Banking System in India

13th Aug, 2021

Functions of Bank

Primary Functions of Banks

The primary functions of a bank are also known as banking functions. They are the main functions of a bank.

These primary functions of banks are explained below.

  1. Accepting Deposits

The bank collects deposits from the public. These deposits can be of different types, such as:-

Saving Deposits

  • This type of deposits encourages saving habit among the public.
  • The rate of interest is low. At present it is about 4% p.a. Withdrawals of deposits are allowed subject to certain restrictions.
  • This account is suitable to salary and wage earners. This account can be opened in single name or in joint names.

Fixed Deposits

  • Lump sum amount is deposited at one time for a specific period. Higher rate of interest is paid, which varies with the period of deposit.
  • Withdrawals are not allowed before the expiry of the period. Those who have surplus funds go for fixed deposit.

Current Deposits

  • This type of account is operated by businessmen. Withdrawals are freely allowed. No interest is paid.
  • In fact, there are service charges. The account holders can get the benefit of overdraft facility.

Recurring Deposits

  • This type of account is operated by salaried persons and petty traders.
  • A certain sum of money is periodically deposited into the bank.
  • Withdrawals are permitted only after the expiry of certain period. A higher rate of interest is paid.

2. Granting of Loans and Advances

The bank advances loans to the business community and other members of the public. The rate charged is higher than what it pays on deposits. The difference in the interest rates (lending rate and the deposit rate) is its profit.

The types of bank loans and advances are:-

Secondary functions of the bank

In addition to the primary functions of accepting deposits and lending money, banks perform a number of other functions, which are called secondary functions. These are as follows:

  1. Issuing letters of credit, travelers cheque, etc.
  2. Undertaking safe custody of valuables, important document and securities by providing safe deposit vaults or lockers.
  3. Providing customers with facilities of foreign exchange dealings.
  4. Transferring money from one account to another; and from one branch to another branch of the bank through cheque, pay order, demand draft.
  5. Standing guarantee on behalf of its customers, for making payment for purchase of goods, machinery, vehicles etc.
  6. Collecting and supplying business information.
  7. Providing reports on the credit worthiness of customers.
  8. Providing consumer finance for individuals by way of loans on easy terms for purchase of consumer durables like televisions, refrigerators, etc.
  9. Educational loans to students at reasonable rate of interest for higher studies, especially for professional courses.

Types of Banks

  • There are various types of banks which operate in our country to meet the financial requirements of different categories of people engaged in agriculture, business, profession, etc.
  • On the basis of functions, the banking institutions in India may be divided into the following types:
Central Bank
  • A bank which is entrusted with the functions of guiding and regulating the banking system of a country is known as its Central bank.
  • Such a bank does not deal with the general public. It acts essentially as Government’s banker; maintain deposit accounts of all other banks and advances money to other banks, when needed.
  • The Central Bank provides guidance to other banks whenever they face any problem. It is therefore known as the banker’s bank.
  • The Reserve Bank of India is the central bank of our country. The Central Bank maintains record of Government revenue and expenditure under various heads.
  • It also advises the Government on monetary and credit policies and decides on the interest rates for bank deposits and bank loans.
  • In addition, foreign exchange rates are also determined by the central bank. Another important function of the Central Bank is the issuance of currency notes, regulating their circulation in the country by different methods. No other bank than the Central Bank can issue currency.
Commercial Banks
  • Commercial Banks are banking institutions that accept deposits and grant short-term loans and advances to their customers.
  • In addition to giving short-term loans, commercial banks also give medium-term and long-term loan to business enterprises.
  • Now-a-days some of the commercial banks are also providing housing loan on a long-term basis to individuals.

Types of Commercial banks

Commercial banks are of three types i.e., Public sector banks, Private sector banks and Foreign banks.

  1. Public Sector Banks: These are banks where majority stake is held by the Government of India or Reserve Bank of India. Examples of public sector banks are: State Bank of India, Corporation Bank, Bank of Boroda and Dena Bank, etc.
  2. Private Sectors Banks: In case of private sector banks majority of share capital of the bank is held by private individuals. These banks are registered as companies with limited liability. For example: The Jammu and Kashmir Bank Ltd., Bank of Rajasthan Ltd., Development Credit Bank Ltd, Vysya Bank, etc.
  3. Foreign Banks: These banks are registered and have their headquarters in a foreign country but operate their branches in our country. Some of the foreign banks operating in our country are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, etc. The number of foreign banks operating in our country has increased since the financial sector reforms of 1991.
Development Banks
  • Business often requires medium and long-term capital for purchase of machinery and equipment, for using latest technology, or for expansion and modernization.
  • Such financial assistance is provided by Development Banks.
  • They also undertake other development measures like subscribing to the shares and debentures issued by companies, in case of under subscription of the issue by the public.
  • Industrial Finance Corporation of India (IFCI) and State Financial Corporations (SFCs) are examples of development banks in India.
Co-operative Banks
  • People who come together to jointly serve their common interest often form a co-operative society under the Co-operative Societies Act.
  • When a co-operative society engages itself in banking business it is called a Co-operative Bank.
  • The society has to obtain a license from the Reserve Bank of India before starting banking business.
  • Any co-operative bank as a society is to function under the overall supervision of the Registrar, Co-operative Societies of the State.
  • As regards banking business, the society must follow the guidelines set and issued by the Reserve Bank of India.

Types of Co-operative Banks

There are three types of cooperative banks operating in our country. They are primary credit societies, central co-operative banks, and state co-operative banks. These banks are organized at three levels, village or town level, district level, and state level.

(i) Primary Credit Societies: These are formed at the village or town level with the borrower and non-borrower members residing in one locality. The operations of each society are restricted to a small area so that the members know each other and are able to watch over the activities of all members to prevent fraud.

(ii) Central Co-operative Banks: These banks operate at the district level having some of the primary credit societies belonging to the same district as their members. These banks provide loans to their members (i.e., primary credit societies) and function as a link between the primary credit societies and state cooperative banks.

(iii) State Co-operative Banks: These are the apex (highest level) cooperative banks in all the states of the country. They mobilize funds and help in its proper channelization among various sectors. The money reaches the individual borrowers from the state cooperative banks through the central cooperative banks and the primary credit societies.

Specialized Banks
  • There are some banks, which cater to the requirements and provide overall support for setting up business in specific areas of activity.
  • EXIM Bank, SIDBI and NABARD are examples of such banks.
  • They engage themselves in some specific area or activity and thus, are called specialized banks.
  1. Export Import Bank of India (EXIM Bank): If you want to set up a business for exporting products abroad or importing products from foreign countries for sale in our country, EXIM bank can provide you the required support and assistance. The bank grants loans to exporters and importers and also provides information about the international market. It gives guidance about the opportunities for export or import, the risks involved in it and the competition to be faced, etc.
  2. Small Industries Development Bank of India (SIDBI): If you want to establish a small-scale business unit or industry, loan on easy terms can be available through SIDBI. It also finances modernisation of small-scale industrial units, use of new technology and market activities. The aim and focus of SIDBI is to promote, finance and develop small-scale industries.
  3. National Bank for Agricultural and Rural Development (NABARD): It is a central or apex institution for financing agricultural and rural sectors. If a person is engaged in agriculture or other activities like handloom weaving, fishing, etc. NABARD can provide credit, both short-term and long-term, through regional rural banks. It provides financial assistance, especially, to co-operative credit, in the field of agriculture, small-scale industries, cottage and village industries handicrafts and allied economic activities in rural areas.

Reserve Bank of India

  • The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.
  • The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated.
  • Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India.
  • The Reserve Bank’s affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.
  • The directors are appointed/nominated for a period of four years.
  • RBI is a statutory body. It is responsible for printing of currency notes and managing the supply of money in the Indian economy.

Functions of Reserve Bank

Issue of Notes

  • The Reserve Bank has the monopoly for printing the currency notes in the country.
  • It has the sole right to issue currency notes of various denominations except one rupee note (which is issued by the Ministry of Finance).
  • The Reserve Bank has adopted the Minimum Reserve System for issuing/printing the currency notes.

Banker to the Government

  • The second important function of the Reserve Bank is to act as the Banker, Agent and Adviser to the Government of India and states.
  • It performs all the banking functions of the State and Central Government and it also tenders useful advice to the government on matters related to economic and monetary policy.
  • It also manages the public debt of the government.

Banker’s Bank

  • The Reserve Bank performs the same functions for the other commercial banks as the other banks ordinarily perform for their customers.
  • RBI lends money to all the commercial banks of the country. 

Controller of the Credit

  • The RBI undertakes the responsibility of controlling credit created by the commercial banks.
  • RBI uses two methods to control the extra flow of money in the economy. These methods are quantitative and qualitative techniques to control and regulate the credit flow in the country. 
  • When RBI observes that the economy has sufficient money supply and it may cause inflationary situation in the country then it squeezes the money supply through its tight monetary policy and vice versa.

Custodian of Foreign Reserves

  • For the purpose of keeping the foreign exchange rates stable, the Reserve Bank buys and sells the foreign currencies and also protects the country’s foreign exchange funds.
  • RBI sells the foreign currency in the foreign exchange market when its supply decreases in the economy and vice-versa. Currently India has Foreign Exchange Reserve of around US$ 390bn.

Other Functions

  • The Reserve Bank performs a number of other developmental works.
  • These works include the function of clearing house arranging credit for agriculture (which has been transferred to NABARD) collecting and publishing the economic data, buying and selling of Government securities (gilt edge, treasury bills etc)and trade bills, giving loans to the Government buying and selling of valuable commodities etc.
  • It also acts as the representative of Government in International Monetary Fund (I.M.F.) and represents the membership of India.

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