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Top 14 Functions of Commercial Banks – Discussed! Research Team | Posted On Monday, April 15,2019, 12:03 PM

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Top 14 Functions of Commercial Banks – Discussed!



Banks are the lifeline of the economy. The commercial banks play an important role in mobilization of deposits and disbursement of credit to various sectors of the economy. A bank is a financial institution whose purpose is to receive deposits and lend money to individuals and businesses, disburse payments, invest funds in securities for returns, and safeguard customer money. It services savings and current accounts, provides credit to borrowers in the form of loans and through credit cards, and functions as trustees to clients.

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Top 14 Functions of Commercial Banks – Discussed!

Listed below are some of the important functions performed by the commercial banks:

1. Accepting Deposits: This is one of the primary functions of commercial banks. They accept customer deposits and pay interest on them. The banks then use these deposits to offer loans. The deposits accepted by the banks are of two types. They are demand deposits and time deposits.

2. Demand Deposits also called Current Accounts: A demand deposit consists of funds held in accounts where they can be withdrawn on time on demand. A demand deposit is an account with the bank or any financial institution that holds the depositors money. The amounts lying in the current accounts are known as demand deposits as they can be withdrawn as per the need of the depositor. There are no restrictions on the amount that can be kept in these deposits. Usually, no interest is paid on these deposits as the bank cannot utilize short term deposits. The banks also charges a maintenance fee for the services provided on these deposits.

3. Fixed Deposits or Time Deposits: Fixed deposit is an investment offered by commercial banks, where you deposit money for a higher rate of interest than savings bank accounts. The deposit can be made for a period of 1 year to 10 years. Once the money is invested, it earns interest across the duration of the deposit. One of the main criteria of fixed deposit is that the money cannot be withdrawn before maturity. If withdrawn before maturity, you incur a penalty. The rate of interest varies across banks and fixed deposits are available at almost all banks in India. The rate of interest also depends on the time period for which the deposits are made and the age of the depositor.

4. Savings Bank Deposits: A savings bank account is a deposit held at a commercial bank that offers interest around 3.5-4% a year. These accounts enable you put aside some of your idle cash and earn interest. There are rules on withdrawal from savings bank accounts from ATMs. After a certain number of withdrawals (free withdrawals), the bank charges fees for a further withdrawal. There are limits on the amount of withdrawals that can be made per day. The savings bank account offers lower rate of interest vis-a-vis fixed deposits.

SEE ALSO: The Functions of A Banking Business

5. Offering Loans: One of the most important functions of commercial banks is offering loans to borrowers. Banks serve as reliable sources of credit where borrowers can get money at a reasonable rate of interest. Repayment is through EMIs. The banks offer loans using depositor’s money.

The bank invests the money and lends to suitable borrowers. Money is lent to businessmen and traders for a short period of time. The rate of interest banks charge on loans is higher than the interest rate they offer to the depositors. The difference between the rates of interest after accounting for operating expenses is the Net Interest Margin or NIM. As banks deal with other people’s money, they exercise great care in matters of lending. The bank must strike a balance between liquidity and profitability and should be able to meet customer demands.

6. By allowing an Overdraft: Overdraft refers to extension of credit from a lending institution, which is granted when an account is at zero balance. It is a credit linked to the customer’s transaction account. Customers who have current accounts at banks can avail the facility of an overdraft. This facility is generally used when a cheque has been drawn on the current account and the account balance does not meet fund requirements.

Under the overdraft facility, the bank’s customers are offered an arrangement, where they can get money for an immediate need. However, the money is considered borrowed and the account holder must pay back the amount within a stipulated time along with interest. Overdraft facilities are generally granted to businessman who can pay off the money after the sale of goods.

7. By Creating a Deposit: Cash credit is another method followed by commercial banks for lending. Under this system, banks set a specified credit limit up to which the customer can borrow from the bank. However, the actual utilization of the credit limit by the borrower depends on withdrawing power. The interest payable by the borrower is calculated on the amount of credit limit actually drawn.

8. Discounting Bills: Discounting bills refer to an accepted draft or bill of exchange sold for early payment to a bank or credit institution, at less than face value after the bank deducts fees and applicable interest charges.

Discounting of bills is another way of lending money. Discounting of bills is generally applicable in scenarios where the customer purchases goods from the retailer and the payment has to be made through letter of credit. The bills offer high liquidity and can be readily converted to cash. This investment is considered very safe, as the bill offers security to holders.

SEE ALSO: Public Sector Banks in India

9. Remitting Funds: You can remit funds via bank draft to any place where banks have branches or agencies. This is the cheapest way of sending money. It is also very safe. Funds can also be remitted to foreign countries.

10. Demand loans: Demand loans are short term loans that do not have fixed dates of repayment. Demand loans have floating interest rates that vary according to the prime interest rate or other defined contract terms. Demand loans can be called for repayment at any time by the lending institution or commercial banks without prior notice to the borrower. When the demand loans are sanctioned by the commercial banks or the lending institute then the entire sum is transferred to the bank account of the borrower. The interest is applicable on the entire amount of loan sanctioned. Demand loans are generally given to stock brokers who need credit on a day to day basis.

11. Safe Custody: Commercial banks offer safety to wealth and assets of the customer. The commercial banks offer locker facility where the customer can keep assets like ornaments and property documents. It is a facility that can be availed by the bank’s customer just by raising a request. The banks charge a maintenance fee for offering this service. The safe deposit vault facility helps keep customer assets safe and reduces the chances of loss due to theft.

12. Agency Functions: Banks also function as agents. They receive payments on your behalf. They collect rent, dividends on shares and so on. They pay insurance premiums and make other payments as instructed by depositors. They accept bills of exchange on behalf of customers. They pass bills of lading or railway receipts to the purchasers of goods when payments are made. This amount is passed on to the suppliers of goods.

13. References: Banks provide references to individuals or companies on the financial position of customers, whenever required. Banks are institutions that can be trusted for reviews on the financial condition of a person. So, bank references are of prime importance for businessmen and business entities, when they want to establish connections with new firms within and outside India.

14. Letters of Credit: A letter of credit is a document that guarantees buyer’s payment to sellers. It is issued by the banks and ensures timely and full payment to retailers.  If the buyer is unable to make such a payment, the bank covers the full or the remaining amount on behalf of the buyer.

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