Commercial Banking

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 Functions and Responsibilities of
CB
Setting
Lending
reserve Providing Acting Controlling
money
Issuing requirements for as Supervising the
to
currency and check fiscal banks money
financial
holding collection agent supply
institutions
reserves

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 Two characteristics:
– Banks can create money through lending
– Banks are vulnerable to “panics” or “runs.”

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 Functions of Commercial Banks

Primary functions:

The primary functions of a commercial bank include:

a) accepting deposits

b) granting loans and advances

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Modes of short-term financial assistance

Cash Credit

Cash credit is an arrangement whereby the bank allows the

borrower to draw amounts up to a specified limit.

Interest is charged on the amount actually withdrawn.

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 Overdraft

A customer who has a current account with the bank is allowed to

withdraw more than the amount of credit balance in his account.

It is a temporary arrangement. Overdraft facility with a specified limit

is allowed either on the security of assets, or on personal security, or
both.

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Discounting of Bills

Banks provide short-term finance by discounting bills, that is, making

payment of the amount before the due date of the bills after deducting
a certain rate of discount.

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 Different modes of Acceptance of Deposits

i) Current deposit
ii) Saving deposit
iii) Fixed deposit
iv) Recurring deposit
v) Miscellaneous deposits

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Current Deposit

Also called „demand deposit‟, current deposit can be withdrawn by the

depositor at any time by cheques. Businessmen generally open current
accounts with banks. Current accounts do not carry any interest as the
amount deposited in these accounts is repayable on demand without
any restriction.

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 Savings deposit/Savings Bank Accounts

Savings deposit account is meant for individuals who wish to deposit

small amounts out of their current income. It helps in safe guarding
their future and also earning interest on the savings. A saving account
can be opened with or without cheque book facility. There are
restrictions on the withdrawals from this account.

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 Fixed deposit

The term „Fixed deposit‟ means deposit repayable after the expiry of
a specified period. Since it is repayable only after a fixed period of
time, which is to be determined at the time of opening of the
account, it is also known as time deposit.

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Recurring Deposits
Recurring Deposits are gaining wide popularity these days. Under this
type of deposit, the depositor is required to deposit a fixed amount of
money every month for a specific period of time. Each installment may
vary from Rs.5/- to Rs.500/- or more per month and the period of
account may vary from 12 months to 10 years. After the completion of
the specified period, the customer gets back all his deposits along with
the cumulative interest accrued on the deposits.

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Agency and General Utility Services provided by
Modern Commercial Banks

i) Agency Services
Agency services are those services which are rendered by commercial
banks as agents of their customers. They include :
a) Collection and payment of cheques and bills on behalf of the
customers;
b) Collection of dividends, interest and rent, etc. on behalf of
customers, if so instructed by them;
c) Purchase and sale of shares and securities on behalf of customers;

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d) Payment of rent, interest, insurance premium, subscriptions etc.
on behalf of customers, if so instructed;
e) Acting as a trustee or executor;
f) Acting as agents or correspondents on behalf of customers for
other banks and financial institutions at home and abroad.

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General utility services
General utility services are those services which are rendered by
commercial banks not only to the customers but also to the general
public. These are available to the public on payment of a fee or charge.
They include :
a) Issuing letters of credit and travellers‟ cheques;
b) Underwriting of shares, debentures, etc.;
c) Safe-keeping of valuables in safe deposit locker;
d) Underwriting loans floated by government and public bodies.

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e) Supplying trade information and statistical data useful to
customers;
f) Acting as a referee regarding the financial status of customers;
g) Undertaking foreign exchange business.

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 Overseas Operations
Overseas operations can be structured in a number of ways. The
following are in order of commitment:

1. Correspondent Banking – lowest possible level of exposure

to the foreign market involving using a native bank in the
foreign market to provide services for the foreign bank.
2. Representative Office – the foreign bank establishes a
physical presence in the foreign market offering a limited
range of services. Officers troll for business opportunities but
cannot accept deposits or lend funds on its own books.
3. Agency – an integral part of the parent bank but cannot
perform all of the functions of a branch.
 1. Branch Office – is an integral part of the parent bank and
acts as a legal and functional arm of the head office. Branches
may perform all banking functions that are permitted by the
host country.
2. Subsidiary – separate legal entity from the parent, thereby
isolating liability within the subsidiary itself. It must be
separately capitalized, and if it is not deposit-taking, the cost
of capital in the foreign market can be considerable.
3. Consortium Banks – a group of banks that form an alliance
to enter a new market.

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 A Single Commercial Bank

 Transaction 1: Creating a bank

 Transaction 2: Acquiring property and
equipment
 Transaction 3: Accepting deposits

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 A Single Commercial Bank

Creating a bank
Balance sheet 1
Assets Liabilities & net worth
Cash $250,000 Stock shares $250,000

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 A Single Commercial Bank

Acquiring property & equipment

Balance sheet 2
Assets Liabilities & net worth
Cash $10,000 Stock shares $250,000
Property $240,000

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 A Single Commercial Bank

Accepting deposits
Balance sheet 3
Assets Liabilities & net worth
Checkable
Cash $110,000 $100,000
deposits

Property $240,000 Stock shares $250,000

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 A Single Commercial Bank

 Transaction 4: Depositing reserves in a

Federal Reserve bank
– Required reserve
– Excess reserve
Transaction 5: Clearing a check drawn
against the bank
 Transaction 6: Granting a loan (creating
money)
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 A Single Commercial Bank

Depositing reserves in
a Federal Reserve bank
Balance sheet 4
Assets Liabilities & net worth
Cash $0 Checkable
$100,000
Reserves $110,000 deposits
Property $240,000 Stock shares $250,000

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 A Single Commercial Bank

Clearing a check
drawn against the bank
Balance sheet 5
Assets Liabilities & net worth
Cash $0 Checkable
$50,000
Reserves $60,000 deposits
Property $240,000 Stock shares $250,000

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 A Single Commercial Bank

Granting a loan (Creating money) –

When a loan is negotiated
Balance sheet 6a
Assets Liabilities & net worth
Reserves $60,000 Checkable
$100,000
Loans $50,000 deposits
Property $240,000 Stock shares $250,000

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 A Single Commercial Bank

Granting a loan (Creating money) –

After a check is drawn on the loan
Balance sheet 6b
Assets Liabilities & net worth
Reserves $10,000 Checkable
$50,000
Loans $50,000 deposits
Property $240,000 Stock shares $250,000

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 The Banking System:
Multiple Deposit Expansion
 Assumptions:
– Reserve ratio = 20%
– Banks are “loaned up,” i.e. they keep no
excess reserves
– The single borrower will write a check for the
entire amount and give it to someone else
who will deposit the check to another bank

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 The Banking System:
Multiple Deposit Expansion
Acquired Required Amount Bank
Reserves Reserves Excess
Can Lend = Loans
&
(RR) Reserves
Bank Deposits = New
(ER)
(CD) rr = 20% Money Created
(1) (2) = (1)x.2 (3) = (1)-(2) (4) = (3)
A $100.00 $20.00 $80.00 $80.00

B $80.00 $16.00 $64.00 $64.00

C $64.00 $12.80 $51.20 $51.20

… … … … …

All banks $500.00 $100.00 $400.00 $400.00

Monetary multiplier (mm) = 1 / rr = 5

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 The Banking System:
Multiple Deposit Expansion

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 The Banking System:
Multiple Deposit Expansion
 The banking system‟s lending potential
– Loans = ER x mm = CD x (1 – rr) x mm
 The monetary multiplier
– mm = 1 / rr
 Reversibility: the multiple destruction of
money
– Money is created when banks make loans
– Money is “destroyed” when loans are paid off

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