Chapter-6: Banking
BANK AND BANKING
Bank is an institution which receives funds from the public and gives loans and advances to those who need them. The supply of money in a country depends on the banking system as a whole and the monetary policy of the Central Bank in general.
Banking implies accepting deposits of money from the public for the purpose of lending or investment which is repayable on demand and can be withdrawn by means of cheques, etc.
NON-BANKING FINANCIAL INSTITUTIONS (NBFI)
If an institution does not receive deposits but only lends money, it will not be a bank, it will be a money lending institutions. E.g. LIC, UTI, etc.
If an institution only accepts deposits but does not perform lending, it will not be a bank, it will be a money accepting institution. E.g. Post office. These institutions are known as Non-banking Financial institutions (NBFI).
COMMERCIAL BANKS
Commercial banks are the financial institution that accept deposits from the public and lend out this money (loan) to consumers and investors with an objective to earn profits.
The rate of interest offered by the bank to deposit holders is called the borrowing rate and the rate at which banks lend out their reserve to investors is called the lending rate. The difference between the two rates, called spread, is the profit that is appropriated by the banks.
FUNCTIONS OF COMMERCIAL BANKS
The commercial banks perform two primary functions:
- Accepting Deposits
The main function of the commercial banks is to accept deposits from the public. These deposits may be in the form of:
- Demand deposits or current account deposits
These deposits are repayable by the banks on demand through the means of a cheque. Banks do not pay any interest on these deposits. Also there are no restrictions on the number of transactions in these deposits. Banks impose service charges on these deposits.
- Savings deposit
A person can open a savings deposit account by depositing a small sum of money. He can withdraw money from his account and make additional deposits at will, but there are certain restrictions on the number of withdrawals. A nominal rate of interest is payable on there deposits.
- Fixed deposit
Repayable after the expiry of the specified period which may range from 6 months to 5 years. Deposits for more than one year are known as ‘term deposit’. These deposits are not repayable on demand and carry a high rate of interest.
- Recurring deposits
The aim of recurring deposits is to inculcate the habit of regular savings by the people. A person can deposit a fixed amount, say Rs. 500 per month for a fixed period. The amount together with interest is paid on maturity. The rate of interest is higher than what is offered on saving deposit.
- Lending Money
The money collected by the commercial banks in the form of various deposits is landed to businessmen, farmers and others. Landing money may take the form of:
- Overdraft: Under this arrangement, a customer having a current account t is allowed to withdraw more than what he has deposited. Interest is charged on the amount actually overdraw during the period.
- Cash credit: Under this arrangement, the bank advances cash loan upto a specified limit against current assets and other securities. The bank opens an account in the name of the borrower and allows him to withdraw the borrowed and allowed money from time. Interest is charged on the amount withdrawn and not on the sanctioned amount.
- Loans and advances: A loan is a lump sum advance repayable on the expiry of the specified period. It may be secured or unsecured. Interest is charged on the whole amount sanctioned. The bank may allow the borrower to repay the loan in a lumpsum or in instalments.
- Discounting of bill of exchange: Under this system, a customer can get the amount of a bill receivable from the bank before the date of maturity. The bank deducts discount charges from the gross amount. On the date of maturity, the bank gets the amount from the acceptor of the bill.