The functions of a bank: Meaning, Objective Role, Structure of Banks in India

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Functions of Bank: In competitive exams, the topic ‘Functions of the Bank’ forms an important part of the question paper, and its knowledge is tested to score good marks. 

Especially, aspirants appearing for various bank exams such as IBPS Exam, SBI Exam, or RBI exam definitely experience questions related to important banking functions in the paper or at the time of interview. 

For other graduate-level government examinations such as the SSC exam, the questions related to bank functions are asked under the professional knowledge heading. Therefore, this article will walk you through important banking functions, their categories, and more.

Aspirants preparing for any competitive or government exams like Bank, SSC, Insurance, and Railway can check the following links for their preparation:

What Is a Bank?

A bank is a lawful organization that accepts deposits that can be withdrawn on demand. Banks are institutions that help the public in the management of their finances, public deposit their savings in banks with the certainty to withdraw money from the deposits whenever required.

Banks accept deposits from the general public and from the business community as well and give two assurances to the depositors –

  1. Safety of deposit
  2. Withdrawal of deposit, whenever needed

Banks give interest on deposits which adds to the original deposit amount and is a great incentive to the depositor. This promotes saving habits among the public. Bank also grants loans based on deposits thereby adding to the economic development of the country and the well-being of the general public. With this stature, it becomes important to understand the major functions of a bank. 

Candidates can check the important Banking Abbreviations in the linked article.

Important Functions of Bank

There are two types of functions of banks:

  1. Primary functions – being primary are also called banking functions.
  2. Secondary Functions

Both the types of functions of a bank are explained below in detail:

Primary Functions of Bank

All banks have to perform two major primary functions namely:

  1. Accepting of deposits
  2. Granting of loans and advances

Accepting of Deposits

A very basic yet important function of all the commercial banks is mobilizing public funds and providing safe custody of savings and interest on the savings to depositors. Bank accepts different types of deposits from the public such as:

  1. Saving Deposits:  encourages saving habits among the public. It is suitable for salary and wage earners. The rate of interest is low. There is no restriction on the number and amount of withdrawals. The account for saving deposits can be opened in a single name or in joint names. The depositors just need to maintain a minimum balance which varies across different banks. Also, Bank provides an ATM cum debit card, checkbook, and Internet banking facility. Candidates can know about the Types of Cheques on the linked page.
  2. Fixed Deposits: Also known as Term Deposits. Money is deposited for a fixed tenure. No withdrawal of money during this period is allowed. In case depositors withdraw before maturity, banks levy a penalty for premature withdrawal. As a lump-sum amount is paid at one time for a specific period, the rate of interest is high but varies with the period of deposit.
  3. Current Deposits: They are opened by businessmen. The account holders get an overdraft facility on this account. These deposits act as short-term loans to meet urgent needs. Bank charges a high-interest rate along with the charges for overdraft facility in order to maintain a reserve for unknown demands for the overdraft.
  4. Recurring Deposits: A certain sum of money is deposited in the bank at a regular interval. Money can be withdrawn only after the expiry of a certain period. A higher rate of interest is paid on recurring deposits as it provides the benefit of compounded rate of interest and enables depositors to collect a big sum of money. This type of account is operated by salaried persons and petty traders.

Granting of Loans & Advances

The deposits accepted from the public are utilized by the banks to advance loans to businesses and individuals to meet their uncertainties. Bank charges a higher rate of interest on loans and advances than what it pays on deposits. The difference between the lending interest rate and interest rate for deposits is bank profit.

Bank offers the following types of Loans and Advances:

  1. Bank Overdraft: This facility is for current account holders. It allows holders to withdraw money anytime more than available in bank balance but up to the provided limit. An overdraft facility is granted against collateral security. The interest for overdraft is paid only on the borrowed amount for the period for which the loan is taken.
  2. Cash Credits: a short-term loan facility up to a specific limit fixed in advance. Banks allow the customer to take a loan against a mortgage of certain property (tangible assets and/or guarantees). Cash credit is given to any type of account holder and also to those who do not have an account with a bank. Interest is charged on the amount withdrawn in excess of the limit. Through cash credit, a larger amount of loan is sanctioned than that of overdraft for a longer period.
  3. Loans: Banks lend money to the customer for short-term or medium periods of say 1 to 5 years against tangible assets. Nowadays, banks do lend money for the long term. The borrower repays the money either in a lump-sum amount or in the form of installments spread over a pre-decided time period. Bank charges interest on the actual amount of loan sanctioned, whether withdrawn or not. The interest rate is lower than overdrafts and cash credits facilities.
  4. Discounting the Bill of Exchange: It is a type of short-term loan, where the seller discounts the bill from the bank for some fees. The bank advances money by discounting or purchasing the bills of exchange. It pays the bill amount to the drawer(seller) on behalf of the drawee (buyer) by deducting the usual discount charges. On maturity, the bank presents the bill to the drawee or acceptor to collect the bill amount.

Secondary Functions of Bank

Like the Primary Functions of a Bank, the secondary functions are also classified into two parts:

  1. Agency functions
  2. Utility Functions

Agency Functions of Bank

Banks are the agents for their customers, hence it has to perform various agency functions as mentioned below:

Transfer of Funds: Transfering of funds from one branch/place to another. 

Periodic Collections: Collecting dividends, salary, pension, and similar periodic collections on the clients’ behalf. 

Periodic Payments: Making periodic payments of rents, electricity bills, etc on behalf of the client.

Collection of Cheques: Like collecting money from the bills of exchanges, the bank collects the money from the cheques through the clearing section of its customers.

Portfolio Management: Banks manage the portfolio of their clients. It undertakes the activity to purchase and sell the shares and debentures of the clients and debits or credits the account.

Other Agency Functions: Under this bank act as a representative of its clients for other institutions. It acts as an executor, trustee, administrator, adviser, etc. of the client.

Utility Functions of Bank

  • Issuing letters of credit, traveler’s cheques, etc.
  • Undertaking safe custody of valuables, important documents, and securities by providing safe deposit vaults or lockers.
  • Providing customers with facilities for foreign exchange dealings
  • Underwriting of shares and debentures
  • Dealing in foreign exchanges
  • Social Welfare programs
  • Project reports
  • Standing guarantee on behalf of its customers, etc.

Functions of Banks in India

 Functions of the World Bank:

At Present, the World Bank is playing an important role in providing loans for development works to member countries, especially to underdeveloped countries. The bank provides loans for various development projects of 5 to 20 years duration.

i. Bank can grant loans to members countries up to 20 % of its share in paid-up capital.

ii. Bank also provides loans to private investors belonging to the members on its own guarantee, but private investors need to take permission from their native country. Banks charge 1% to 2% as service charges.

iii. The quantum of loan service, interest rate, and terms, and conditions are decided by the World Bank itself.

iv.  Generally banks grant loans for a particular project duly submitted to the bank by the member country.

v. The debtor nation has to repay either in reserve currencies or in the currencies in which the loan was sanctioned.

Important Functions of RBI (Reserve Bank of India)

Being a central bank of India, RBI serves a critical role in regulating the financial transactions in the country. Some of the important functions of RBI are listed below:

  • Issue of Bank Notes
  • Banker to the Government
  • Custodian of the Cash Reserves of Commercial Banks
  • Custodian of country’s forex reserves
  • Lender of last resort
  • Controller of credit

Now let us discuss these RBI functions in detail:

The Issuer of Bank Notes

The most important function of RBI is the issuance of currency notes and coins, except the one rupee note and coin which are issued by the Ministry of Finance. All other notes bear the signature of the RBI Governor. However, the agency of distribution of all notes and coins issued by the Government of India is the Reserve Bank of India.

Banker to the Government

Another chief function of the RBI is that it takes care of the banking needs of the government, which includes maintaining & operating the deposit accounts of the government, collecting the receipts of funds, and making payments on behalf of the Government of India. It also represents the Indian Government, as a member of the International Monetary Fund and the World Bank.

Custodian of Cash Reserves of Commercial Banks

Commercial banks are required to maintain their cash reserves at a rate decided by the RBI in its monetary policy.

Custodian of Foreign Exchange Reserve

Another important function of the RBI is maintaining a reserve of foreign currencies that enables the RBI to deal with any crisis situation.

Lender of the Last Resort

Often regarded as the banker of banks, the RBI acts as a parent to all commercial banks in India. Thus, it becomes the lender of the last resort for all banks when they are in a crisis situation. RBI helps them by lending money, although at higher RoI, to sail through the tide of financial difficulties.

Controller of Credit

RBI controls the credit created by the commercial banks in India, in accordance with the economic priorities of the government of India. RBI uses quantitative and qualitative methods to control and regulate the flow of money in the market. These are implemented by announcing monetary policies at regular intervals. The monetary policy involves the management of interest rates and money supply. The central bank of India tweaks the money supply to achieve objectives such as liquidity, inflation, and consumption.

This is an extremely topic to prepare for because not only is it the exam conducting body for RBI Grade B Exam but also your potential employer. Hence, a thorough knowledge of the structure and functions of RBI will help you in understanding it better. Further, over the years, questions from the RBI functions, structure, or the latest announcements/ notifications/guidelines that RBI announces are asked in the exam.

According to the current trends, as many as 16% of the total questions from the Finance section are asked about RBI and monetary policy. Hence, do not skip the topic. Read it at length, as it is important for both Prelims and the Main exam.

If you’ve any difficulty in preparing for these topics, you can consider joining our detailed course on RBI Grade B Mains. We’re providing online classes, mock tests, and doubt-solving sessions to help you achieve your dreams.

Functions of Central Bank

The functions of a central bank can be discussed as follows:

1. Currency regulator or bank of issue

2. Bank to the government

3. Custodian of Cash reserves

4. Custodian of International currency

5. Lender of last resort

6. Clearinghouse for transfer and settlement

7. Controller of credit

8. Protecting depositor’s interests

The above-mentioned functions will be discussed in detail in the following lines.

Currency regulator or bank of issue: Central banks possess the exclusive right to manufacture notes in an economy. All the central banks across the world are involved in issuing notes to the economy.

This is one of the most important functions of the central bank in an economy and due to this, the central bank is also known as the bank of issue.

Earlier all the banks were allowed to publish their own notes which resulted in a disorganized economy. To avoid this situation the government around the world authorized the central banks to function as the issuer of currency, which resulted in uniformity in circulation and a balanced supply of money in the economy.

Bank to the government: One of the important functions of the central bank is to act as the bank of the government. The central bank accepts deposits and issues funds to the government. It is also involved in making and receiving payments from the government. Central banks also offer short-term loans to the government in order to recover from bad phases in the economy.

In addition to being the bank to the government, it acts as an advisor and agent of the government by providing advice to the government in areas of economic policy, capital market, money market, and loans from the government.

In addition to that, the central bank is instrumental in the formulation of monetary and fiscal policies that help in the regulation of money in the market and controlling inflation.

Custodian of Cash reserves: It is a practice of the commercial banks of a country to keep a part of their cash balances in the form of deposits with the central bank. The commercial banks can draw that balance when the requirement for cash is high and pay back the same when there is less requirement of cash.

It is for this reason that the central bank is regarded as the banker’s bank. The central bank also plays an important role in the credit creation policy of commercial banks.

Custodian of International currency: An important function of the central bank is to maintain a minimum balance of foreign currency. The purpose of maintaining such a balance is to manage sudden or emergency requirements of foreign reserves and also to overcome any adverse deficits in the balance of payments.

Lender of last resort: The central bank acts as a lender of last resort by providing money to its member banks in times of cash crunch. It performs this function by providing loans against securities, and treasury bills and also by rediscounting bills.

This is regarded as one of the most crucial functions of the central bank wherein it helps in protecting the financial structure of the economy from collapsing.

Clearinghouse for transfer and settlement: Central bank acts as a clearinghouse of the commercial banks and helps in settling the mutual indebtedness of the commercial banks. In a clearinghouse, the representatives of different banks meet and settle the inter-bank payments.

Controller of credit: Central banks also function as the controller of credit in the economy. It happens that commercial banks create a lot of credit in the economy that increasing inflation.

The central bank controls the way credit creation by commercial banks is done by engaging in open market operations or bringing about a change in the CRR to control the process of credit creation by commercial banks.

Protecting depositor’s interests: Central bank also needs to keep an eye on the functioning of the commercial banks in order to protect the interests of depositors.

Functions of Merchant Bank

Functions of Merchant Banks:

There are six functions of the merchant of banks

1) Portfolio management

2) Raising funds for client

3) Broker in the stock exchange

4) Managing Public Issue of Companies

5) Services to Public Sector Units

6) Money Market Operation

1)Portfolio Management:

Merchant banks provide consultancy services to institutional investors on investment decisions. They trade in exchange/securities on behalf of their clients and also manage their portfolios.

2)Raising funds for clients:

Merchant banks help their client/ business firm to raise capital from domestic and international market by issuing securities the capital raised by merchant banks help the business firm in the expansion of their business activities.

3)Broker in Stock Exchange:

Merchant banks act as brokers for their clients on the stock exchange.  They conduct research on equity shares for their client and also purchase and sell the share on their behalf of them. They also play the role of advisors for, example, they advise their client their clients about which shares to buy, when to buy, how much to buy and when to sell.

4)Managing Public Issue of Companies:

Merchant banks manage the public issue of companies. They provide the following services:

  • Merchant bank advice companies at the time of public issue
  • Merchant banks advise the size and price of public issue
  • Merchant bank helps companies in managing the process of application and allotment of securities
  • Merchant banks help companies at the time of filing IPO on the stock exchange
  • Merchant banks help in appointing underwriters and brokers at the time of issue.
  • Acting in the capacity of the manager to the issue

5)Services to Public Sector Units:

Merchant banks offer different services to public sector units. They provide the facilities to raise long-term capital, marketing of securities, and arrange long-term finance from term lending institutions.

6)Money Market Operation:

Merchant bankers deal with underwriters and also deal with short-term financial/stock market instruments, such as:

  1. Government Bonds.
  2. Commercial paper issued by large corporate firms.
  3. Treasury bills are issued by the Government.

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