An Introduction to Banking Function – GK Notes

Photo of author

8 Minutes Read

An Introduction to Banking Function for the aspirants preparing for bank job such as SBI PO, SBI Clark, IBPS, etc.

What is a Bank? A bank is a type of financial institution that raises funds from the public and loans to entrepreneurs to assist them in making investments. Furthermore, the bank is responsible for international transactions. Banks are the principal economic driving force of a country in the current capitalist economic system. It plays a huge part in maintaining the country’s and the world’s economic operations lively and effective. Banking has been defined in the Banking Regulation Act 1949 (BR Act) as “Accepting for the purpose of lending or investment, deposits from the public, repayable on demand or otherwise withdrawable by cheque/draft/order or otherwise.

The Reserve Bank of India issues licenses to banks in India. The BR Act specifies which activities a bank is allowed to engage in. Banks are prohibited from trading in products, either directly or indirectly, and from holding immovable properties (other than for their own use) for more than seven years from the date of acquisition.

What are the ancillary services a bank provides?

  1. Safe custody/safe deposit locker,
  2. Purchase/sale of government securities,
  3. Credit/debit cards
  4. RTGS/NEFT/ECS, etc. which are the money transfer services
  5. Taxes collection
  6. Merchant Banking engagement
  7. Foreign Exchange services
  8. Mutual Funds
  9. ETF
  10. Wealth management

The last 3 are the third-party services that an Indian bank may offer to the public. With these, the Indian banks also provide some technology-based services such as Net Banking, Mobile Banking, Core Banking ATM, etc.

Retail banking is defined as the provision of services to individuals with a variety of banking needs. It can also refer to a division or service of a bank dealing with individual clients. Banks provide retail products such as various deposits, credit cards. Retail banking also offers various types of loans such as housing loans Car loans Education loans Personal loans Agriculture loans, etc., Credit cards, services such as Safe Deposit Lockers, Demat Accounts, RTGS, NEFT, ECS, Bancassurance, and so on under this category.

This entails serving the needs of industrial and commercial institutions, such as large corporations and trading houses. Commercial banking/corporate banking was the old name for this industry. There are two types of services under Wholesale Banking. These are Fund Based Services and Non-fund-based services. Fund-based services like Working Capital Finance, term loan finance, structured finance, and Export Credit. Non-fund-based services like Bank guarantees, Letters of credit, and Discounting/Collection of invoices and documents, etc. Value-added services like RTGS, Cash Management Services, Loan Syndication, and others are also available.

International Banking: This includes services such as imports, exports, remittances, bank guarantees, letters of credit, and other foreign currency transactions.

Functions of Bank

There are two types of banking functions: Primary Function and Secondary function.

Primary function of Bank:

Accepting Deposits: Deposits are collected by the Bank. These deposits may be of several kinds, for example:-

Saving Deposits: The amount and rate of interest in a savings account are both low. Withdrawals are permitted, but only in a specific number of cases. The account is designed for people who desire to put money aside from their salary and other sources of income.

Fixed Deposits/Term Deposits: Money is deposited for a specified period of time. During this time, no money can be taken out. Banks charge a penalty for premature withdrawals if depositors withdraw before the maturity date. The rate of interest is high since a lump-sum payment is made at once for a specific period, but it fluctuates depending on the deposit period.

Current Deposits: In contrast, the bank does not provide interest on the current account or deposit, and the customer can withdraw or deposit as many times as they want. Businessmen open this type of bank account. These deposits might be used as a short-term loan to cover unexpected expenses.

Recurring Deposits: Depositors deposit a set amount of money on a regular basis in this sort of account. The advantage of a recurrent account is that it offers compounded interest and allows depositors to accumulate large sums of money. Money can only be withdrawn when a set period of time has occurred. Salaried people and small business owners use this kind of account.

Granting Loans and advances

People are given money by the bank on a time-interest basis. The bank approves each loan amount after careful examination and to ensure the bank’s profit. Customers can also get cash advances from the bank. These are also the banks’ fundamental functions.

Giving Loans: But it is not the complete story about the functions of a bank to receive deposits. How could a bank pay interest if it were so? Therefore, a bank invests or loans it after collecting money through deposits. Money is normally only lent for short periods to businessmen and traders. The bank must be prepared to satisfy the demands of the depositors who placed money for brief periods.

Bank Overdraft: This service is only available to current account holders. It permits holders to withdraw money up to the specified limit, regardless of how much money is available in their bank account. An overdraft is issued in exchange for collateral security. The interest on an overdraft is only paid on the amount borrowed for the duration of the loan.

Discounting bills: In a typical day-to-day business, sellers send invoices to buyers whenever they sell their items, and the bill specifies that payment must be made within a certain amount of time. In such circumstances, the vendor may offer a discount on the bank bill in exchange for some expenses. In this case, bill discounting functions act as a short-term loan. If there is a buyer or the drawer defaults, the bank will return the bill to the seller so that he can pursue legal action against the drawer or buyer.

Cash Credits: Another way that banks lend is through cash credit. When a person applies for a bank loan, he must demonstrate his ability to repay the loan, the soundness of the endeavor, and his honesty of purpose to the bank manager. The bank may also demand tangible security or be happy with the borrower’s personal security.

Suggested Reading: Structure of Market & Banks – GK Notes

Secondary Functions Of The Bank

Agency Functions:

In the sense that it invests on behalf of its customers, the bank acts as an agent for them. As the customer’s agent, the bank can transfer cash, collect checks, make periodic payments, manage portfolios, make periodic collections, and perform a variety of other services. All of these functions are the bank’s secondary functions.

Utility Functions of Bank:

  • Issuing letters of credit, traveler’s checks, and other similar documents.
  • Providing safe deposit vaults or lockers for the safekeeping of essential documents, and securities.
  • Providing foreign exchange trading services to customers.
  • Shares and debentures underwriting.
  • Trading in foreign currencies.
  • Programs for social welfare.
  • Reports on projects.
  • On behalf of its consumers, it offers a standing guarantee.
Suggested Reading: RBI & Its Basic Functions – Banking [Notes GK]

Some Economic Functions of Banks:

Issue of money: Money is issued in the form of banknotes and current accounts that are subject to payment by check or at the customer’s request. In the case of banknotes, they can be effectively transferred by simply delivering them, or by drafting a cheque that the payee can deposit or cash.

Netting and settlement of payments – banks function as both collection and payment agents for customers, using interbank clearing and settlement systems to collect, present, receive, and pay payment instruments. Because inner and outbound payments cancel each other out, banks can save money on reserves kept for payment settlement.

Credit intermediation: As middlemen, credit intermediation banks borrow and lend on their own accounts.

Credit quality improvement: Banks offer money to both commercial and personal borrowers, improving credit quality. The improvement arises from the bank’s asset and capital diversification, which offers a cushion to absorb losses without defaulting on its obligations.

Maturity transformation: Banks are borrowing more on-demand debt and short-term debt, but they are also providing more long-term loans. Banks can do this by aggregating issues (such as accepting deposits and issuing banknotes) and redemptions (such as withdrawals and redemptions of banknotes), maintaining cash reserves, investing in marketable securities that can be converted to cash quickly if needed, and raising replacement funding as needed from various sources (e.g. wholesale cash markets and securities markets).

Money creation: In a fractional-reserve banking system, every time a bank makes a loan, a new amount of virtual money is created.