Commercial Banks: Their Primary and Secondary Functions
Commercial banks are banks that accept deposits of money from customers and provide them with a payments transmission service together with savings and loans facilities. They make part of the Depository Financial Institutions and are said to be the main financial intermediary in any economy. As commercial banks are allowed to take deposits from customers, they are heavily regulated.
The primary functions of a commercial bank are said to be accepting deposits and granting loans through the credit multiplier:
This main function involves collecting savingsÂ of individuals and firms. Banks will hold money saved by consumers, who may wish to withdraw this money and use it at a later time. Funds deposited with such a bank earn interest, obviously depending upon the nature of the deposit. Thus, deposits with the bank grow along with the interest earned. The higher the interest rate is the more motivated the public will be to deposit funds within the bank.
A commercial bank offers different types of deposits for the facility of the customers which includes Current Account or Demand Deposits, Saving Account and Fixed Deposits.
Bank lendingÂ Â Â
Commercial banks offer four different types of loans that consist of overdrafts, personal loans, mortgages and credit cards.
- The overdraft facility is a popular method of short term borrowing. The account is permitted to be overdrawn up to a maximum sum for a given period of time. Interest is charged on a daily basis on any overdrawn balance.
- The personal loan is an agreement to borrow an explicit amount for an explicit period of time with a set sum repaid monthly. The rate of interest is fixed and charged on the whole amount.
- Mortgages â€” although there may be specialized mortgage lenders, commercial banks may offer mortgages too. The loan is secured on the property and any loan which is secured will bear a much lower rate of interest as the bank is less at risk.
- Another way of lending is the credit card. The two major international brand names are Visa and MasterCard. They are offered by banks, retailers and others. A statement is sent monthly with a given time to pay. In general, credit cards are now very widely used.
Another important retail banking service is the provision of money transfers by way of cheques. The typical current account enables the client to pay money in and take money out, by paying in a cheque or writing a cheque in favour of a creditor. Alternatively, a bill may be paid by completing a giro form and sending the form to the clientâ€™s own bank so that money can be transferred to the creditorâ€™s account. An alternative to the cheque for payment in a retail shop is the debit card.
Besides the primary functions of accepting deposits and lending money, banks perform a number of other functions which are called Secondary functions including:
- Securities purchases â€” today, due to deregulation, banks have been allowed either to own brokers or set up their own operations and offer their branch customers a securities service.
- Securities custody â€” often bonds and shares are in ?bearerâ€™ format and not registered. The problem is that, in the event of a burglary, the burglar is now the bearer. The banks will, therefore, often hold the certifications for safe keeping and claim interest payments/dividends for clients. They also notify them of AGMs, rights issues and other company events.
- Mutual funds â€” these are pools of shares run by investment managers and giving the small shareholder a spread of risk.
- Advice â€” the bank manager is available for advice. This may be about investments, trust funds for children, wills and similar issues. This position as adviser puts the bank manager in an ideal position to sell the banksâ€™ products. This has caused much controversy over the years. The ruling now is that either the bank manager is an agent for the banksâ€™ products or an independent investment adviser.Â Â Most banks have decided that their managers will be agents for the banksâ€™ products.
- Safe deposits â€” banks provide safe deposits to house jewellery, other valuable items and cash.
- Foreign exchange â€” apart from the banksâ€™ wholesale foreign exchange operations, they will provide a service for their customersâ€™ holiday needs. This will involve travellersâ€™ cheques and cash. They may also be involved in requests to transfer sums of money to accounts abroad.
- Insurance â€” most banks are now offering insurance policies either through an association with an insurance company or through their own subsidiary.