial institutions, like captive auto financing operations run by automobile manufacturers and dealers.

Credit Cards

Credit cards are another significant type of financing. Credit cards are, in essence, personal lines of credit that can be drawn down at any time. Private card issuers offer them through commercial banks.

Visa and Mastercard run the networks through which money is moved around between the shopper’s bank and the merchant’s bank after a transaction. Not all banks engage in credit card lending, as the rates of default are traditionally much higher than in mortgage lending or other types of secured lending.

Credit card lending delivers lucrative fees for banks. For example, interchange fees are charged to merchants for accepting the card and entering into the transaction. Banks also charge customers late-payment fees, currency exchange, over-limit , and other fees, as well as elevated rates on the balances that credit card users carry from one month to the next.

The total number of commercial banks in the United States in 2023.

Importance of Commercial Banks

Commercial banks are an important part of the economy . They not only provide consumers with an essential service but also help create capital and liquidity in the market.

Commercial banks ensure liquidity by taking the funds that their customers deposit in their accounts and lending them out to others. Commercial banks play a role in the creation of credit , which leads to an increase in production, employment, and consumer spending, thereby boosting the economy .

As such, these banks are heavily regulated by a central bank in their country or region. For instance, central banks impose reserve requirements on commercial banks. This means that banks are required to hold a certain percentage of their consumer deposits at the central bank as a cushion if the public rushes to withdraw funds .

Commercial Banks vs. Investment Banks

Both commercial and investment banks provide important services and play key roles in the economy. For much of the 20th century, these two branches of the banking industry were generally kept separate from one another in the United States, thanks to the Glass-Steagall Act of 1933 , which was passed during the Great Depression . It was largely repealed by the Gramm-Leach-Bliley Act of 1999 , allowing for the creation of financial holding companies that could have both commercial and investment bank subsidiaries.

While commercial banks traditionally provide services to individuals and businesses, investment banks focus on offering banking services to large companies and institutional investors . They act as financial intermediaries, providing their clients with underwriting services, merger and acquisition (M&A) strategies, corporate reorganization services, and other types of brokerage services for institutional and high-net-worth individuals (HNWIs) .

While commercial banking clients include individual consumers and small businesses, investment banking clients include governments, hedge funds , other financial institutions, pension funds , and large companies.

The Gramm-Leach-Bliley Act tore down the wall between commercial and investment banks but maintained some safeguards. For instance, it forbids a bank and a nonbank subsidiary of the same holding company from marketing the products or services of the other entity—to prevent banks from promoting securities underwritten by other subsidiaries to their customers—and placed size limitations on subsidiaries.

Examples of Commercial Banks

Some of the world’s largest financial institutions are commercial banks or have commercial banking operations—many of which can be found in the U.S. For instance:

Chase Bank is the commercial banking unit of JPMorgan Chase ( JPM ). Headquartered in New York City, Chase Bank reported more than $3.39 trillion in assets as of December 2023.
Bank of America ( BAC ) is the second-largest U.S. bank, with more than $2.54 trillion in assets and 6 million customers, including both retail clients and small and midsize businesses.

As noted above, banking has had to change with the rise of financial technology (fintech) . Some of the major commercial banks have an increased online presence. Some banks operate exclusively online. For example, Ally Bank ( ALLY ) is one of the major online commercial banks in the United States. The bank is headquartered in Detroit and has $196 billion in assets as of December 2023.

Is My Bank a Commercial Bank?

Possibly! Commercial banks are what most people think of when they hear the term “bank.” Commercial banks are for-profit institutions that accept deposits, make loans, safeguard assets, and work with many different types of clients, including the general public and businesses. However, if your account is with a community bank or credit union , it probably would not be a commercial bank.

What Role Do Commercial Banks Play in the Economy?

Commercial banks are crucial to the fractional reserve banking system, currently found in most developed countries. This allows banks to extend new loans of up to (typically) 90% of the deposits they have on hand, theoretically growing the economy by freeing capital for lending.

Is My Money Safe at a Commercial Bank?

For the most part, yes. Commercial banks are heavily regulated, and most deposit accounts are covered up to $250,000 by the Federal Deposit Insurance Corporation. Moreover, commercial and investment banking funds cannot be co-mingled by law.

Commercial banks are a critical component of the U.S. economy by providing vital capital to businesses and individuals in the form of credit and loans. They provide a secure place where people save money, earn interest, and make payments through checks , debit cards , and credit cards.

Commercial banks are typically in brick-and-mortar locations in cities and towns, many with extensive branch networks . A growing number have no physical location, however—instead, they are accessible online and through mobile applications.

Federal Deposit Insurance Corp. “ Understanding Deposit Insurance .”

IBIS World. " Commercial Banking in the US - Number of Businesses ."

Federal Reserve History. “ Banking Act of 1933 (Glass-Steagall) .”

GovInfo. “ Public Law 106-102: Gramm-Leach-Bliley Act ,” 113 Stat. 1349 (Page 13 of PDF).

Federal Reserve System. “ Statistical Release: Large Commercial Banks .”

Bank of America, Newsroom. “ Company Overview .”

Ally. " Who We Are ."

GovInfo. “ Public Law 106-102: Gramm-Leach-Bliley Act ,” 113 Stat. 1399 (Page 62 of PDF).

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Essay on Commercial Bank

Students are often asked to write an essay on Commercial Bank in their schools and colleges. And if you’re also looking for the same, we have created 100-word, 250-word, and 500-word essays on the topic.

Let’s take a look…

100 Words Essay on Commercial Bank

What is a commercial bank.

A commercial bank is a place where people keep their money safe. Banks also lend money to people and businesses. When someone needs money to buy a house or start a company, they can borrow it from a bank. In return, the bank charges interest, which is like a fee for using the bank’s money.

Services Offered

Banks provide various services like saving accounts, checking accounts, and certificates of deposit. They also have ATMs where you can get cash anytime. Online banking lets you handle your money using a computer or phone.

Role in the Economy

Commercial banks are important for the economy. They help money flow from people who save to those who want to invest in businesses. This helps new businesses start and existing ones grow, which can create jobs.

Also check:

Advantages and Disadvantages of Commercial Bank

250 Words Essay on Commercial Bank

What is a commercial bank.

A commercial bank is like a big store where money is the main product. People and companies come to the bank to keep their money safe or to borrow some when they need it. The bank keeps this money in accounts, which are like special boxes with names on them, so everyone’s money is separate and secure.

How Do Banks Work?

When you put your money in a bank, the bank doesn’t just keep it in a vault. It uses the money to lend to others who need it. For example, someone might need a loan to buy a house or start a business. The bank charges them interest, which is like a small fee for using the money. This interest is how banks earn most of their money.

Banks offer many services. They let you save money in savings accounts, which can earn you a little extra money over time. They also have checking accounts so you can pay for things with checks or a bank card. Banks can also help you send money to people in different places, give you loans, and help you manage your money.

Why Are Banks Important?

Commercial banks are important because they keep money moving in the economy. By lending money to people and businesses, they help them grow and create new jobs. They also make it easier to buy and sell things, which is good for everyone. Banks are like the heart of the money world, keeping the flow of money healthy and strong.

500 Words Essay on Commercial Bank

A commercial bank is like a big money shop where people and companies can keep their money safe. They also help people borrow money when they need to buy something big like a house or to help their business grow. These banks are very important because they help the flow of money around the economy, making it easier for people to do business and spend money on things they need.

Services Offered by Commercial Banks

Commercial banks offer many services. One of the main things they do is take deposits. This means that they keep people’s money safe until they need it. When you put your money in a bank, you can take it out anytime using an ATM or by writing a check.

Another service is giving loans. If you want to buy something expensive, the bank can lend you the money. You then pay the bank back over time, usually with a little bit extra called interest. Banks also help people buy houses through something called a mortgage, which is a special kind of loan.

Banks also help people and businesses send money to each other, even if they are in different parts of the world. They offer credit cards, which let you buy things now and pay for them later. Plus, they have safe deposit boxes where you can keep important things like a birth certificate or a special piece of jewelry.

How Do Commercial Banks Make Money?

You might wonder how banks make money. They make money from the interest they charge people when they lend them money. They also charge fees for some of the services they offer. For example, if you use your credit card a lot or go over the limit of how much money you can take out of your account, the bank might charge you a fee.

The Role of Commercial Banks in the Economy

Commercial banks play a big part in the economy. They help money move around by lending it to people and businesses. This helps businesses grow and create new jobs. When people have jobs, they have money to spend, which helps other businesses too. It’s like a big circle where money keeps moving and helping everyone.

Banks also keep money safe. If everyone kept their money at home, it could get stolen or lost. But banks have strong safes and security systems to protect the money. They also use the money people deposit to give loans to others, which helps the economy grow.

In simple words, commercial banks are important because they keep our money safe, help us buy things we need, and make sure the economy stays healthy. They offer many services that make our lives easier, like loans, credit cards, and ways to send money. They also make money themselves, which allows them to keep offering these services. So, next time you pass by a bank or use an ATM, you’ll know a bit more about what commercial banks do and why they’re such a big part of our daily lives.

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Commercial Banks, Definition, Functions, Types, Roles

Commercial banks are profit-based institutions that offer financial products to their customers. Know all about Commercial Banks Functions, Definition, Types & Roles in this article.

Table of Contents

Commercial Banks

Commercial banks are financial institutions that are primarily engaged in accepting deposits from individuals and businesses and providing loans and credit facilities to borrowers. They are for-profit organizations that operate with the primary objective of generating profit for their shareholders.

Commercial banks are also known as retail banks or universal banks as they provide a wide range of services to retail customers, including payment services, investment services, and foreign exchange services, in addition to their core functions of deposit-taking and lending. Commercial banks are regulated by the central bank of the country and are subject to various regulatory and supervisory requirements to ensure the safety and soundness of the banking system.

Read about: List of RBI Governors of India

Functions of Commercial Banks

Commercial Banks play a crucial role in the economy by providing various financial services and products to individuals, businesses, and governments. Functions of Commercial Banks are classified into Primary Functions and Secondary Functions.

Primary Functions of Commercial Banks

The primary functions of Commercial Banks revolve around the mobilization of funds from the public and the allocation of these funds to borrowers who require them for their various financial needs, thereby facilitating economic growth and development.

The primary functions of commercial banks include:

Accepting Deposits

Commercial banks accept deposits from individuals and businesses, including checking accounts, savings accounts, and time deposits such as certificates of deposit (CDs).

Providing Loans

Banks lend money to individuals and businesses for various purposes, such as buying a home, starting a business, or funding a project.

Issuing Checks

Banks provide customers with a chequebook, which they can use to write checks for payment.

Clearing Checks

Banks process checks written by their customers and those deposited by other banks.

Maintaining Accounts

Banks maintain account records for their customers, including transaction history, balances, and interest earned.

Providing Safekeeping Services

Banks offer safe deposit boxes for customers to store valuables and important documents.

Providing Currency Exchange

Banks provide currency exchange services for customers who need to convert one currency to another.

Providing Overdraft Facilities

Banks offer overdraft facilities to customers who need to borrow money temporarily to cover short-term expenses.

Read about: Finance Ministers of India List

Modern or Secondary Functions of Commercial Banks

The modern functions of commercial banks have evolved from the conventional functions of commercial banks in response to changing customer needs, technological advancements, and economic conditions. They can also be called as secondary functions of commercial banks. Here are some examples of how modern functions have evolved from conventional functions:

Facilitating Payments

With the advent of electronic payments, commercial banks have evolved their payment services to include online bill payment, mobile banking, and person-to-person payments.

Issuing Credit and Debit Cards

Credit and debit cards have become a ubiquitous part of modern banking, but they were not always available. In the past, banks primarily issued checks and travellers’ checks as a means of payment.

Managing Investments

Commercial banks have expanded their investment services to include a wider range of products, such as mutual funds, exchange-traded funds (ETFs), and online investment platforms.

Providing Foreign Exchange Services

While commercial banks have always offered foreign exchange services, the rise of global trade and travel has led to an increased demand for these services.

Offering Insurance Products

Banks have expanded their product offerings to include insurance products, such as life insurance and property insurance, to meet the changing needs of customers.

Providing Financial Advice

Banks have expanded their financial advice services to include retirement planning, investment advice, and debt management, as customers seek more guidance and support in managing their finances.

Read about: India’s GDP Growth Rate

Types of Commercial Banks

The types of commercial banks include:

Public Sector Banks

These banks are owned and controlled by the government, and they provide banking services to the public. Examples include State Bank of India, Punjab National Bank, and Bank of Baroda.

Private Sector Banks

These banks are owned and controlled by private entities, and they provide banking services to the public. Examples include HDFC Bank, ICICI Bank, and Axis Bank.

Foreign Banks

These banks are headquartered in foreign countries and have branches or subsidiaries in India. Examples include Citibank, Standard Chartered Bank, and HSBC Bank.

Regional Rural Banks

These banks are set up with the objective of providing banking services to rural areas. They are sponsored by a public sector bank, a private sector bank, or the government. Examples include Narmada Jhabua Gramin Bank, Pragathi Krishna Gramin Bank, and Baroda Uttar Pradesh Gramin Bank.

Co-operative Banks

These banks are owned and controlled by members who use the banking services provided by the bank. Examples include Urban Co-operative Banks and Rural Co-operative Banks.

Commercial Banks UPSC

The functions of commercial banks are an important topic for UPSC (Union Public Service Commission) aspirants as it is included in the UPSC Syllabus under the Economics section of the General Studies Paper III. Understanding the functions of commercial banks is crucial for candidates preparing for the UPSC Civil Services Exam as it is a part of the Indian Economy and banking sector, which is an important component of the Indian Financial System .

Moreover, the topic of commercial bank functions is often included in the StudyIQ UPSC Online Coaching and UPSC Mock Test , which are popular resources for UPSC aspirants. Through these resources, candidates can gain a deeper understanding of the traditional and modern functions of commercial banks and how they have evolved over time. This can help candidates to answer questions related to banking and financial services in the UPSC Prelims and Mains exams.

Additionally, a strong understanding of the functions of commercial banks can also help candidates in the Essay paper, where they may be asked to analyze the role of banking in the Indian economy or discuss the impact of digital banking on the traditional functions of commercial banks.

Read about: GDP of Indian States

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Commercial Banks FAQs

What are 5 functions of a commercial bank.

1. Accepting deposits from customers 2. Providing loans and credit to individuals and businesses 3. Facilitating payments through various means, such as checks and electronic transfers 4. Offering investment products and services 5. Providing foreign exchange services to customers

What are the functions of commercial bank?

The functions of commercial banks typically include accepting deposits, providing loans and advances, facilitating payments, offering overdraft facilities, and providing foreign exchange services.

What are the 3 types of commercial bank?

3 types of commercial banks include- Public Sector Banks, Private Sector Banks and Foreign Banks.

What is a commercial bank an example of?

A commercial bank is an example of a financial intermediary that accepts deposits from customers and provides loans and other financial services. Examples include State Bank of India, HDFC Bank, and Citibank.

What banks are commercial banks?

Commercial banks include Public Sector Banks, Private Sector Banks, Foreign Banks, Regional Rural Banks, and Co-operative Banks.

What is commercial bank and its types?

A commercial bank is a financial institution that accepts deposits from customers and provides loans and other financial services. Types of commercial banks include Public Sector Banks, Private Sector Banks, Foreign Banks, Regional Rural Banks, and Co-operative Banks.

Who introduced commercial bank?

The concept of commercial banking dates back to ancient times, but modern commercial banking can be traced back to the 17th century when the Bank of England was established in 1694 as the first commercial bank.

I, Sakshi Gupta, am a content writer to empower students aiming for UPSC, PSC, and other competitive exams. My objective is to provide clear, concise, and informative content that caters to your exam preparation needs. I strive to make my content not only informative but also engaging, keeping you motivated throughout your journey!

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Essay: What are Commercial Banks?

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2.0 Functions of Commercial Banks

Commercial bank has two main characteristics which are borrowing and lending. For an instance, acceptance of deposits and lending of money to projects to earn interest as profit. In brief, commercial banks borrow to lend. The interest rate which offered by the commercial banks to their depositors is called as the borrowing rate while the rate which commercial banks lend out is called as lending rate. “Spread” refers to the difference between the rates and is appropriated by the commercial banks. Keep in mind that not necessary all financial institutions are commercial banks as only those which perform dual functions of accepting deposits and giving loans are termed as commercial banks. For an instance, post offices are not termed as a bank as they do not give loans. The functions of commercial banks are categorized in to two categories which are:-

a) Primary Functions

b) Secondary Functions

2.1 Primary Functions

i) Accepting Deposits

The primary function of commercial banks is accepting deposits and it is the basis of its existence. A bank could not perform any other functions without accepting deposits. Commercial banks attracts deposits in order to make loans and investments. This is where people deposit their money in banks because of safety and at the same time to earn interest. A commercial banks accept various types of deposits from individual, institutions, and businesses. There are few different types of deposit accounts offered by the banks to cater the need of various depositors (Gazu Lakhotia, undated). Below are the few types of deposits:-

• Saving Deposits

The main objective of saving accounts is to encourage the habit of savings among people. This type of account is most suitable for individual households. Saving deposits combine the features of both current and fixed deposits (J. Singh, undated). Saving accounts only allowed to withdrawn for a specified number of times in a week. However, the deposits can be made any number of times. On such deposits, the rate of interest is very less( Gazu Lakhotia, undated).

• Fixed Deposits

Fixed deposits is where the depositors deposit a lump sum of money for a definite period of time. The period of time refers to not less than one year, therefore it is called as long term deposits. These type of deposits could not be withdrawn before the expiry of the stipulated time, therefore it is called as time deposits (K. Upadhyaya, undated). Besides that, these type of deposits are repayable on the expiry of the stated period. Furthermore, the rate of interest on such deposits is higher compared to other deposits.

• Current Deposits

Current deposits are payable on demand, therefore it is called demand deposits. Money can be withdrawn by the depositors as often as they want depending on the balance in such account. There is no interest allowed on such deposits, however the banks provides cheque facilities (J. Singh, undated). Besides that, overdraft facility is provided as well. Current accounts are generally maintained by businessmen who receive and make business payments of large amounts via cheques. A fee known as “bank charges” or incidental charges” is charged in order to maintain the current deposits (Gazu Lakhotia, undated).

ii) Advancing of Loans

Refer as one of the important function of a commercial bank. This is where the commercial banks giving loans and advances to businessmen and entrepreneurs, thus earning interest. The banks keep a portion of the deposits to itself as reserve and lending the balance to the borrowers as loans and advance. Commercial banks grant loans in the forms of cash credit, demand loans, short-term loans etc.

• Cash Credit

Refer as a loan which given to an eligible borrower against his/her current assets such as bonds, shares, stocks etc. A credit limit is sanctioned and the amount is credited to his/her account. The borrower is allowed to withdraw any amount within the credit limit and interest is charged upon the amount withdrawn.

• Demand Loans

Demand loans refer to those loans which can be recalled on demand is called demand loan. There is no maturity stated. This is where the loan is paid in a lump sum by crediting it to the borrower’s loan account and the interest is payable on the entire loan.

• Short-term Loans

Refer to a loan which given against some security as personal loans to finance working capital or as priority sector advances. The entire loan is repaid either by one installment or few numbers of installments over the period of loan (J. Singh, undated).

iii) Credit Creation

Credit creation is considered as important function of the commercial banks. This is where when the bank sanctioning a loan to a borrower, the bank do not provide cash, instead the bank opens a deposit account from where the borrower could withdraw (Gaurav Akrani, 2010).

2.2 Secondary Functions

Besides performing primary functions, each commercial bank has to perform several secondary functions too. This consists many agency functions or general utility functions. The secondary functions is divided into:-

i) agency functions

ii) general utility functions

i) Agency Functions

• to collect and clear cheques, dividends and interest warrant

• to make payment of rent, insurance premium etc

• to deal in foreign exchange transactions

• to purchase and sell securities

• to act as trusty, attorney, correspondent and executor

• to accept tax proceeds and tax returns

ii) General Utility Functions

• to provide safety locker facility to customers

• to provide money transfer facility

• to issue traveler’s cheque

• to act as referees

• to accept various bills for payment such as phone bills, water bills etc

• to provide merchant banking facility

• to provide various cards such as credit cards, debit cards etc

3.0 Islamic Banking

In Malaysia, Islamic banking as well known, it is consistent with the Shariah principles and guided by the Islamic economics. Under the Shariah principles, there are several common shariah contract which are Prohibition of Interest (Riba), Profit Sharing (Mudharabah), Safekeeping (Wadiah), Joint Venture (Musharakha), Cost Plus ( Murabahab), Leasing (Ijarah) and others (bankinginfo.com.my, 2009).

3.1 Prohibition of Interest (Riba)

The prohibition of payment or acceptance of the fixed interest on the basis of the Islamic doctrine, money is only a medium of communication, the value of a thing is defined which itself has no value, and therefore should not be allowed to increase more money, through fixed interest payments, simply put in the bank or lend to others. A person’s efforts, initiative, and adventure are more important than the use of financial money (Islamic-banking.com, 2010).

3.2 Profit Sharing (Mudharabah)

Mudharabah is a profit sha rring arrangement between two parties which is an investor and the entrepreneur. The investor will provide money and get a return of funds base on the contribution rate that has been agreed earlier. The principle of Mudharabah can be applied to Islamic banking operations in 2 ways: between a bank (as the entrepreneur) and the capital provider, and between a bank (as capital provider) and the entrepreneur. Losses suffered shall be borne by the capital provider (bankinginfo.com.my, 2009).

3.3 Safekeeping (Wadiah)

Wadiah means custody or safekeeping. In the Wadiah arrangement, customer deposit cash or other asset in the bank for safekeeping. The bank guarantees the security of the item (bankinginfo.com.my, 2009).

3.4 Joint Venture (Musharakha)

In the commercial and trade environment, musyarakah refer to the partnership or joint venture business to make profits. According to the agreed proportion of the amount invested by the partners, they share the profit may not be the same. If resulting in loss will be shared on the basis of the proportion of investment by each partner (bankinginfo.com.my, 2009).

3.5 Cost Plus ( Murabahab)

In Murabahab, it is a contract sale between the bank and its customer for the sale of goods at a price which includes a profit margin agreed by both parties. However, in Murabahab, the seller must let the buyer know the actual cost of the asset and profit margin of the sale agreement (bankinginfo.com.my, 2009).

3.6 Leasing (Ijarah)

It means to employ the services of a person on wages. Another type of Ijarah relates to pay rent for the use of an asset or property (bankinginfo.com.my, 2009).

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Commercial Banks and Savings Banks

First Online: 19 December 2019

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Both commercial banks and savings & loans provide banking and loan products to consumers. Commercial banks are classified as: retail banks and wholesale banks. Commercial banks are intermediaries between the central bank (FED) and the ultimate money borrowers. However, savings banks are financial institution whose primary purpose consists of accepting savings deposits and paying interest on those deposits.

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Timothy Clark, Astrid Dick, and others (2007): The Role of Retail Banking in the US Banking Industry-Risk, Return, and Industry Structure, FRBNY Economic Policy Review, December 2007, pp. 39–40.

Timothy Clark, Astrid Dick, and others (2007): The Role of Retail Banking in the US Banking Industry-Risk, Return, and Industry Structure, FRBNY Economic Policy Review, December 2007, p. 42.

Timothy Clark, Astrid Dick, and others (2007): The Role of Retail Banking in the US Banking Industry-Risk, Return, and Industry Structure, FRBNY Economic Policy Review, December 2007, p. 50.

Joe Peek and Eric S. Rosengren (2013): The Role of Banks in the Transmission of Monetary, Public Policy Discussion Papers, no. 13-5, Federal Reserve Bank of Boston, MA.

Joe Peek and Eric S. Rosengren (2013): The Role of Banks in the Transmission of Monetary, Public Policy Discussion Papers, no. 13-5, Federal Reserve Bank of Boston, MA, p. 4.

R.P. Kishan and T.P. Opiela (2000): Bank Size, Bank Capital, and the Bank Lending Channel, Journal of Money, Credit and Banking 32(1): 121–141.

Joe Peek and Eric S. Rosengren (2013): The Role of Banks in the Transmission of Monetary, Public Policy Discussion Papers, no. 13-5, Federal Reserve Bank of Boston, MA, p. 12.

E. Loutskina and P. Strahan (2009): Securitization and the Declining Impact of Bank Finance on Loan Supply-Evidence from Mortgage Originations, Journal of Finance 64(2): 861–889.

That is, banks with international operations are more able to insulate their lending activities from domestic liquidity shock, such as monetary policy tightening.

Credit Card Accountability, Responsibility, and Disclosure Act of 2009 (Credit CARD Act of 2009), 2009 Truth in Lending Act (TILA), 1968.

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Lessambo, F.I. (2020). Commercial Banks and Savings Banks. In: The U.S. Banking System. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-34792-5_6

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What are Commercial Banks? (Financial Economics)

Last updated 21 Mar 2021

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This short revision video looks at the core functions of commercial banks in the UK.

Commercial banks provide retail banking services to household and business customers
They are licensed deposit-takers – providing a range of savings accounts for households and businesses
They are licensed to lend money (and thereby “create” money e.g. in the form of loans, overdrafts and mortgages
Commercial banks can also make profits from providing other services such as deposit security, currency trading, business advice, cheque and credit-card processing
A commercial bank’s business model relies on receiving a higher interest rate on the loans (or other assets) than the rate it pays out on its deposits (or other liabilities)
This “spread” on their assets and liabilities is used to pay the operating expenses of a bank and also to make a profit

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CBSE Class 12 Macroeconomics Notes

Chapter 1: Introduction

Introduction to Macroeconomics
Basic Concepts of Macroeconomics
What is Factor Income and Transfer Income?
Consumption Goods and Capital Goods
Final Goods and Intermediate Goods
What is Net Indirect Tax (NIT)?
What is Net Factor Income from Abroad (NFIA)?
Circular Flow of Income: Meaning, Phases, Types and Significance
Difference between Real Flow and Money Flow
Circular Flow of Income
Leakages and Injections in Circular flow of Income

Chapter 2: National Income Accounting

National Income and Related Aggregates
Domestic Income and Personal Income
Private Income: Meaning, Types and Steps
Personal, National, and Gross National Disposable Income
Difference between Stock and Flow
Circular Flow of Income and Methods of Calculating National Income
Product or Value Added Method of calculating National Income
Expenditure Method of calculating National Income
Income Method of calculating National Income
Three Methods of calculating National Income: Value added Method, Expenditure Method and Income Method
Treatment of Different Items in National Income
Treatment of Different Items in Domestic Income
National Income at Current Price and Constant Price
Difference between Nominal GDP and Real GDP
GDP and Welfare
GDP Deflator | Meaning and Formula

Chapter 3: Money and Banking

What is barter system and double coincidence of wants?
Evolution and Definitions of Money
Significance of Money
Functions of Money
Contingent, Static and Dynamic Functions of Money
Classification of Money
Demand for Money
Monetary System in India
Money Supply - Features and Measures
Functions of Commercial Bank : Primary and Secondary Functions
Commercial Banks : Features, Advantages & Disadvantages
Credit Creation
Money Multiplier
Functions of Central Bank
Difference between Commercial Bank and Central Bank

Chapter 4: Determination of Income and Employment

Components of Aggregate Demand
Explain the Components of Aggregate Supply or National Income.
What is Consumption Function (Propensity to Consume)?
Types of Propensities to Consume
Difference between APC and MPC
What is Saving Function (Propensity to Save)?
Types of Propensities to Save
Difference between APS and MPS
Relationship between different propensities (APC, MPC, APS and MPS)
Explain the Derivation of Saving Curve from Consumption Curve.
Investment Function: Induced Investment, Autonomous Investment and Determinants of Investment
Ex-Ante and Ex-Post Investment
Full Employment and Involuntary Unemployment
Determination of Equilibrium Level of Income: AD-AS Approach and S-I Approach
Aggregate Demand-Aggregate Supply (AD-AS) Approach
Saving-Investment (S-I) Approach
How can we achieve equilibrium level?
What is Investment Multiplier?
Explain the working of Investment Multiplier.
Short-run Fixed Price Analysis of Product Market
What is Excess Demand?
What is Deficient Demand?
Difference between Excess Demand and Deficient Demand
How to Control Excess Demand?
How to Control Deficient Demand?
What are the different measures to control Excess Demand and Deficient Demand?
Excess and Deficient Demand in Three-Sector Economy
What is Fiscal Policy and how it used to correct Excess Demand and Deficient Demand?

Chapter 5: Government Budget and the Economy

Government Budget : Characteristics, Objectives and Components
Revenue Receipt and Revenue Expenditure: Meaning and Classification
Difference between Direct and Indirect Tax
Capital Receipt and Capital Expenditure: Meaning and Sources of Capital Receipts
Difference between Revenue Receipt and Capital Receipt
Difference between Revenue Expenditure and Capital Expenditure
Measures of Government Deficit: Revenue Deficit, Fiscal Deficit and Primary Deficit
Difference between Fiscal Deficit and Revenue Deficit
Difference between Primary Deficit and Fiscal Deficit
Difference between Plan & Non-plan Expenditure
Developmental and Non-Developmental Expenditure

Chapter 6: Open Economy Macroeconomics

Foreign Exchange Rate : Meaning and Types
Currency Depreciation and Currency Appreciation
Types of Foreign Exchange Rate
Demand and Supply for Foreign Exchange
Determination of Exchange Rate
Foreign Exchange Market : Functions and Types
Fixed Exchange Rate System | Meaning, Methods, Merits and Demerits
Flexible Exchange Rate System | Meaning, Merits and Demerits
Managed Floating Exchange Rate System : Meaning, Objectives, Merits and Demerits
Devaluation of Currency| Reasons, Effects, Example and Critical Evaluation
Depreciation of Currency : Effects, Examples and Critical Evaluation
Difference between Devaluation and Depreciation
Balance of Payment and its Components: Capital and Current Account
Difference between Current Account and Capital Account of BoP
Difference between Balance of Payment and Balance of Trade
Balance of Payments: Surplus and Deficit, Autonomous and Accommodating Transactions, Errors and Omissions

Important Formulas

Important Formulas in Macroeconomics | Class 12

CBSE Previous Year Papers (2020)

CBSE Class 12 Economics Solved Question Paper 2020 - Set 1
CBSE Class 12 Economics Solved Question Paper 2020 (Set 58/1/2)
Class 12 Economics Solved Question Paper 2020 (Set 58/1/3)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 2
CBSE Class 12 Economics Solved Question Paper 2020 - Set 2 (58/2/2)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 2 (58/2/3)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 3
CBSE Class 12 Economics Solved Question Paper 2020 - Set 3 (58/3/2)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 3 (58/3/3)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 4 (Code No. 58/4/1)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 4 (58/4/2)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 4 (58/4/3)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 5 (58/5/1)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 5 (58/5/2)
CBSE Class 12 Economics Solved Question Paper 2020 - Set 5 (58/5/3)

Commercial Banks : Features, Advantages & Disadvantages

What are commercial banks.

A commercial bank is a financial institution that provides services like accepting deposits, granting loans, bank overdrafts, offering certificates of deposits, and savings accounts to individuals and businesses. Commercial banks are considered to be an important component of the banking system. These are the banks that perform banking services with the aim of earning profits. Commercial banks are generally famous because they provide funds for a different span of time: short-term & medium-term. Also, commercial banks are very active in accepting deposits. Usually, the rate of interest charged on the loans is more than the interest offered on the deposits. The disparity between both interest rates then becomes the primary source of income or profits for the banks. Common examples of commercial banks are the State Bank of India (SBI), Bank of Baroda, Punjab National Bank (PNB), Central Bank of India, Canara Bank, Bank of India, etc.

Table of Content

Characteristics of Commercial Banks

Advantages of commercial bank, disadvantages of commercial bank.

Commercial banks lend money to almost all sizes of businesses and firms.
The credibility and paying capacity of the firm is examined comprehensively before lending loan to any firm.
A commercial bank is an easy and flexible source of accepting and withdrawing money.
These are the economical source of funds as it manages deposits and withdrawals at a low cost and involves no hidden cost.
It generally provides the loan against some security.
Loans from commercial banks do not require much formality, but have to fulfil the terms and conditions laid by the banks.

The advantages of Commercial Banks are as follows:

1. Confidentiality of Information: The banks when lends funds or accept deposits do not share the information with anyone. Banks value the privacy of their customers by preserving the secrecy of personal information of customers. The personal details of the customers or the account holders are kept safe with the banks.

2. Economical: Commercial banks are widely regarded as the cheaper funding source. The reason for its being an economical source is that it does not involves any cost for issuing of a prospectus, underwriting fees or any other charges. Banking services under commercial banks are free from any sort of hidden charges.

3. Flexible: Commercial banks are considered to be a flexible source of funding because the borrower can easily borrow money from the banks whenever they are in urgent need of money or funds. The borrowers can easily increase or reduce the amount of borrowings as per their convenience and requirements. The banks make the funds available as and when needed by the borrowers. Also, borrowers can repay the money when they don’t feel the requirement.

4. Lesser Formalities: It’s easy for borrowers to raise funds from commercial banks because it requires no stringent formalities to follow up. As such no paperwork is involved in the whole borrowing process. It requires no formalities like looking for an underwriter or issuing of a prospectus. So, it makes the process hassle-free and smooth.

5. Encourage Savings: Commercial Banks through their operations encourage savings among the general public. With this facility, banks offer a safer way to collect money from individuals, which otherwise they could have consumed impulsively. The amount of savings is subject to some fixed rate of interest. So savings from individuals whether in small or big amount increases the capital accumulation with the banks, which then can be used to invest or lend to the general public.

6. Facilitates Digital Transactions: With the growth of digitisation, commercial banks have emerged as significant financial institution because it provides a technologically advanced platform for making digital payments. Apart from basic facilities, it makes online transfers easy, use of cheques, ATMs, bank drafts, etc. A very few and recent development of commercial banks is the facility of online wallet. Earlier individuals and businessmen had to handle a lot of money which was subjected to theft, but now they can keep their money safe in the wallets and can use to make digital payments.

The disadvantages of Commercial Banks are as follows:

1. Procedural Difficulty: While lending funds to borrowers, it’s important for commercial banks to check if the advances are being made to the right entity. The only way to check is to conduct a detailed investigation of the firm’s background and its financial affairs. It follows stringent rules, so it makes the procedure of borrowing very tricky and rigorous.

2. Difficulty in Renewal: Loans from Commercial Banks can be generally borrowed for a short period of time only. It’s almost difficult to renew or extend the borrowings. Also, extending the tenure of borrowed funds can be tough and only fresh loans can be borrowed.

3. Need for Security: Loans from commercial banks can’t be provided without any security. For any amount of loan or advances, there is a requirement of any asset or personal guarantees from the borrowers against which borrowings can be issued. Most of the time, the loan amount is lower than the security’s value. So it has become disadvantageous for the public and firms.

4. Stringent Terms and Conditions: Commercial banks sometimes put forward a few challenging conditions for borrowers before lending loans or funds. At times, terms and conditions are so difficult to fulfil that it hampers the complete borrowing process. So, this restricts the borrowing decision of firms that they even back out from this source of funds and shift to some other source of funds with some feasible terms and conditions.

5. Bankruptcy: Sometimes, the banks may not be capable to provide the amount requested by the borrowers even if that money belongs to the customers and they have only deposited those to their savings account. This happens when the management of the banks does not take proper care of depositors’ or investors’ finances and rather mismanages them. But sometimes, it could also happen due to weaker economic health, like in times of recession when customers do more withdrawal than borrowings.

6. Risk of Online Frauds: Growing digitisation has not only soothed operations but also has given rise to online frauds. Cyber attacks have become more common and often nowadays, ATM cards are more subjected to theft, hackers hack the accounts and passwords for digital payments, and steal money online. There’s an urgent need to strengthen the game of internet banking.

On the whole, it can be concluded that commercial banks are a very crucial component of the whole Banking system. Also, gradually with time, the outlook of commercial banks is expanding with regard to the economy. Commercial Banks offer a proper organised financial market in less developed countries by providing financial assistance and fulfilling the financial needs of individuals, firms and businesses.

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Essay On Bank

Essay on Bank

500+ words essay on bank.

Banks are an integral part of the modern economy. They play a major role in the economic growth and development of a country. The idea of banking evolved with the idea of money. In India, public sector banks (PSBs) have been working to provide banking services in urban and rural areas since 1970. These public sector banks account for nearly 70% of banking activity in India. With the help of this essay on banks, students will get to know the functions performed by banks and their importance for individuals and the country. To help students in improving their essay-writing skills, we have also compiled a list of CBSE Essays on different topics. By practising these essays, they can boost their writing skills and also score good marks on the English exam.

Meaning of Bank

Banks are mainly linked to depositing and lending money. In Indian society, moneylenders used to give money to people in ancient times. They charged a high rate of interest to people as there were no banks or banking systems available at that time. But, with the change in time, the banking system was introduced in India. Now, we have public sector banks and private banks.

A bank is a financial institution that deals with deposits, withdrawals and other related banking services. Bank receives money from those who want to save in the form of deposits, and it lends money to those who need it. A bank is a financial institution that works as an intermediary to accept deposits and channels those deposits into various lending activities. It does so through loans or capital markets. A bank establishes the connection between the customers who have capital surpluses and those with capital deficits. In India, all banks operate under the guidelines of the Reserve Bank of India, which is known as the banker’s bank.

Functions of Bank

Banking is the lifeline of the modern economy. It has played a very important role in the economic development of all the nations of the world. We can not think of modern commerce without banking. Banking is a business which seeks profits like any other business. The banking business mainly constitutes borrowing and lending as their basic functions. Now, banks are providing many other services to people, such as net banking, online shopping, mobile banking, granting loans and advances, short-term credit, pension payments, acting as a dealer in foreign currency etc. A common person can safely deposit their money in the banks.

How Important are Banks for Development?

Banks are the most important financial pillars. They play a vital role in the economic development of a country. The financing requirements of industries, trades, agriculture and other business are met with the help of banks. Therefore, if the banking system of a country becomes strong, then the development of the country will also be at a faster rate. In today’s economy, banks are not only dealing with money, but they are also contributing to the development of the nation. They play a crucial role in the disbursement of credit and the mobilisation of deposits to various sectors of the economy. Banks also represent the economic health of the country. The strength of a nation’s economy depends on the strength of the financial system, which depends on the banking system.

In India, banks play a crucial role in the social and economic growth of the country after independence. The banking sector in India accounts for more than half the assets of the financial sector. The Indian banks have shown much growth after the implementation of financial sector reforms.

Banks are the backbone of any country’s economy. They are responsible for running the economy and controlling the price of the markets. They perform various important functions. However, there are default NPAs, cases of corruption and security threat-related issues, but these can be resolved by implementing strict laws and rules by the government.

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Explain the role of commercial banks (UK) - 15 Marks

Subject: Economics

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Essay on Central Bank | Banking

In this essay we will discuss about central bank. After reading this essay you will learn about: 1. Essay on the Definition of a Central Bank 2. Essay on the Functions of a Central Bank 3. Essay on the Objectives of Credit Control by the Central Bank 4. Essay on the Role of Central Bank in a Developing Economy 5. Essay on the Need for Central Bank.

Essay Contents:

Essay on the Need for Central Bank

1. Essay on the Definition of a Central Bank:

A central bank has been defined in terms of its functions. According to Vera Smith, “The primary definition of central banking is a banking system in which a single bank has either complete control or a residuary monopoly of note issue.” W.A. Shaw defines a central bank as a bank which control credit. To Hawtrey, a central bank is that which is the lender of the last resort. According to A.C.L. Day, a central bank is “to help control and stabilise the monetary and banking system.”

ADVERTISEMENTS:

According to Sayers, the central bank “is the organ of government that undertakes the major financial operations of the government and by its conduct of these operations and by other means, influences the behaviour of financial institutions so as to support the economic policy of the Government.” Sayers refers only to the nature of the central bank as the government’s bank. All these definitions are narrow because they refer only to one particular function of a central bank.

On the other hand, Samuelson’s definition is wide. According to him, a central bank “is a bank of bankers. Its duty is to control the monetary base…. and through control of this ‘high-powered money’ to control the community’s supply of money.” But the broadest definition has been given by De Kock.

In his words, a central bank is “a bank which constitutes the apex of the monetary and banking structure of its country and which performs as best as it can in the national economic interest, the following functions:

(i) The regulation of currency in accordance with the requirements of business and the general public for which purpose it is granted either the sole right of note issue or at least a partial monopoly thereof,

(ii) The performance of general banking and agency for the state,

(iii) The custody of the cash reserves of the commercial banks,

(iv) The custody and management of the nation’s reserves of international currency,

(v) The granting of accommodation in the form of re-discounts and collateral advances to commercial banks, bill brokers and dealers, or other financial institutions and the general acceptance of the responsibility of lender of the last resort,

(vi) The settlement of clearance balances between the banks,

(vii) The control of credit in accordance with the needs of business and with a view to carrying out the broad monetary policy adopted by the state.” De Kock’s definition is too long to be called a definition. For, a definition must be brief.

2. Essay on the Functions of Central Bank:

A central bank performs the following functions, as given by De Kock and accepted by the majority of economists:

1. Regulator of currency :

The central bank is the bank of issue. It has the monopoly of note issue. Notes issued by it circulate as legal tender money. It has its issue department which issues notes and coins to commercial banks. Coins are manufactured in the government mint but they are put into circulation through the central bank.

Central banks have been following different methods of note issue in different countries. The centred bank is required by law to keep a certain amount of gold and foreign securities against the issue of notes. In some countries, the amount of gold and foreign securities bears a fixed proportion, between 25 to 40 per cent of the total notes issued.

In other countries, a minimum fixed amount of gold and foreign currencies is required to be kept against note issue by the central bank. This system is operative in India whereby the Reserve Bank of India is required to keep Rs115crores in gold and Rs85crores in foreign securities. There is no limit to the issue of notes after keeping this minimum amount of Rs200crores in gold and foreign securities.

The monopoly of issuing notes vested in the central bank ensures uniformity in the notes issued which helps in facilitating exchange and trade within the country. It brings stability in the monetary system and creates confidence among the public.

The central bank can restrict or expand the supply of cash according to the requirements of the economy. Thus it provides elasticity to the monetary system. By having a monopoly of note issue, the central bank also controls the banking system by being the ultimate source of cash. Last but not the least, by entrusting the monopoly of note issue to the central bank, the government is able to earn profits from printing notes whose cost is very low as compared with their face value.

2. Banker, fiscal agent and adviser to the g overnment :

Central banks everywhere act as bankers, fiscal agents and advisers to their respective governments. As banker to the government, the central bank keeps the deposits of the central and state governments and makes payments on behalf of governments. But it does not pay interest on governments deposits. It buys and sells foreign currencies on behalf of the government., It keeps the stock of gold of the government.

Thus it is the custodian of government money and wealth. As a fiscal agent, the central bank makes short-term loans to the government for a period not exceeding 90 days. It floats loans, pays interest on them, and finally repays them on behalf of the government. Thus it manages the entire public debt.

The central bank also advises the government on such economic and money matters as controlling inflation or deflation, devaluation or revaluation of the currency, deficit financing, balance of payments, etc. As pointed out by De Kock, “Central banks everywhere operate as bankers to the state not only because it may be more convenient and economical to the state, but also because of the intimate connection between public finance and monetary affairs.”

3. Custodian of cash reserves of commercial banks :

Commercial banks are required by law to keep reserves equal to a certain percentage of both time and demand deposits liabilities with the central banks. It is on the basis of these reserves that the central bank transfers funds from one bank to another to facilitate the clearing of cheques. Thus the central bank acts as the custodian of the cash reserves of commercial banks and helps in facilitating their transactions.

There are many advantages of keeping the cash reserves of the commercial banks with the central bank, according to De Kock.

In the first place, the centralisation of cash reserves in the central bank is a source of great strength to the banking system of a country.

Secondly, centralised cash reserves can serve as the basis of a large and more elastic credit structure than if the same amount were scattered among the individual banks.

Thirdly, centralised cash reserves can be utilised fully and most effectively during periods of seasonal strains and in financial crises or emergencies.

Fourthly, by varying these cash reserves the central bank can control the credit creation by commercial banks. Lastly, the central bank can provide additional funds on a temporary and short term basis to commercial banks to overcome their financial difficulties.

4. Custody and management of foreign exchange reserves :

The central bank keeps and manages the foreign exchange reserves of the country. It is an official reservoir of gold and foreign currencies. It sells gold at fixed prices to the monetary authorities of other countries. It also buys and sells foreign currencies at international prices. Further, it fixes the exchange rates of the domestic currency in terms of foreign currencies.

It holds these rates within narrow limits in keeping with its obligations as a member of the International Monetary Fund and tries to bring stability in foreign exchange rates. Further, it manages exchange control operations by supplying foreign currencies to importers and persons visiting foreign countries on business, studies, etc. in keeping with the rules laid down by the government.

5. Lender of the last resort :

De Kock regards this function as a sine qua non of central banking. By granting accommodation in the form of re-discounts and collateral advances to commercial banks, bill brokers and dealers, or other financial institutions, the central bank acts as the lender of the last resort. The central bank lends to such institutions in order to help them in times of stress so as to save the financial structure of the country from collapse.

It acts as lender of the last resort through discount house on the basis of treasury bills, government securities and bonds at “the front door”. The other method is to give temporary accommodation to the commercial banks or discount houses directly through the “back door”.

The difference between the two methods is that lending at the front door is at the bank rate and in the second case at the market rate. Thus the central bank as lender of the last resort is a big source of cash and also influences prices and market rates,

6. Clearing house for transfer and settlement :

As bankers’ bank, the central bank acts as a clearing house for transfer and settlement of mutual claims of commercial banks. Since the central bank holds reserves of commercial banks, it transfers funds from one bank to other banks to facilitate clearing of cheques.

This is done by making transfer entries in their accounts on the principle of book-keeping. To transfer and settle claims of one bank upon others, the central bank operates a separate department in big cities and trade centres. This department is known as the “clearing house” and it renders the service free to commercial banks.

When the central bank acts as a clearing agency, it is time-saving and convenient for the commercial banks to settle their claims at one place. It also economises the use of money. “It is not only a means of economising cash and capital but is also a means of testing at any time the degree of liquidity which the community is maintaining.”

7. Controller of credit :

The most important function of the central bank is to control the credit creation power of commercial bank in order to control inflationary and deflationary pressures within this economy. For this purpose, it adopts quantitative methods and qualitative methods.

Quantitative methods aim at controlling the cost and quantity of credit by adopting bank rate policy, open market operations, and by variations in reserve ratios of commercial banks. Qualitative methods control the use and direction of credit. These involve selective credit controls and direct action. By adopting such methods, the central bank tries to influence and control credit creation by commercial banks in order to stabilise economic activity in the country.

Besides the above noted functions, the central banks in a number of developing countries have been entrusted with the responsibility of developing a strong banking system to meet the expanding requirements of agriculture, industry, trade and commerce. Accordingly, the central banks possess some additional powers of supervision and control over the commercial banks.

They are the issuing of licences; the regulation of branch expansion; to see that every bank maintains the minimum paid up capital and reserves as provided by law; inspecting or auditing the accounts of banks; to approve the appointment of chairmen and directors of such banks in accordance with the rules and qualifications; to control and recommend merger of weak banks in order to avoid their failures and to protect the interest of depositors; to recommend nationalisation of certain banks to the government in public interest; to publish periodical reports relating to different aspects of monetary and economic policies for the benefit of banks and the public; and to engage in research and train banking personnel etc.

3. Essay on the Objectives of Credit Control by the Central Bank :

Credit control is the means to control the lending policy of commercial banks by the central bank.

The central bank controls credit to achieve the following objectives:

1. To stabilise the internal price level:

One of the objective of controlling credit is to stabilise the price level in the country. Frequent changes in prices adversely affect the economy. Inflationary or deflationary trends need to be prevented. This can be achieved by adopting a judicious policy of credit control.

2. To stabilise the rate of foreign exchange:

With the change in the internal prices level, exports and imports of the country are affected. When prices fall, exports increase and imports decline. Consequently, the demand for domestic currency increases in the foreign market and its exchange rate rises. On the contrary, a rise in domestic prices leads to a decline in exports and an increase in imports.

As a result, the demand for foreign currency increases and that of domestic currency falls, thereby lowering the exchange rate of the domestic currency. Since it is the volume of credit money that affects prices, the central bank can stabilise the rate of foreign exchange by controlling bank credit.

3. To protect the outflow of gold:

The central bank holds the gold reserves of the country in its vaults. Expansion of bank credit leads to rise in prices which reduce exports and increase imports, thereby creating an unfavourable balance of payments. This necessitates the export of gold to other countries. The central bank has to control credit in order to prevent such outflows of gold to other countries.

4. To control business cycles:

Business cycles are a common phenomenon of capitalist countries which lead to periodic fluctuations in production, employment and prices. They are characterised by alternating periods of prosperity and depression. During prosperity, there is large expansion in the volume of credit, and production, employment and prices rise.

During depression, credit contracts, and production, employment and prices fall. The central bank can counteract such cyclical fluctuations through contraction of bank credit during boom periods, and expansion of bank credit during depression.

5. To meet business needs:

According to Burgess, one of the important objectives of credit control is the “adjustment of the volume of credit to the volume of business.” Credit is needed to meet the requirements of trade and industry. As business expands, larger quantity of credit is needed, and when business contracts less credit is needed. Therefore, it is the central bank which can meet the requirements of business by controlling credit.

6. To have growth with stability:

In recent years, the principal objective of credit control is to have growth with stability. The other objectives, such as price stability, foreign exchange rate stability, etc., are regarded as secondary. The aim of credit control is to help in achieving full employment and accelerated growth with stability in the economy without inflationary pressures and balance of payments deficits.

4. Essay on the Role of Central Bank in a Developing Economy :

The central bank in a developing economy performs both traditional and non-traditional functions. The principal traditional functions performed by it are the monopoly of note issue, banker to the government, bankers’ bank, lender of the last resort, controller of credit and maintaining stable exchange rate. But all these functions are related to the foremost function of helping in the economic development of the country.

The central bank in a developing country aims at the promotion and maintenance of a rising level of production, employment and real income in the country. The central banks in the majority of underdeveloped countries have been given wide powers to promote the growth of such economies.

They, therefore, perform the following functions towards this end:

Creation and expansion of financial institutions:

One of the aims of a central bank in an underdeveloped country is to improve its currency and credit system. More banks and financial institutions are required to be set up to provide larger credit facilities and to divert voluntary savings into productive channels. Financial institutions are localised in big cities in underdeveloped countries and provide credit facilities to estates, plantations, big industrial and commercial houses.

In order to remedy this, the central bank should extend branch banking to rural areas to make credit available to peasants, small businessmen and traders. In underdeveloped countries, the commercial banks provide only short-term loans. Credit facilities in rural areas are mostly non-existent.

The only source is the village moneylender who charges exorbitant interest rates. The hold of the village moneylender in rural areas can be slackened if new institutional arrangements are made by the central bank in providing short-term, medium term and long-term credit at lower interest rates to the cultivators.

A network of co-operative credit societies with apex banks financed by the central bank can help solve the problem. Similarly, it can help the establishment of lead banks and through them regional rural banks for providing credit facilities to marginal farmers, landless agricultural workers and other weaker sections.

With the vast resources at its command, the central bank can also help in establishing industrial banks and financial corporations in order to finance large and small industries.

Proper adjustment between demand for and supply of money:

The central bank plays an important role in bringing about a proper adjustment between demand for and supply of money. An imbalance between the two is reflected in the price level. A shortage of money supply will inhibit growth while an excess of it will lead to inflation. As the economy develops, the demand for money is likely to go up due to gradual monetization of the non-monetized sector and the increase in agricultural and industrial production and prices.

The demand for money for transactions and speculative motives will also rise. So the increase in money supply will have to be more than proportionate to the increase in the demand for money in order to avoid inflation. There is, however, the likelihood of increased money supply being used for speculative purposes, thereby inhibiting growth and causing inflation.

The central bank controls the uses of money and credit by an appropriate monetary policy. Thus in an underdeveloped economy, the central bank should control the supply of money in such a way that the price level is prevented from rising without affecting investment and production adversely.

A suitable interest rate policy:

In an underdeveloped country the interest rate structure stands at a very high level. There are also vast disparities between long-term and short-term interest rates and between interest rates in different sectors of the economy. The existence of high interest rates acts as an obstacle to the growth of both private and public investment, in an underdeveloped economy. A low interest rate is, therefore, essential for encouraging private investment in agriculture and industry.

Since in an underdeveloped country businessmen have little savings out of undistributed profits, they have to borrow from the banks or from the capital market for purposes of investment and they would borrow only if the interest rate is low.

A low interest rate policy is also essential for encouraging public investment. A low interest rate policy is a cheap money policy. It makes public borrowing cheap, keeps the cost of servicing public debt low, and thus helps in financing economic development.

In order to discourage the flow of resources into speculative borrowing and investment, the central bank should follow a policy of discriminatory interest rates, charging high rates for non-essential and unproductive loans and low rates for productive loans.

But this does not imply that savings are interest-elastic in an underdeveloped economy. Since the level of income is low in such economies, a high rate of interest is not likely to raise the propensity to save.

In the context of economic growth, as the economy develops, a progressive rise in the price level is inevitable. The value of money falls and the propensity to save declines further. Money conditions become tight and there is a tendency for the rate of interest to rise automatically. This would result in inflation. In such a situation any effort to control inflation by raising the rate of interest would be disastrous. A stable price level is, therefore, essential for the success of a low interest rate policy which can be maintained by following a judicious monetary policy by the central bank.

Debt management:

Debt management is one of the important functions of the central bank in an underdeveloped country. It should aim at proper timing and issuing of government bonds, stabilizing their prices and minimizing the cost of servicing public debt. It is the central bank which undertakes the selling and buying of government bonds and making timely changes in the structure and composition of public debt.

In order to strengthen and stabilize the market for government bonds, the policy of low interest rates is essential. For, a low rate of interest raises the price of government bonds, thereby making them more attractive to the public and giving an impetus to the public borrowing programmes of the government.

The maintenance of structure of low interest rates is also called for minimizing the cost of servicing the national debt. Further, it encourages funding of debt by private firms. However, the success of debt management would depend upon the existence of well-developed money and capital markets in which wide range of securities exist both for short and long periods. It is the central bank which can help in the development of these markets.

Credit control:

Central Bank should also aim at controlling credit in order to influence the patterns of investment and production in a developing economy. Its main objective is to control inflationary pressures arising in the process of development. This requires the use of both quantitative and qualitative methods of credit control.

Open market operations are not successful in controlling inflation in underdeveloped countries because the bill market is small and undeveloped. Commercial banks keep an elastic cash-deposit ratio because the central bank’s control over them is not complete. They are also reluctant to invest in government securities due to their relatively low interest rates.

Moreover, instead of investing in government securities, they prefer to keep their reserves in liquid form such as gold, foreign exchange and cash. Commercial banks are also not in the habit of rediscounting or borrowing from the central bank.

The bank rate policy is also not so effective in controlling credit in LDCs due to:

(a) The lack of bills of discount;

(b) The narrow size of the bill market;

(d) The existence of a large unorganised money market;

(e) The existence of indigenous banks which do not discount bills with the central banks; and

(f) The habit of commercial banks to keep large cash reserves.

The use of variable reserve ratio as method of credit control is more effective than open market operations and bank rate policy in LDCs. Since the market for securities is very small, open market operations are not successful. But a rise or fall in the reserve ratio by the central bank reduces or increases the cash available with the commercial banks without affecting adversely the prices of securities. Again, the commercial banks keep large cash reserves which cannot be reduced by a raise in the bank rate or sale of securities by the central bank.

But raising the cash-reserve ratio reduces liquidity with the banks. However, the use of variable reserve ratio has certain limitations in LDCs. First, the non-banking financial intermediaries do not keep deposits with the central bank so they are not affected by it. Second, banks which do not maintain excess liquidity are not affected than those who maintain it.

The qualitative credit control measures are, however, more effective than the quantitative measures in influencing the allocation of credit, and thereby the pattern of investment. In underdeveloped countries, there is a strong tendency to invest in gold, jewellery, inventories, real estate, etc., instead of in alternative productive channels available in agriculture, mining, plantations and industry.

The selective credit controls are more appropriate for controlling and limiting credit facilitates for such unproductive purposes. They are beneficial in controlling speculative activities in food grains and raw materials. They prove more useful in controlling ‘sectional inflations’ in the economy. They curtail the demand for imports by making it obligatory on importers to deposit in advance an amount equal to the value of foreign currency.

This has also the effect of reducing the reserves of the banks in so far as their deposits are transferred to the central banks in the process. The selective credit control measures may take the form of changing the margin requirements against certain types of collateral, the regulation of consumer credit and the rationing of credit.

Solving the balance of payments problem:

The central bank should also aim at preventing and solving the balance of payments problem in a developing economy. Such economies face serious balance of payments difficulties to fulfill the targets of development plans. An imbalance is created between imports and exports which continues to widen with development.

The central bank manages and controls the foreign exchange of the country and also acts as the technical adviser to the government on foreign exchange policy. It is the function of the central bank to avoid fluctuations in the foreign exchange rates and to maintain stability. It does so through exchange controls and variations in the bank rate. For instance, if the value of the national currency continues to fall, it may raise the bank rate and thus encourage the inflow of foreign currencies.

5. Essay on the Need for Central Bank:

It is widely recognised that the central bank is a valuable and indispensable institution for the proper functioning of a modern economy. But, there is a difference of opinion regarding the necessity and usefulness of the central bank in economically backward countries having underdeveloped money markets.

Some people argue that the central bank is not necessary in such countries for various reasons: such as the absence of well-organised banking institutions over which the central bank exercises its supervision and control, the absence of short-term money markets and of well-developed bill markets to enable the central bank to perform the rediscounting operations properly, the fear of political pressure of the governments of these countries over the normal working of the central bank, and others. For all these reasons it is argued that the central bank in the under-developed countries cannot execute its monetary policy and control-techniques properly and effectively.

But, the fact remains that the central bank is as indispensable in the underdeveloped countries as it is in the developed countries.

For this reason it is now established that every country, whether developed or underdeveloped, must set up a central bank for the following reasons:

(a) Economic stability:

The central bank is indispensable for maintaining stability in the economy of a country. It can maintain both price and foreign exchange stability through the exercise of proper and effective control over the country’s total money supply.

Such economic stability is as essential for underdeveloped countries as for developed ones, for promoting rapid economic growth. No other institutions except the central bank is competent enough to maintain this overall economic stability.

(b) Control over bank credit:

The central bank is necessary to exercise a judicious control over bank credit. As bank credit constitutes the most important component of the money supply, its supply is to be properly regulated in time for avoiding instability in the price-level and for regulating its supply in accordance with the country’s requirements.

(c) Control and supervision over the activities of other banks:

The central bank of a country can develop the banking system by exercising proper control and supervision over the operations of other banks. In the absence of the central bank, it becomes a difficult task to bring about proper co-ordination among the banks and to develop these institutions along a sound line.

(d) Proper execution of the monetary policy:

The central bank is the leader of the money market of a country. Therefore, its existence is of utmost importance for pursuing the country’s monetary (credit) policy.

(e) Special role of the central bank in a developing economy:

The central bank has a special role to play in a developing economy in promoting economic growth with stability, in providing special finance for agriculture, industry and other top priority sectors.

(f) Foreign exchange regulations and international dealings:

Every country, whether a developed or an underdeveloped one, must have a monetary institution like the central bank for foreign exchange regulations Sid for dealing with international institutions like the International Monetary Fund and the Bank for International Settlements. When the gold standard was in existence, it had some special importance.

(g) Control over the money supply:

The central bank is also necessary for the control over the money supply and for the regulation of the country s interest rates. For this reason the central bank enjoys the monopoly power regarding the issue of paper notes, and its rate of interest (i.e., the bank rate) acts as the pace-setter to other rates such as market rates of interest.

Conclusion:

The above description shows that every country, whether a developed or an underdeveloped one, must set up a Central Bank of its own.

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