Functions of Banks: Banks play a vital role in the economic development of a country. They act as a link between people who have surplus money and those who need funds for business, investment, consumption, or other financial requirements. The functions of banks can broadly be divided into primary functions and secondary functions.
The primary functions of banks mainly include accepting deposits and granting loans and advances. Secondary functions include services such as fund transfers, cheque collection, locker facilities, foreign exchange services, portfolio management, and underwriting.
Understanding the primary and secondary functions of banks is important for students preparing for competitive examinations such as SSC, Banking exams, IBPS, SBI, RRB, Railway, UPSC and other government exams.
Primary Functions of Banks
The two major primary functions of commercial banks are accepting deposits and granting loans and advances.
1. Accepting Deposits
Accepting deposits is one of the most important functions of a bank. Banks mobilize savings from the public and provide a safe place for people to keep their money. In return, banks generally pay interest on eligible deposit accounts.
The major types of bank deposits include savings deposits, fixed deposits, current accounts and recurring deposits.
(I). Savings Deposit
A savings deposit account is designed mainly for individuals who want to save money for future needs and financial uncertainties. Banks usually provide facilities such as cheque books, ATM or debit cards and internet banking with savings accounts.
A minimum balance may be required depending on the type of account and the bank’s applicable rules. Savings accounts generally provide interest on the deposited amount.
(II). Fixed Deposit or Term Deposit
A Fixed Deposit (FD), also known as a Term Deposit, allows a customer to deposit money with a bank for a predetermined period.
The depositor agrees to keep the money with the bank until the maturity date in return for interest. The deposit documentation generally contains important details such as the depositor’s name, deposit amount, tenure and maturity information.
In many cases, premature withdrawal is permitted subject to the bank’s terms and applicable penalty or reduced interest. Fixed deposits are commonly preferred by people looking for relatively predictable returns and a defined investment period.
(III). Current Account
A current account is generally used by businesses, traders and other customers who make frequent financial transactions. Unlike a typical savings account, the primary purpose of a current account is transaction convenience rather than earning interest.
Banks may provide an overdraft facility to eligible current account holders. Under an overdraft, the customer can withdraw more money than the available account balance, up to an approved limit. Interest is generally charged on the amount actually utilized and for the applicable period.
(IV). Recurring Deposit
A Recurring Deposit (RD) allows customers to deposit a fixed amount regularly, usually every month, for a predetermined period.
The major advantage of a recurring deposit is that it encourages regular saving and helps a depositor accumulate a larger amount over time. Interest is paid according to the bank’s applicable recurring deposit terms.
2. Granting Loans and Advances
Another major primary function of banks is providing loans and advances to individuals, businesses and other eligible borrowers. Banks lend money for purposes such as working capital, education, housing, business expansion, consumption and investment.
Major forms of bank credit include cash credit, overdraft, loans and bill discounting.
(I). Cash Credit
Cash credit is generally a short-term credit facility provided to eligible customers, particularly businesses, to meet working-capital requirements.
The bank sanctions a credit limit based on factors such as the borrower’s financial position, security and creditworthiness. The borrower can utilize funds within the sanctioned limit according to the terms of the facility.
(II). Bank Overdraft
A bank overdraft is a credit facility under which an eligible current account holder can withdraw funds beyond the available account balance, subject to an approved limit.
The customer generally pays interest on the amount actually utilized rather than the entire sanctioned limit. Overdraft facilities can help businesses manage temporary cash-flow shortages.
(III). Loans
Banks provide different types of short-term and long-term loans to meet the financial requirements of individuals and organizations.
Depending on the type of loan, borrowers repay the amount through installments along with applicable interest and other charges. Examples include personal loans, housing loans, education loans, vehicle loans and business loans.
(IV). Discounting of Bills
Bill discounting is an important banking service used in business transactions. When a seller sells goods or services on credit, the buyer may agree to make payment after a specified period.
Instead of waiting until the due date, the seller may approach a bank to discount the bill. The bank provides funds to the seller after deducting applicable charges or discount. The bank then receives payment from the drawee when the bill becomes due, subject to the terms of the arrangement.
Thus, bill discounting provides short-term finance and can help businesses maintain working capital and cash flow.
Secondary Functions of Banks
Apart from their primary functions, banks provide several additional services to customers. These are generally referred to as the secondary functions of banks.
1. Funds Transfer
Banks provide facilities for transferring money from one account or location to another. Modern banking systems allow customers to transfer funds through digital banking channels as well as traditional banking methods.
2. Cheque Collection
Banks collect cheques deposited by customers and process them through the banking system. This service makes it easier for customers to receive payments without directly collecting cash from the payer.
3. Periodic Payments and Collection
Banks can assist customers in making regular payments such as utility bills, loan installments and other scheduled payments. They may also facilitate the collection of recurring receipts, subject to the available banking facility.
4. Portfolio Management
Banks may provide portfolio management and investment-related services to eligible customers. These services can involve managing investments according to the customer’s financial objectives, risk profile and applicable regulations.
5. Locker Facility
A bank locker facility allows customers to keep valuable documents, jewellery and other permitted items in a secure locker at a bank branch. Customers pay applicable rent and follow the bank’s terms and conditions for using the facility.
6. Underwriting of Shares
Banks and financial institutions may provide underwriting services in connection with the issue of securities. Underwriting provides assurance, subject to the applicable agreement and regulations, that a specified portion of an issue will be subscribed if the public subscription is insufficient.
7. Dealing in Foreign Exchange
Banks facilitate foreign exchange transactions, enabling customers and businesses to buy or sell foreign currencies for permitted purposes. Foreign exchange services are particularly important for international trade, travel and cross-border transactions.
8. Project Reports
Banks may assist customers and businesses with financial information and project-related services. Project reports can help evaluate the financial feasibility, investment requirements, expected returns and repayment capacity of a proposed project.
9. Social Welfare Programmes
Banks also participate in various social welfare and financial inclusion programmes. They help implement government-supported financial schemes, promote access to banking services and extend financial services to underserved sections of society.
Primary vs Secondary Functions of Banks
The key difference is that primary functions are the core banking activities, particularly accepting deposits and providing loans and advances. Secondary functions are additional agency and general utility services offered by banks to provide greater convenience and support to customers.
For competitive exams, remember the basic classification:
Primary Functions
- Accepting deposits
- Granting loans and advances
Secondary Functions
- Funds transfer
- Cheque collection
- Periodic payments and collections
- Portfolio management
- Locker facility
- Underwriting
- Foreign exchange services
- Project-related services
- Social welfare programmes
Banks are essential institutions in a modern economy. By accepting deposits, banks mobilize savings, while through loans and advances, they make funds available to individuals, businesses and other sectors of the economy. Their secondary functions further expand the range of financial services available to customers.
For students preparing for banking and competitive examinations, understanding the difference between primary functions and secondary functions of banks is especially important because questions on bank deposits, loans, overdrafts, cash credit, bill discounting and banking services frequently appear in examination syllabus.