Tag: Banks

  • Marketing Risk Management in Banks Framework Types

    Marketing Risk Management in Banks Framework Types

    Marketing Risk Management in Banks with their Meaning, Framework, Types, and also Importance; Credit risk management has traditionally been a major challenge for banks. As deregulation progresses, the market risk becomes relatively more important due to adverse changes in market variables; such as interest rates, exchange rates, stock prices, and commodity prices. Even small changes in market variables result in significant changes in the income and economic value of banks.

    Here is the article to explain, Market Risk Management in Banks Meaning and Definition with Marketing Framework, their Types, and also Importance.

    Market risk can define as the possibility of a bank losing money due to changes in market variables. There is a risk that the value of off-balance sheet positions will affect by movements in the stock market and interest rates, exchange rates, and commodity prices.

    Market risk is the risk to bank profits and capital due to changes in market rates of interest rates or prices of securities, currencies, and stocks as well as the volatility of these prices. Market risk management offers a comprehensive and dynamic framework for measuring, monitoring, and controlling a bank’s liquidity, interest rate, currency, and equity, as well as commodity price risk, which should tightly integrate into the bank’s business strategy.

    Scenario analysis and stress tests are other tools for assessing potential problem areas in a portfolio. Identify future changes in economic conditions such as;

    • Economic/industrial turnover.
    • Market risk events.
    • Liquidity conditions.

    What can affect a bank’s portfolio is a precedent for stress testing. As the underlying assumptions change over time, test results should review periodically. Market risk arises from dynamics of market forces, which for the banking sector can include interest rate fluctuations, maturity discrepancies, exchange rate fluctuations, market competition for services and products, changes in customer preferences and requirements leading to product aging, together with changing scenarios. national and international politics and economy. These risks are like maritime hazards that can arise from any change occurring anywhere at the national and international levels.

    What is the meaning and definition of marketing risk management?

    Market risk includes the risk of financial loss due to market price movements. Market risk assessed based on, but not limited to, the following valuation factors:

    The sensitivity of a financial institution’s earnings or the economic value of its capital to adverse changes in interest rates, exchange rates, commodity, or stock prices. Management’s ability to identify, measure, monitor, and control marketing risk exposure by considering the size, complexity, and risk profile, and loss of the institution.

    The nature and complexity of interest rate risk in banking arising from non-trading positions. Where applicable, the type and complexity of market risk positions from international trade and transactions. This topic also contains specific guidelines on interest rate risk, i. H exposure of the bank’s current and future profits and capital to adverse interest rate movements, and capital market rules, regulatory capital requirements for bank holding companies, and members of government-owned banks that are significantly exposed to certain market risks.

    Marketing Risk Management Framework;

    Successful marketing initiatives require a disciplined approach that aligns objectives with management practices and tools for developing expectations, budgeting costs, and monitoring key activities. Following the traditional marketing process of strategy development, marketing planning, implementation, and evaluation, a multi-level platform of business goals, performance indicators, risk factors, and control factors should develop. These development stages should consist of the following factors:

    • Business Goals: Leadership goals for companies that drive marketing Key Performance Indicators (KPIs)
    • KPIs: Marketing metrics that track how marketing meets its needs for business objectives. They are usually market-oriented/focused and results-oriented. This KPI provides a Key Risk Indicator (KRI)
    • KRIs: They focus on the company’s business and are usually based on information (changes in customer preferences, behavior, and demands), strategic (poor strategy validation and prioritization), and operations (inefficient people, processes, and technology). KRIs are obstacles to getting good results in KPI marketing. They anticipate hazards and allow organizations to decide what needs to reduce them. KRIs usually flow into the development of Key Control Indicators (KCI).
    • KCI: They relate to management and help manage processes to achieve goals. They serve to ensure that the company does not reach the risk indicators; KCI are the resources, controls, and mitigation factors for managing risk.

    This platform combines marketing strategy with multifunctional implementation in the company. Level indicators reflect cascading top management goals with the day-to-day management of marketing programs and support for operational activities.

    Changes in marketing costs;

    For example, a credit card company looking to align its product message with the small business owner’s business needs requires a scalable marketing cost approach to managing the risks of this major change. They developed a system of indicators for key performance indicators (with a strong focus on business operations) and complemented them with risk and control indicators at the departmental level to enable rapid evaluation and adjustment of important additional procedures.

    Marketing costs control very carefully against these key figures, as distribution only increases when the measures show increased efficiency. The company was able to redistribute 100 percent of its costs to on-demand programs within 15 months and increase its average return on marketing costs by 30 percent.

    We repeat the process;

    This framework is a continuous cycle in which control, risk, and effectiveness indicators dynamically reassess, and information, strategy, and operations then adjust and improve. It designs to address the unique challenge of allocating marketing resources in a multifunctional environment where marketing has significant responsibility but the limited authority to achieve increased revenue and profitability.

    The dynamics of marketing risk management require methodologies and a set of tools that can facilitate rapid decision making and corrective action to produce successful results. However, marketing management must meet the requirements of this approach through timely decisions and adjustments in the allocation of marketing resources.

    Types of marketing risk;

    Today’s marketing environment is changing dramatically. To stay ahead of the game, you need to implement marketing techniques and strategies that take into account the risks of today’s business. Here are some of them:

    Product Brand risk;

    Any company can lose its brand value. This can be due to strong competition or poor marketing. If you overestimate the power of your brand, you may be using the wrong marketing techniques. It may be too late by the time you realize that you need to increase your efforts or expend more resources on promoting your brand.

    Incorrect calculation of your target market;

    Failure to do extensive market research, collect data in the wrong places, and misuse data can jeopardize your marketing plans. If you don’t understand your market, you can create strategies that will target the wrong people or get the wrong picture of your selling product. To create a marketing message that your target audience will love, make sure you do thorough research first.

    In today’s digital world, marketing trends change every day. When your marketing strategy is out of date, your business is at risk. Always keep an eye on the latest promotional messages in your niche, price changes, automation technology, and keep a check on what your competitors are doing.

    Promotional or advertising risk;

    The way you promote your product will have a strong impact on the success of your marketing plan. If you use a poorly calculated approach, your efforts will fail. Fake, misleading, and exaggerating news can also harm your marketing efforts. You ensure that your advertising techniques are attractive, powerful, and effective and ensure that your advertising practices are ethical.

    The Importance of a Marketing Risk Management for Business Plan;

    Risk is the main reason for uncertainty in marketing. You may wonder whether your message is reaching its intended destination; whether potential customers are responding positively, or whether your brand is recognizable. A marketing risk management plan can help you limit this risk. That’s why such a plan is important:

    Risky tasks;

    The most important role of a marketing risk management plan is for you to identify and identify any bottlenecks that your marketing team may face. Knowing what you’re dealing with can help you make the right decisions to avoid threats or minimize negative impacts. With this knowledge, you will feel more confident in developing and implementing marketing strategies.

    Risk analysis;

    The risk management plan provides you with important information about the risks you intend to take during the planning phase and after the implementation of your marketing measures. By analyzing each potential risk; you can find out how likely it is, how big, and how often it can happen. You can then change your marketing strategy to meet any challenges that stand in your way. Therefore, analyzing all the risks before starting your marketing efforts will prepare you for success.

    Planning risk response and action;

    Most threats are unique and every challenge needs to mitigate differently. With a risk management plan, you can overcome any challenge by taking precautions beforehand. You can choose to address the underlying risk, remove the driver, reduce its severity, or avoid it altogether. Once you’ve established and realized that your desired marketing message isn’t generating potential customers; you can respond with more effective strategies.

    Product Risk monitoring;

    If you keep track of all threats, you are less likely to fall victim to them. You can predict when a threat will become a serious problem and take action to counter it. In today’s marketing landscape, we constantly face challenges. Your competitors may innovate better, your customer preferences may change, or sales may decline. A risk management plan helps you monitor new and existing challenges and prepare for most of them.

    Risk management is an important process that every company should incorporate into its business operations. Implementing a risk management plan into your marketing strategy can help you anticipate all challenges, prepare for them, and avoid them altogether.

    How can I influence the bank to manage marketing risk?

    Marketing risk affects banks in two ways:

    Marketing risk is the potential error or loss that can result from a marketing plan. To limit your risk when trying to sell a product, you must have a marketing risk management plan in place. A comprehensive risk mitigation system will help you anticipate, prepare for, avoid or overcome the challenges you will face.

    • Customer requirements change due to changing economic scenarios. Therefore, banks need to improve/modify their products to make them more comfortable for customers; otherwise, the aging of the products will shift customers to other banks thereby reducing the bank’s business and profits.
    • Macroeconomic changes in national and international political and economic scenarios have different effects on the elements of risk in different business activities. This aspect has become important in modern times due to the increasing integration of world markets.
    • Since both aspects are dynamic and change is the only constant; market risks must continuously monitor and appropriate strategies developed to keep these risks within manageable limits. Because you can only manage what you can measure, risk measurement always requires immediate attention.

    Market risk can define as the risk of loss on off-balance-sheet and off-balance sheet positions due to unfavorable developments in market variables.

    Marketing Risk Management in Indian Banks;

    Market risk management should be the main concern of top management in banks. The board should clearly articulate policies, market risk management procedures, supervisory risk limits, review mechanisms, and reporting and auditing systems. The guidelines should discuss bank risk in a consolidated manner and formulate a clear risk measurement system that covers all material sources of market risk and assesses their impact on the bank. Operational regulatory constraints and line management accountability should also clearly define. The Asset Liability Management Committee (ALCO) shall act as the highest operating unit for balance sheet management within the performance/risk parameters set by the board.

    Banks also need to establish an independent middle office to monitor the level of market risk in real-time. The middle office should consist of market risk management experts, economists, statisticians; and, general bankers and be functionally able to report directly to ALCO. The middle office must also be separate from the Ministry of Finance and not take part in the Ministry of Finance’s ongoing management (ALCO) regarding compliance with supervisory/risk parameters and summarize all assumptions of market risk position in banking.

    Marketing Risk Management in Banks Meaning Definition Framework Types Importance Image
    Marketing Risk Management in Banks Meaning Definition Framework Types Importance; Image by Credit Commerce from Pixabay.
  • Interest Rate Risk in Banking Principles Management

    Interest Rate Risk in Banking Principles Management

    Interest Rate Risk in Banking, the banks define their meaning, definition, principles, example, types with Management and Business Finance; The management should be an important part of market risk management in banks. In the past, regulatory restrictions have significantly reduced many risks in the banking system. However, deregulation of interest rates has exposed them to the negative effects of interest rate risk.

    Here is the article to explain, Interest Rate Risk Management in Banking Principles Business Finance

    Interest rate risk management in banking is a potential negative impact on net interest income and is related to the vulnerability of an institution’s financial position to changes in interest rates. Changes in interest rates affect income, assets, liabilities, off-balance sheet items, and cash flows. Therefore, the objectives of interest rate risk management are to maintain profitability; the ability to increase the capacity to bear losses and ensure adequate risk compensation received, and reach a compromise between return and risk.

    The significance or meaning of interest rate risk;

    What does mean interest rate risk? Interest rate risk is the potential investment loss caused by changes in interest rates. For example, if interest rates rise, the value of bonds or other fixed-income investments falls. The change in bond prices when interest rates change knows as duration. Interest rate risk can be reduced by holding bonds with different maturities; and, investors can also reduce interest rate risk by hedging fixed-income investments with interest rate swaps, options, or other interest rate derivatives.

    Interest rate risk management aims to record the risk of non-adherence to maturity and revaluation and is measured in terms of both profit and economic value. The bank’s net interest income (NII) or net interest margin (NIM) depends on the development of interest rates. Any difference in cash flows (fixed assets or liabilities) or revaluation dates (moving assets or liabilities) will make the NII or NIM of the bank fluctuate. Returns on assets and prices of liabilities are now closely related to the volatility of market interest rates.

    The profit perspective includes an analysis of the effect of changes in interest rates on fees or reported earnings shortly. This measure by measuring changes in Net Interest Income (NII); which is the difference between total interest income and total interest expense. The economic outlook includes an analysis of the expected cash flows from assets minus the expected cash flows from liabilities plus net cash flows or balance sheet items. The economic outlook determines the risk value of the difference in long-term interest rates.

    Determination or Definition of interest rate risk in banking;

    Interest rate risk defines as the risk of changes in asset value due to interest rate volatility. It makes the security in question uncompetitive or increases its value. Although risk should arise from an unexpected move, investors are generally concerned about reducing risk. This risk directly affects holders of fixed-income securities. If the interest rate rises, the price of fixed-income security falls and vice versa.

    It banking book describes the risk to bank capital, management; and, gains from adverse interest rate developments that affect positions in the banking book. Any changes in interest rates will affect the present value of the bank’s future cash flows. This affects the basic value of the bank’s assets, liabilities, and off-balance sheet. This causes a change in its economic value. When interest rates change, it affects the bank’s bottom line, as net interest income (NII) changes; which depends on interest-sensitive income and expenses.

    Interest rate risk is the potential that changes in overall interest rates will reduce the value of bonds or other fixed-income investments:

    • If interest rates rise, bond prices fall and vice versa. This means that the market price of existing bonds will fall to offset the prices of new, more attractive bonds.
    • Interest rate risk measure by the duration of fixed-income securities, with long-term bonds being more sensitive to price changes.
    • Interest rate risk can reduce by diversifying the terms of the bonds or hedging with interest rate derivatives.

    Understanding risk opportunities;

    The feedback between interest rates and bond prices can explain by the possibility of risk. By buying bonds, investors accept that if interest rates rise; they will relinquish the option to buy bonds with more attractive yields. When interest rates rise, the demand for existing bonds with lower yields decreases as new investment opportunities arise (for example, new bonds with higher yields issue). Although fluctuations in interest rates affect the prices of all bonds, the rate of change varies between bonds.

    Different bonds show different price sensitivity to interest rate fluctuations. It is therefore important to assess the duration of a bond when assessing interest rate risk. Bonds with shorter maturities usually involve lower interest rate risk than bonds with longer maturities. With longer-term bonds, interest rates are more likely to change. Therefore, they bear the risk of higher interest rate changes.

    The principle of interest rate risk in banking;

    The Basel Committee has established the following principles for measuring and managing interest rate risk. Part one below are;

    • Risks critical to all banks must specifically identified, measured, monitored, and controlled. In addition, banks must monitor and assess CSRBB (Credit Spread Risk in the banking book).
    • The governance body of each bank is responsible for overseeing the IT governance framework and the bank’s risk appetite for IRRB. Their monitoring and management may delegate by senior management, experts, or an asset-liability management committee. Banks must have an adequate IT governance framework, including periodic independent reviews and assessments of system effectiveness.
    • Bank’s risk appetite must formulate in terms of risk, both economic value, and profit. Banks should apply policy limits to keep their exposure in line with their risk appetite.
    • Your measurements should be based on the results of economic values ​​and income-based metrics derived from abroad and a precise set of interest rate shock and pressure scenarios.
    • When measuring IRRB, the most important behavioral and model assumptions should fully understand, conceptually justified and documented. These assumptions must rigorously examine and consistent with the bank’s business strategy.
    • The measurement systems and models used should be based on accurate data and subject to appropriate documentation, tests, and controls to ensure the accuracy of calculations. The model used to measure it must be comprehensive and covered by the management process to control the risk model, including a validation function that is independent of the development process.
    Part two below are;
    • The results of your hedging assessments and strategies should report regularly to the management body or its agents at the appropriate aggregation level (by consolidation level and currency).
    • Information on exposure levels and measurement and control practices should regularly disclose to the public.
    • Capital adequacy should specifically consider as part of the Authority’s Approved Capital Adequacy Assessment Process (ICAAP) in line with the bank’s risk appetite for IRRB.
    • Supervisors should regularly obtain sufficient information from banks to monitor trends in bank credit exposure, assess the soundness of bank governance, and identify additional banks that require review and/or additional regulatory capital.
    • Supervisors should regularly evaluate this and the effectiveness of the approach banks use to identify, measure, monitor, and control IRRB. Regulators should use dedicated resources to support such assessments. The supervisory authorities should cooperate and exchange information with the competent supervisory authorities in other jurisdictions regarding the supervision of banking exposures.
    • Supervisors should publish their criteria to further identify banks. Banks identified as having extraordinary value should consider as potential illegal IRRB holders. If a bank’s exposure review reveals inadequate management or excessive risk to capital, earnings, or overall risk profile, regulators should require measures to reduce risk and/or capital gain.

    How high is the detailed interest rate risk in banking?

    In detail Interest rate risk in banks the risk due to changes in market interest rates which can harm the bank’s financial position, management. Changes in interest rates have a direct impact on bank profits through a decrease in net interest income (NII). Ultimately, the potential long-term effects of changes in interest rates will have an impact on the underlying economic value of bank assets, liabilities, and off-balance sheet items. Interest rate risk seen from these two perspectives refers to as “Profit Outlook” or “Economic Value Outlook”.

    Simply put, a high percentage of fixed-income assets means that raising interest rates will not increase interest income (because interest rates fix), and lowering interest rates will not reduce interest income either. The low proportion of fixed assets has the opposite effect.

    For the classification of securities in the trading book, the bank has set guidelines for volume, minimum period, holding period, duration, stop loss, rating standards, etc. The interest rate sensitivity declaration makes by the bank. Regulatory restrictions have been imposed on gaps in total assets, income, or equity.

    Interest rates explain using examples;

    For example, a bank accepts 13% long-term deposits and uses a 17% down payment. If the market interest rate falls by 1%; it must decrease the down payment rate by 1%, because advances revalue every three months. However, it will not be able to reduce the fixed time deposit interest. This will reduce the bank’s net interest income by 1%.

    Or let’s say the bank has a 90-day deposit of 9% in a 12% annual bond. If the market interest rate rises by 1%, the bank must renew the deposit after 90 days at a higher interest rate. However, it still receives interest from the old bond interest rates. And in this case, net interest income fell by 1%.

    Examples of interest rate risk;

    Let’s understand interest rate risk using an example.

    If the investor has invested a certain amount in a fixed rate of interest, the bond will be at its current price; which offers a 5% coupon; and, if the interest rate then rises to 6%, the bond price will fall. This is because bonds offer a 5% interest rate while the market offers a 6% yield. If the investor wants to sell these bonds in the market, then the buyer will offer a lower amount for the bonds; because these bonds have low yields compared to the market. New investors will try to achieve a return similar to the market because the amount invested is lower.

    In other words, the opportunity cost of earning better returns elsewhere increases as interest rates increase. Therefore, this leads to a decrease in the price of the binding. There are several ways to counter interest rate risk. One can buy interest rate swaps, buy calls or place options on securities, or invest in negatively correlated securities to hedge risk.

    The effect of changes in interest rates on bonds;

    Changes in interest rates have different effects on bonds with different maturities. The correlation between interest rate movements and price movements increases with increasing maturity. Because if interest rates rise, bonds with longer maturities will suffer longer from lower interest rates than bonds with shorter maturities. For this reason, investing in bonds with different maturities use as a hedging technique to combat interest rate risk.

    Changes in interest rates affect coupon bonds and no-coupon bonds differently. If we look at two types of bonds with the same maturities; they will see a sharper decline in the price of a no-coupon bond compared to a coupon bond due to rising interest rates. This is because, with zero-coupon bonds, the full amount must receive at the end of the specified term and thus increases the effective duration; whereas with coupon bonds, returns generate periodically and thus the effective payment reduces the duration.

    Interest rate risk also affects by interest rates. Bonds with lower interest rates carry a higher interest rate risk than bonds with higher interest rates. This is because small changes in the market rate can easily overwhelm the lower rate and lower the bond’s market price.

    Types of interest rate risk in banking;

    The various following types of interest rate risk in banking identified below are:

    Price Risk:

    Price risk arises when an asset sale before a specified maturity. In financial markets, bond prices and yields are inversely related. Price risk closely ties to the trading book, which should benefit from short-term interest rate movements. Therefore, banks that have active trading portfolios should formulate guidelines for limiting portfolio size, holding period, duration, offset period, stop loss limit, market marking, etc. This is the risk of changes in the price of a security that could result in an unexpected gain or loss on the sale of the security.

    Reinvestment or Investment Risk:

    Uncertainty about the rate at which future cash flows can reinvest knows as reinvestment risk. Any difference in cash flow will expose the bank to fluctuations in NII because market interest rates move in different directions. This refers to the risk of changes in interest rates that could lead to a lack of ability to reinvest at current interest rates. Also, It divides into 2 parts.

    • Duration of risk; This refers to the risk that arises from the possibility that you will not want to repay or extend an investment early after a predetermined period of time.
    • Main or Basis risks; This refers to the risk of not experiencing a reversal of changes in the interest rates of securities with an inverse characteristic.
    Interest Rate Risk in Banking Principles Management Finance Image
    Interest Rate Risk in Banking Principles Management Finance; Image by Gerd Altmann from Pixabay.
  • Lending procedures and Role of development banks

    Lending procedures and Role of development banks

    A development bank is a “bank” established for “financing development”. They provide medium and long-term finance to the industrial and agricultural sectors. This article explains the Lending procedures and Role of development banks, and some points also highlight. They provide finance to both the private and public sectors. Also, Development banks are multipurpose financial institutions. They do term lending, investment in securities and other activities. They even promote saving and investment habit in the public.

    Here are the explain the Lending procedures and Role of development banks.

    As per banking subject, “Development banks are financial institutions established to lend (loan) finance (money) on the subsidized interest rate. Such lending is sanctioned to promote and develop important sectors like agriculture, industry, import-export, housing, and allied activities”.

    Features of development banks:

    A development bank has the following features or characteristics:

    • A development bank does not accept deposits from the public like commercial banks and other financial institutions who entirely depend upon saving mobilization.
    • It is a specialized financial institution that provides medium-term and long- term lending facilities.
    • It is a multipurpose financial institution. Besides providing financial help it undertakes promotional activities also. It helps enterprises from planning to the operational level.
    • The objective of these banks is to serve the public interest rather than earning profits.
    • Development banks react to the socio-economic needs of development.
    • It provides financial assistance to both private as well as public sector institutions.
    • The role of a development bank is of gap filler. When assistance from other sources is not sufficient then this channel helps. It does not compete with normal channels of finance.

    Objectives of Development Banks:

    A development bank has the following objectives;

    • Lay Foundations for Industrialization.
    • Meet Capital Needs.
    • Need for Promotional Activities, and.
    • Help Small and Medium Sectors.

    Functions of Development Banks:

    A development bank has the following functions;

    • Financial Gap Fillers.
    • Undertake Entrepreneurial Role.
    • Commercial Banking Business.
    • Joint Finance.
    • Refinance Facility.
    • Credit Guarantee, and.
    • Underwriting of Securities.

    Lending Procedures of Development Banks:

    Development banks follow a procedure for evaluating a proposal for a project. The basic objective is to check whether the applicant fulfills various conditions prescribed by the lending institution and the project is viable. The acceptance of a wrong proposal will result in the wastage of scarce resources.

    We also study their Role, but first Development banks have the following Lending Procedures;

    1. Project Appraisal and Eligibility of the Applicant.
    2. Technical Appraisal.
    3. Economic Viability.
    4. Assessing Commercial Aspects.
    5. Financial Feasibility.
    6. Managerial Competence.
    7. National Contribution.
    8. Balancing of Various Factors.
    9. Loan Sanction.
    10. Loan Disbursement, and.
    11. Follow up.

    Now, explain each one;

    Project Appraisal and Eligibility of Applicant:

    Every financial institution serves a particular area of activity or there are certain limits prescribed beyond which they cannot go. Before processing the application, it is important to find out whether the applicant is eligible under the norms of the institution or not.

    The second aspect which is looked into is to determine whether the enterprise has fulfilled various conditions prescribed by the government. In case some license is required from the government. It should have been taken or assurance is received from the licensing authority.

    After satisfying these preliminary issues the project is appraised by a team of technical financial and economic officers of the institutions from various discussions with the promoters and clarifications sought on various points.

    The bank institution considers financial assistance in the light of;

    • Guidelines for assistance to industries issued by the government or others concerned from time to time.
    • Guidelines issued by the bank, and.
    • Policy decisions of the Board of Directors of the bank.
    Technical Appraisal:

    A technical appraisal involves the study of:

    • Feasibility and suitability of technical process in Indian conditions.
    • Location, of the project about the availability of raw materials, power: water. labor, fuel, transport, communication facilities and the market for finished products.
    • The scale of operations and its suitability for the planned project.
    • The technical soundness of the projects.
    • Sources of purchasing plant and machinery and the reputation of suppliers, etc.
    • Arrangement for the disposal of factory effluent and use of bye products, if any.
    • The estimated cost of the project and probable selling price of the product, and.
    • The programmer for completing the project.
    Economic Viability:

    The economic appraisal will consider the national and industrial priorities of the project export potential of the product employment potential, the study of the market.

    Assessing Commercial Aspects:

    The examination of commercial aspects relates to the arrangements for the purchase of raw materials and the sale of finished products. If the concern has some arrangement for sale then the position of the party should assess.

    Financial Feasibility:

    The financial feasibility of a new and an existing concern will be assessed differently. The assessment for a new concern will involve;

    • The needs for fixed assets, working capital, and preliminary expenses will estimate to find out its needs.
    • The financing plans will be studied about capital structure, promoters’ contribution, debt-equity ratio.
    • Projected cash flow statements both during the construction and operation periods, and.
    • Projected profitability and the like dividend shortly.
    Managerial Competence:

    The success of concern depends upon the competence of management. Proper application of various policies will determine the success of an enterprise.

    Also, a lending institution would see the background, qualifications, business experience promoters and other persons associated with management.

    National Contribution:

    Besides commercial profitability, the national contribution .of the project is also taken into account. The role of the project in the national economy and its benefits to society in the form of good quality products, reasonable prices, employment generation, helpful in social infrastructure, etc. should be assessed. Development banks aim at the overall welfare of society.

    Balancing of Various Factors:

    Various factors should be balanced against each other. The circumstances of the individual project will help in weighing various factors. Some factors may be strong as their in-depth analysis should be avoided.

    In case a project is profitable, there will be no need to assess cash flow. Weaknesses located in certain areas may be offset by the good points in the other.

    Also, experienced management and sound economic outlook may compensate for some weaknesses in financial positions. The responsibility of lending the bank lies in balancing judiciously different considerations for arriving at a consensus.

    Loan Sanction:

    After the appraisal report on the project prepares by the bank’s officers, it places before the advisory committee consisting of experts drawn from various fields of the particular industry. If the advisory committee satisfies a tile proposal then it recommends the case to the Managing Director or Board of Directors along with its report. When the assistance sanctions hen a letter to this effect issues to the pay giving details of conditions.

    Loan Disbursement:

    The loan disburses after the execution of the loan agreement. The execution of documents of security or guarantee etc. should precede the disbursement of the loan. In case some property pledges to the bank then the title deeds of such property are properly scrutinized. The fulfillment of various conditions proceeding to disbursement will determine the time of paying the money to the party.

    Follow up:

    The job of a lending bank does note by disbursing the assistance. It has first to see whether the construction .of the project is as per schedule decided earlier. In case some delay is taking place in executing the plans then the reasons for it should be determined. Later during operations, the result should be properly followed. It should be seen whether the revenue earned by the concern will be sufficient to meet its obligations or not so a proper follow up by the bank will enable it to follow the progress of the unit.

    Lending procedures and Role of development banks
    Lending procedures and Role of development banks, Cheques administration hand #Pixabay.

    Role of development banks:

    Financial institutions provide means and mechanisms of transferring resources from those who have an excess of income over expenditure to those who can make productive use of the same.

    Also, commercial banks and investment institutions mobilize savings of people and channel them into productive uses. Financial institutions provide all types of assistant required infrastructural facilities Institutions e p economic persons who can take the development in the following ways.

    After Lending procedures the Development banks have the following role;

    1. Providing Funds.
    2. Infrastructural Facilities.
    3. Promotional Activities.
    4. Development of Backward Areas.
    5. Planned Development.
    6. Accelerating Industrialization, and.
    7. Employment Generation.

    Now, explain each one;

    Providing Funds:

    Underdeveloped countries have low levels of capital formation. Due to low incomes, people are not able to save sufficient funds which are needed for sensing up new units and also for expansion diversification and modernization of existing units.

    The persons who have the capability of starting a business but does not have requisite help approach to financial institutions for help. These institutions help a large number of persons for taking up some industrial activity.

    The addition of new industrial units and increasing the activities of existing units will certainly help in accelerating the pace of economic development. Financial institutions have large inventible funds which are used for productive purposes.

    Infrastructural Facilities:

    The economic development of a country links to the availability of infrastructural facilities. There is a need for roads, water, sewage, communication facilities, electricity, etc. Financial institutions prepare their investment policies by keeping national priorities in major and the institutions invest in those aims is which can help in increasing the development of the country.

    Also, the Indian industry and agriculture are facing an acute shortage of electricity. All India institutions are giving priority to invest funds in projects generating electricity. These investments will certainly increase the availability of electricity. Small entrepreneurs cannot spare funds for creating infrastructural facilities.

    To overcome this problem, institutions at the state level are developing industrial estates and provide sheds, having all facilities at easy installments. So financial institutions are helping in the creation of all those facilities which are essential for the development of a country.

    Promotional Activities:

    An entrepreneur faces many problems while setting up a new unit. One has to undertake a feasibility report, prepare project reports, complete registration formalities, seek approval from various agencies, etc. All these things require time, money and energy.

    Some people are not able to undertake this exercise or some do not even take initiative. Financial institutions are the expense and manpower resources for undertaking the exercise of starting a new unit. So these institutions take up this work on behalf of entrepreneurs.

    Some units may be set up jointly with some financial institutions and in that case, the formalities are completed collectively. Also, some units may not have come up had they not received promotional help from financial institutions. As well as, the promotional role of financial institutions helps increase the development of a country.

    Development of Backward Areas:

    Some areas remain neglected because facilities needed for setting up new units are not available here. The entrepreneurs set up new units at those places which are already developed. It causes an imbalance in the economic development of some areas.

    Also, to help the development of backward areas, financial institutions provide special assistance to entrepreneurs for setting up new units in these areas. IDBI, IFCI, ICICI give priority in assisting units set up in backward areas and even charge lower interest rates on lending.

    Such efforts certainly encourage entrepreneurs to set up new units in backward areas. The industrial units in these areas improve basic amenities and create employment opportunities. These measures will certainly help in increasing the economic development of backward areas.

    Planned Development:

    Financial institutions help in the planned development of the economy. Different institutions earmark their spheres of activities so that every business activity helps. Some institutions like SIDBI, SFCI’s especially help small scale sector while IFCI and SIDC’s finance large scale sector or extend loans above a certain limit.

    Some institutions help different segments like foreign trade, tourism, etc. In this way, financial institutions devise their roles and help the development in their way. Financial institutions also follow the development priorities set by central and state governments.

    They give preference to those industrial activities which have been specified in industrial policy statements and five-year plans. Financial institutions help in the overall development of the country.

    Accelerating Industrialization:

    The economic development of a country links to the level of industrialization there. The setting up of more industrial units will generate direct and indirect employment, make available goods and services in the country and help in increasing the standard of living.

    Also, Financial institutions provide requisite financial, managerial, technical help for setting up new units. In some areas, private entrepreneurs do not want to risk their funds or gestation period His long but the industries are needed for the development of the area.

    Financial institutions provide sufficient funds for their development. Since 1947, financial institutions have played a key role in accelerating the pace of industrialization. The country has progressed in almost all areas of economic development.

    Employment Generation:

    Financial institutions have helped both direct and indirect employment generation. They have employed many persons to man their offices. Besides office staff, institutions need the services of experts which help them in finalizing lending proposals. These institutions help in creating employment by financing new and existing industrial units.

    Also, they help in creating employment opportunities in backward areas by encouraging the setting up of units in those areas, Thus financial institutions have helped in creating new and better job opportunities.

    Reference:

    1. https://www.mbaknol.com/business-finance/lending-procedures-of-development-banks/
    2. https://www.mbaknol.com/business-finance/role-of-development-banks-in-financial-sector/
    3. Other information collecting from the internet.
  • Learn Investment Banks with their Principle and Functions

    Learn Investment Banks with their Principle and Functions

    Investment Banks: This is because of the profit motive as a result of which all companies have to do something to increase their portfolios and get better funds as well. Learn Investment Banks with their Principle and Functions; A lot of this comes in the form of bonds, stock transfer etc. but the biggest contribution is made through investments. Investment banking is a post that helps companies get these investments.

    Here are explained; What is Investment Banks? with their Principle and Functions.

    Investment banking is a field that involves many levels of division of work. The investment banking advice given would differ in different stages, from the smaller levels of the organizations to the higher levels. The magnitude of the advice given would vary with the level, of course. The clients are to be advised on matters of business, especially financial.

    Issues relating to mergers, acquisitions, bonds, strategies regarding investments, the sale of company stocks to public etc. are also to be discussed. These are the most important financial aspects of running a company and these are the strategies that would determine a company’s success or failure in the future. Global investment banks typically have several business units, each looking after one of the functions of investment banks.

    For example, Corporate Finance, concerned with advising on the finances of corporations, including mergers, acquisitions and divestitures; Research, concerned with investigating, valuing, and making recommendations to clients – both individual investors and larger entities such as hedge funds and mutual funds regarding shares and corporate and government bonds; and Sales and Trading, concerned with buying and selling shares both on behalf of the bank’s clients and also for the bank itself.

    Investment banks management of the bank’s own capital, or Proprietary Trading, is often one of the biggest sources of profit. For example, the banks may arbitrage stock on a large scale if they see a suitable profit opportunity or they may structure their books so that they profit from a fall in bond price or yields.

    #Principal Functions of Investment Banks:

    The principal functions of investment banks include:

    • Raising Capital.
    • Brokerage Services.
    • Proprietary Trading.
    • Research Activities, and.
    • Sales and Trading.

    Now, explain;

    Raising Capital:

    Corporate finance is a traditional aspect of Investment banks, which involves helping customers raise funds in the capital market and advising on mergers and acquisitions. Generally, the highest profit margins come from advising on mergers and acquisitions.

    Investment bankers have had a palpable effect on the history of American business, as they often proactively meet with executives to encourage deals or expansion.

    Brokerage Services:

    Brokerage services typically involve trading and order executions on behalf of the investors. This in turn also provides liquidity to the market. These brokerages assist in the purchase and sale of stocks, bonds, and mutual funds.

    Proprietary Trading:

    Underinvestment banking, proprietary trading is what is generally used to describe a situation when a bank trades in stocks, bonds, options, commodities, or other items with its own money as opposed to its customer’s money, with a view to making a profit for itself.

    Though investment banks are usually defined as businesses, which assist other business in raising money in the capital markets (by selling stocks or bonds), they are not shy of making the profit for itself by engaging in trading activities.

    Research Activities:

    Research is usually referred to as a division which reviews companies and writes reports about their prospects, often with “buy” or “sell” ratings.

    Although in theory, this activity would make the most sense at a stock brokerage where the advice could be given to the brokerage’s customers, research has historically been performed by Investment Banks (JM Morgan Stanley, Goldman Sachs etc).

    The primary reason for this is because the Investment Bank must take responsibility for the quality of the company that they are underwriting vis a vis the prices involved to the investor.

    Sales and Trading:

    Often referred to as the most profitable area of an investment bank, it is usually responsible for a much larger amount of revenue than the other divisions. In the process of market making, investment banks will buy and sell stocks and bonds with the goal of making an incremental amount of money on each trade.

    Sales are the term for the investment banks sales force, whose primary job is to call on institutional investors to buy the stocks and bonds, underwritten by the firm. Another activity of the sales force is to call institutional investors to sell stocks, bonds, commodities, or other things the firm might have on its books.

    #Functions of Investment Banks:

    The following functions below are; Basic functions:

    Consultative:

    Investment banking is all about financial planning and consultation. After all, this is the primary function of investment banking. The functions of an investment banker who is working as a consultant would involve guiding the companies and providing them with advice on their activities pertaining to investments. Investment banking would also influence a company’s mergers or acquisitions as well.

    It involves providing companies with some advice on how they manage public assets and affairs as well. In fact, this is a very strategic field of study and work. The functions of an investment banker might also collide and complement with the works of a private broker who also give advice regarding buying and selling assets to companies, so brokerage and investment banking are related fields.

    Transactions:

    Investment banking also involves taking practical steps towards achieving what has been advanced on. In larger firms and companies, the functions of investment banking would be limited to an advisory capacity, because the larger firms prefer to contemplate on the advice given and make the decisions themselves.

    However, for smaller companies that wish to expand, getting an outside consultant to help out with the implementation of the advice given through investment banking professionals would be a really good option. Smaller companies to require more guidance.

    Learn Investment Banks with their Principle and Functions
    Learn Investment Banks with their Principle and Functions, #Pixabay.

    Important Functions:

    Bills of Exchange:

    This instrument safeguards that a bill is accepted so that control is not lost of the item’s involved. A “bill of exchange” contains a stated date of payment that must be concluded on that date irrespective of any disputes concerning the item named. There are legal measures to prevent payment, termed “non-honoring”, which are subject to different rules depending upon the country involved.

    Corporate Finance:

    This aspect of investment banking represents a specific finance area that deals with corporate financial decisions as well as the tools and analysis formulas and processes utilized to arrive at these decisions. It is divided into “short-term” and “long-term” techniques and decisions whereby the objective is to enhance corporate value through ensuring the “return on capital” is more than the “cost of capital”. The equation rests on a conservative application of risks.

    Corporate finance is related to managerial finance, although the latter is larger in scope as it entails financial techniques that are possible in all business forms, whether they are corporate or non-corporate.

    A. IPO’s:

    Termed “Initial Public Offerings”, IPO’s represent the beginning of a publicly listed company and as such those investors who are in position at this stage are poised to reap almost immediate gains if the stock rises on opening day. Similarly, these same investors stand to lose money if the opening price drops substantially.

    During the last few years, the offering prices have tended to average out as being overpriced. This is borne out by the fact that the closing price, on average, the day of opening generated an annual return of just 2%. In terms of profitability, IPO’s generate large fees for the participating firms and represent the most profitable underwriting area. Fees generally average seven percent (7%).

    After the various splits between managing underwriters, brokerage firms, law firms, and staff the profit hovers in the 34% through 40% range. This service is a cornerstone in aiding firms to float securities needed to expand or underwrite operations and as such represents one of the more important functions performed by investment banks.

    B. Rights Issues:

    These are equity issues whereby shareholders of record have the right to purchase new shares that have a fixed exercise price.

    C. Mergers & Acquisitions:

    Investment banks act in the capacity as advisors in merger and acquisition deals. In working with both the target’s of acquisition as well as the acquirer’s, investment banks provide their information expertise to help arrive at the “reservation price”. They also calculate the potential for gains and the risks in the transaction.

    And while investment banks have a vested interest in these deals, their pragmatism is an effective counterweight in maintaining a balance between undervaluing and overvaluing. Operating under banking regulations, investment banks represent a sort of intermediary that engenders public trust in the legitimacy of the transaction and is a part of a system that represents checks and balances over these types of transactions.

    Commercial banks might have potential conflicts of interest in these types of deals, so even while they have recently taken on this role, the majority of these transactions are still funneled through investment banks.

    Investment Management:

    As the term implies, investment management is also known as portfolio management as well as money management. It is a segment of investment analysis that examines the management of money relating to securities purchases as well as their sale.

    A. High Net Worth Individuals:

    Investment banking services for individuals of high net worth has been a long-standing feature for an elite group whose banking investment needs exceed the capabilities of commercial banks and traditional specialists. The complex variable regarding the client’s return targets and relative degrees of risk along with long as well as short-term requirements represent specialized analysis.

    The resources of an investment bank are suited to meet the demanding requirements of these types of individuals as well as confidentiality. The extremely sophisticated variables comprising recommendations and placement in various instruments are crafted to fit an approved plan of action.

    Because high net worth individuals have access to their own channels of information, the demands of these types of clients in terms of sophistication requires the resources of a specialized institution.

    B. Corporations:

    The investment management of corporations entails handling a number of asset management areas. As is the case with high net worth individuals, it entails an extensive analysis of the goals and objectives desired as well as the cash availability requirements for specific periods of time.

    The preceding represents a valuable service as a result of the high-level contacts and access to specialized information, opportunities, and rates of return with the moderate risk that investment banks can avail themselves of.

    C. Pension Funds:

    These funds represent extremely large sums that require placement in investment avenues that contain high degrees of safety as well as meeting return rates in established parameters.

    The important nature of these retirement funds requires an institution to pay close attention to risk avoidance as well as any potential changes and shifts in the market that could potentially affect the money in the Fund.

    D. Mutual Funds:

    In terms of mutual funds, there are literally hundreds of fund types to select from as a result of the classifications within this group. One particular type of fund which investment banks have an advantage over commercial banks is in hedge funds. These types of funds are unregulated and usually governed by unconventional strategies.

    Hedge funds trade in equities, money markets and bonds and offer yields as well as risks that exceed traditional long stock and bond methodologies. The secretive nature of these funds and the fact that they cater to institutions, corporations and high net worth individuals only is within the purview of investment banks.

  • What are the Functions of the Central Banks?

    What are the Functions of the Central Banks?

    Definition and Functions of Central Bank; Central Bank is the supreme financial institution that regulates the banking and monetary system of the country. It forms to bring monetary stability, issue notes, and maintain the value of a country’s currency in the international market. Also, It administers the currency and credit system of the nation.

    Learn, Explain What are Functions of the Central Banks? 

    The following points highlight the top twelve functions of the central bank. The functions are:

    Control of bank credit:

    The central bank of a country controls the bank advances or bank credit through its various methods of control such as the bank rate policy, open market operations, variable reserve raveled, credit controls, etc., for maintaining both internal and external stability. Also, This considers being a very important and perhaps the most essential function of the central bank.

    The monopoly of note-issue:

    To regulate the supply of currency, the central bank in every country has been given the monopoly power to issue paper notes by the existing legal provisions.

    The banker to the government:

    The central bank acts as the banker to the government of the country. It keeps the cash balances of the government and maintains its accounts. It gives advances to the government and also takes responsibility for the sale of government securities. Also manages public debt and advises the government on various financial matters.

    The banker to other banks:

    As the banker to other banks, the central bank gives direct advances against the government securities or bill rediscounting facilities to other banks. Also, The latter requires to maintain a portion of their total deposits (from 3% to -15% of total deposits as in India) as the reserve at the central bank. By varying this reserve ratio, the central bank can control the advances of other banks.

    The lender of the last resort:

    The central bank is the ultimate source of funds in the money market of a country. During any crisis or panic, it gives all sorts of funds to other banks to enable them to tide over the crisis.

    Control and supervision of other banks:

    The central bank controls and supervises the operations of other banks through licensing, an inspection of bank accounts, bank mergers, etc. 

    The custodian of the nation’s gold and foreign exchange reserve:

    The central bank keeps the nation’s gold and foreign exchange reserve under its direct supervision.

    Maintenance of the foreign exchange rates:

    The central bank requires to maintain the rate of exchange, i.e., the external value of the currency; It has to conduct foreign exchange operations at some specified exchange rates. It also exercises exchange control, i.e., control of the foreign exchange.

    Stability of the value of money:

    The central bank has the duty of keeping both the internal and external value of the country’s currency through various monetary and exchange control measures.

    Strengthening the banking structure:

    The central bank requires to take various steps such as deposits insurance, the extension of banking facilities in the unbanked areas, etc. for strengthening the country’s banking structure.

    A special role in a developing country:

    The central bank has a special role to play in a developing economy like that of India in promoting growth with stability, providing special credit for agriculture and industry, etc.

    Other functions:

    The central bank also acts as the clearinghouse publishes valuable reports and data; and performs various other functions relating to the management and development of the economy.

    What are the Functions of the Central Banks Image
    What are the Functions of the Central Banks? Image by Mudassar Iqbal from Pixabay.
  • Difference between Central and Commercial Banks

    Difference between Central and Commercial Banks

    The primary difference between Central and Commercial Banks; In any country’s financial sector, banks play a crucial role in the overall economic development, by mobilizing savings of individuals and entities. The Content of Difference between the Central Banks and Commercial Banks – Definition, Functions, Differences, Comparison, and Main Key Differences. They act as an intermediary between depositor and borrower. Besides lending money, banks provide various other value-added services, that help in the smooth functioning of the economy. Also, the Central bank, as the name suggests is the apex body, that regulates the entire banking system of the economy.

    Learn, Explain the Difference between Central and Commercial Banks! 

    The Central bank is not the same as a commercial bank, which is the financial institution that provides banking services to individuals and firms. There is a big difference between the central bank and commercial bank in India, in the sense that the former is the top financial institution in the country, whereas the latter is an agent of the Central Bank. Check out the article in which we have compiled some differences in tabular form.

    Definition of Central Banks:

    Central Bank is the supreme financial institution that regulates the banking and monetary system of the country. It is formed to bring monetary stability, issue notes, and maintain the value of a country’s currency in the international market. It administers the currency and credit system of the nation.

    In India, the Reserve Bank of India plays the role of a central bank, which came into existence, after passing an act in parliament in 1934. The bank is headquartered in Mumbai, Maharashtra.

    The following are the main functions of the Central Banks:
    • It has the power to control, direct, and supervise commercial banks. Also helps them at the time of need.
    • It employs various measures to control the credit operations of the commercial banks.
    • It’s the banker and advisor to the government of the country.
    • It acts as a manager of foreign exchange reserves.
    • It collects and publishes information relating to the banking and financial sector.
    • It’s authorized to issue currency notes except coins and notes of small magnitude.
    • It oversees the credit and monetary policy of the nation.

    Definition of Commercial Banks:

    The entities that provide banking and financial services to a large number of people are known as Commercial Banks. They act as a mediator between the borrowers and savers. Also, Commercial Banks receive deposits from the general public and lends it at high interest to individuals and organizations. In this way, the mobilization of savings takes place, and the economic cycle goes on smoothly.

    In earlier times, people used to deposit money in post offices for saving purposes, when the requirement of the banking system was felt. The people want an establishment where they can deposit their savings and withdraw them at the time of need. At present, there are more than 600 commercial banks in India, which include public sector banks, private sector banks, scheduled banks, non-scheduled banks, nationalized banks, etc.

    The essential functions of a Commercial Bank are:
    • It accepts deposits from the general public, firms, institutions, and organizations. Further, it gives the facility to withdraw money on demand. Banks pay interest on deposits at various rates on different deposits.
    • The lends money to the public, institutions, and organizations in the form of long term and short term loans for a particular period and charges interest on the amount lent. Moreover, it provides overdraft and cash credit facilities to the customer.
    • It performs agency functions like collections of bills of exchange and promissory notes, trading of shares and debentures, payment to third parties on standing instructions of the customer, etc.
    • It provides the facility of safekeeping of valuables like jewelry and documents.
    • Collects, transfers, and makes payment of funds on behalf of the customer.
    • It provides the facility of ATM card, Debit Card, Credit Card, Cheques, etc., to its account holders.

    Differences in Central Banks:

    • Work for the public welfare and economic development of a country. A central bank is governed by the government of a country.
    • Controls and regulates the entry banking system of a country.
    • Do not deal directly with the public. It issues guidelines to commercial banks for the economic development of the country.
    • Issues currency and control the supply of money in the Market.
    • Acts as a state-owned institution.
    • Act as a custodian of foreign exchange in the country.
    • Act as a banker to the Government.
    • Controls credit creations in the economy thus act as a clearinghouse of other banks.

    Differences in Commercial Banks:

    • Operates for Profit Motive. The Majority of Stake is held by the government as well as the private sector.
    • Operates under the direct control and supervision of the central bank. In India, all the commercial banks work under the guidelines issued by RBI.
    • Deals directly with the Public. It serves the financial requirement of the public by providing short and medium terms loans and depositing and securing money that can be drawn on demand.
    • Does not Issue currency, but only adds to the approval of the central bank.
    • Acts as a state or privately owned institution.
    • Perform foreign exchange business only on the approval of the central bank.
    • Acts as agents of the central bank.
    • Acts as a clearinghouse only as an agent of the central bank.

    Comparison of Central and Commercial Banks:

    The Basis for Comparison CENTRAL BANKS COMMERCIAL BANKS
    Meaning The bank which looks after the monetary system of the country is known as Central Bank. The establishment, which provides banking services to the public is known as Commercial Bank.
    What is it? It is a banker to the banks and the government of the country. It is the banker to the citizens of the nation.
    Governing Statute Reserve Bank of India Act, 1934. Banking Regulation Act, 1949.
    Ownership’s Public Public or Private
    Profit motive It does not exist for making a profit for its owners It exists for making a profit for its owners.
    Monetary Authority It is the supreme monetary authority with wide powers. No such authority.
    Objective Public welfare and economic development. Earning Profits
    Money supply Ultimate source of money supply in the economy. No such function is performed by it.
    Right to print and issue currency notes Yes No
    Deals with General Public Banks and Governments
    How many banks are there? Only one Many

    Main Key Differences between Central and Commercial Banks:

    Difference between Central and Commercial Banks
    Difference between Central and Commercial Banks

    The following are the differences between the central and commercial banks:

    • The bank, which monitors, regulates, and controls the financial system of the economy knows as Central Bank. The financial institution which receives deposits from people and advances them money is known as Commercial Bank.
    • Also, Central Bank is the banker to banks, government, and the financial institution, whereas Commercial Bank is the banker to the citizens.
    • The Central Bank is the supreme monetary authority of the country. As against this, the commercial bank does not have such authority and powers.
    • Central Bank of India i.e. the Reserve Bank of India is governed by RBI Act, 1934. Conversely, the Commercial Bank is regulating by the Banking Regulation Act, 1949.
    • The Central Bank is a publicly own institution while the Commercial Bank can be a publicly or privately owned institution.
    • The Central Bank does not exist for making a profit, whereas a commercial bank operates for making a profit for its owners.
    • Also, Central Bank is the fundamental source of money supply in the economy. While the commercial bank does not perform such a function on the contrary.
    • There is only one Central Bank in every country, but the Commercial Banks are many which serve the whole country.
    • The Central Bank does not deal with the general public, but Commercial Bank does.
    • The Central Bank has got the authority to print and issue the notes. Also, on the other hand, the commercial bank does not have such authority.
    • Bank main purpose of the Central Bank is a public welfare and economic development. In contrast Commercial Bank, which runs for-profit motive.

  • The Relationship between Central and Commercial Banks!

    The central bank and commercial banks have their distinct identities and functions. The central bank, through its function of the lender of the last resort, acts as an active agent of the government in implementing its monetary policies. In developed countries, the efficient carrying out of this function is easy. Also learned, Economic and Market Value Added, The Relationship between Central and Commercial Banks!

    Learn, Explain The Relationship between Central and Commercial Banks! 

    The following concept of relationship below are;

    Central Banks:

    A central bank, reserve bank, or monetary authority is an institution that manages a state’s currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency, which usually serves as the state’s legal tender.

    Central banks also act as a “lender of last resort” to the banking sector during times of financial crisis. Most central banks usually also have supervisory and regulatory powers to ensure the solvency of member institutions, prevent bank runs, and prevent reckless or fraudulent behavior by member banks.

    Commercial Banks:

    A commercial bank is an institution that provides services such as accepting deposits, providing business loans, and offering basic investment products. The commercial bank can also refer to a bank, or a division of a large bank, which more specifically deals with deposit and loan services provided to corporations or large/middle-sized business – as opposed to individual members of the public/small business.

    In developing economies, however, this is not so simple. Here a case is often made for entry of the central bank in some selected fields to promote the development of the economy; besides ensuring the growth of a sound banking structure to cope with the increasing needs of credit. Commercial bankers take this as an encroachment on their field.

    The Relationship between the commercial banks and the central banks:

    The relationship between the commercial banks and the central bank has to be based on reciprocity. The commercial banks should conform to the spirit of central bank directives rather than letters. On the other side, the central bank should invariably satisfy the genuine needs of the commercial banks in times of stresses and strains. A moral code of conduct between the two will have to be evolved, accepted and followed.

    They argue that the major part of the Central Bank’s funds comprise the reserves of the commercial banks meant for safeguarding their safety (liquidity). It would be immoral on the part of the central bank to compete in business with the commercial banks with their money. In view of the co-operation that the central bank often seeks from commercial banks for carrying out its policies, the central bank should not invite hostility from them by giving them unjust competition through its special privileges as the bankers’ bank and the banker of the government.

    In spite of these arguments, opinion has gone in favor of the undertaking of some commercial business by the central bank, especially in underdeveloped economies. A small amount of business can hardly affect the liquidity position of the ‘creator of liquidity’. It is not at all necessary that the central bank uses the commercial banks’ funds for this. It can set up a separate department for commercial business and create resources also.

    In fact, it may organize a special agent bank as its favored child for doing the arduous business necessary for economic development often avoided by commercial banks. Further, if the central bank feels that the steering wheel of credit control in its banks is loose and not functioning satisfactory, it may gain an edge of maneuverability by keeping in touch with the market through a limited amount of business.

    Besides, in an agriculturally depressed economy like India, the central bank may take up the onus of developing a bill market, granting direct loans, or discounting good bills of exchange. As regards direct loans, it may be a bit difficult to democrat clearly the central bank’s field vis-a-vis that of the commercial banks.

    The difficulty is removed if the central bank while doing ordinary commercial business keeps in mind that in its operations, the public interest and not profit-earning motive, prevails; what it can get done through commercial banks it never undertakes to do itself.

    The various quantitative and qualitative instruments of credit control should be judiciously used by the central bank. No doubt, the bank has the drastic weapons of reserve ratio requirements, open market operations or changes in the bank rate, etc. but none of them is fool-proof.

    After all, it is bank official on the spot who can judge between the credits asked for socially desirable productive purposes or credit being taken in the name of bonafide purposes, but to be used for some anti-social actions. Unless the commercial bank and the central bank provide willing co-operation, the one will be weakened and the other will be frustrated. This is why moral persuasion must be preferred now to direct action.

  • Central Banks: Objectives, Role, Operations, and Autonomy

    Central Banks: Objectives, Role, Operations, and Autonomy

    A central bank, institution, such as the Bank of England, the U.S. Federal Reserve System, or the Bank of Japan, that charges with regulating the size of a nation’s money supply, the availability, and cost of credit, and the foreign-exchange value of its currency. This article explains the Concept of Central Banks: Meaning, Objectives, Role, Operations, and Autonomy. Regulation of the availability and cost of credit may be non-selective or may design to influence the distribution of credit among competing uses.

    Learn, Explain Central Banks: Objectives, Role, Operations, and Autonomy.

    The principal objectives of a modern central bank in carrying out these functions are to maintain monetary and credit conditions conducive to a high level of employment and production, a reasonably stable level of domestic prices, and an adequate level of international reserves. The Concept of Central Banks: Meaning, Objectives of Central Banks, Role of Central Banks, Operations of Central Banks, and the Autonomy of Central Banks…all information below are;

    Objectives of Central Banks:

    The objectives of the central bank include economic growth in line with the economy’s potential to expand; a high level of employment; stable prices (that is, stability in the purchasing power of money); and moderate long-term interest rates.

    The central bank is ultimately concerned with preserving the integrity of a country’s financial institutions, combating inflation, defending the exchange rate of the country’s currency and preventing excessive unemployment.

    Role of Central Banks:

    The central bank, which is responsible for managing a country’s monetary affairs, determines the level of short-term interest rates, thereby profoundly affecting financial markets, wealth, output, employment, and prices.

    Indeed the central bank’s influents spread not only within the domestic territory of a country but even, through financial and trade linkages — to virtually every corner of the globe.

    The central bank’s main goal is low and stable inflation.

    It also seeks to promote steady growth in national output, low unemployment, and orderly financial markets. If the output is growing rapidly and inflation is rising the central bank is likely to raise interest rates, as this puts a brake on the economy and reduces inflationary pressures.

    If the economy is sluggish and business is languishing, an exactly opposite type of monetary action calls for. The central bank will lower interest rates — which is likely to boost aggregate demand, increase output and reduce unemployment.

    Through 5 steps, how the central bank affects economic activity. (1) is the change in reserves, which leads to changes in M, in (2); leading to (3), changes in interest rates and credit availability. In (4) AD change’s in response to investment and other interest-sensitive components of desired expenditure.

    In (5) changes in output, employment and general price level follow. (It should not, however, miss that fiscal policy also affects aggregate demand).

    Operations of Central Banks:

    The central bank has at its disposal several policy instruments. These can affect certain intermediate targets. These instruments are directed towards achieving the ultimate objectives of monetary policy — low inflation, rapid growth in output and low unemployment which are the signs of a healthy economy. For the sake of analysis, it is important to keep the different groups (policy instruments, intermediate targets, and ultimate objectives) separate and distinct.

    The three instruments of monetary policy are open market operations, discount rate policy and reserve-requirements policy. The pros and cons of each will discuss. In determining its monetary policy, the central bank directly manipulates these instruments or policy variables under its control. These help determine bank reserves, the money supply, and interest rates — the intermediate targets of monetary policy.

    More Things…

    In managing money, the central bank must keep its eye on a set of variables known as intermediate targets. These are economic variables that are intermediate in the transmission mechanism between monetary policy instruments and ultimate policy goals. When the central bank seeks to affect its ultimate objectives, it first changes one of its instruments, such as the discount rate.

    This change affects an intermediate variable such as interest rates, credit availability or the money supply. For maintaining sound health of the economy the central bank keeps a close watch on its intermediate targets. Ultimately monetary and fiscal policies are partners in pursuing the measure objectives of rapid growth, low unemployment, and stable prices.

    The autonomy of the Central Banks:

    In recent years there is a strong demand for central bank independence. Monetary policy independence is not necessary primarily in order to protect a ‘conservative’ central banker from the influence that a less ‘conservative’ government might seek to bring to bear, but rather to enable central bankers with a longer-term decision horizon (and/or a lower rate of time preference) to assert their authority when faced with a government with a shorter planning “horizon (and/or a higher rate of time preference).

    Then, when the government ‘by a conscious act relinquishes its power’, it does not mean that the institution to which the power of decision-making transfers has different inflation and employment prefer­ences from the population, but simply that it is operating with a longer time horizon than the government.

    Thus, the central bank may react appropriately to temporary output shocks if it thinks that such a policy can pursue without long-term disadvantages for price stability. From this standpoint, the economic rationale for indepen­dence is that it enables those deciding monetary policy to conduct their policy without being always scrutinized by the government for short-term results.

    More Things…

    The longer-term horizon in their decision-making implies that they make full allowance for the long-time lags involved in the conduct of monetary policy, i.e., its formulation and implementation.

    It is now felt that the most important aim of central bank legislation should be to create an incentive structure that guarantees a long-term time horizon of central bankers. As most politicians are characterized by rather myopic behavior, this implies, above all, that the monetary policy decisions taken in the central bank have to insulate from the general political process as far as possible.

    This explains why central bank independence is now widely regarded as a prerequisite for an effective monetary policy. The trick is to attain the appropriate balance between the need to be responsive to short-term pressures and the need to ensure that those pressures are exerted in a system that safeguards the long-term interest of the population. However, there are different definitions of central bank independence.

    Types:

    Two main types of independence are — “goal independence” and “instrument indepen­dence“. A central bank enjoys goal independence when it is free to choose its goals or, at least, free to decide the actual target values for a given goal. A central bank has instrument independence when it ‘is given control over the levers of monetary policy and allowed to use them’.

    An alternative definition distinguishes between political and economic independence. By political independence, we mean a central bank’s ability to pursue the goal of price stability unfettered by formal or informal instructions emanating from the ruling government. Independence refers to the autonomy to pursue the goal of low inflation.

    Any institutional feature that enhances the central bank’s capacity to pursue this goal will increase central bank independence. Economic independence means that a central bank has unlimited freedom to determine all monetary policy transactions that lead to changes in its operating targets.

    Central Banks Objectives Role Operations and Autonomy Image
    Central Banks: Objectives, Role, Operations, and Autonomy.

    The different notions of independence:

    Since all these definitions have both merits and shortcomings it is necessary to make a synthesis of both approaches, which distinguishes three different notions of independence.

    1. Goal independence: Goal independence requires that the government has no direct influence on the goals of monetary policy.
    2. Instrument independence: Instrument independence requires that the central bank can set its operating targets (interest rate, exchange rate) autonomously. This notion of instrument independence is identical to the concept of ‘economic independence’.
    3. Personal independence: Personal independence requires that the decision-making body of a central bank be in a position to resist formal directives as well as informal pressure from the government.

    Now, Explain;

    Goal Independence:

    The definition of the goals of the monetary policy includes not only the choice between price stability and nominal GDP but also a definition of the time horizon for their realization, the definition of concrete indices, their numerical target values and the definition of escape clauses.

    Thus, ‘goal independence’ can take various forms. It can include a framework wherein the central bank has complete freedom on all these issues, as well as a framework wherein it can decide on only some of these issues. In reality, one can find three variants of the definition of goal independence.

    In the USA monetary policy seeks to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. But ‘stable long-term interest rates’ is not compatible with the standard definition of the goals of monetary policy. Long-term interest rates are, at best, an intermediate target.

    The European Central Bank grants a somewhat more limited degree of goal independence. Similar arrangements are found in Japan and, to some extent, in Sweden.

    More Things…

    A low degree of goal independence characterizes the central bank legislation of the United Kingdom, Canada, and New Zealand. In these countries, the central bank legislation defines price stability as the main goal of monetary policy but gives the government the right to determine the concrete target values.

    The most important prediction of both theoretical and empirical kinds of literature is that a central bank should have instrument independence, but should not have goal independence.

    There are no permanent trade-offs between price stability and other macroeconomic targets. Therefore, there is no real choice that ‘elected officials’ could make for the population in the long run. In the short-term, supply shocks make it necessary to allow for deviations from a medium-term inflation target. But entrusting the government or the parliament with this decision could lead to the risk of an inflation bias.

    This leads to a possible trade-off between:
    • A more flexible response of monetary policy in the case of supply shocks, but only if the central bank overly commits to price stability, and
    • The reduced political independence of monetary policy with all the attendant risks.

    Instrument Independence:

    Instrument independence implies that a central bank can set its operating targets without any interference from the government.

    It includes three important elements:
    • Control of the short-term interest rate as the most important operating target of monetary policy.
    • Control of the exchange rate, which can uses as an additional operating target, especially in a relatively open economy, and.
    • Restrictions of central bank credits to the government, which could undermine the control over the monetary base and, thus, over short-term interest rates.

    Instrument independence constitutes an indispensable element of stability-oriented central bank legislation. Inflation targeting seems to be the most effective and it leads to the most democratically accountable policy-making when the central bank is instrument independent but not fully goal dependent.

    In most countries, monetary policy can autonomously determine interest rates. However, as in the case of goal independence, there are countries where the government can still override the central bank’s decisions.

    As far as the control over the exchange rate is concerned, there is at present no central bank that has unlimited responsibility for this target of monetary policy. Only the ECB makes a distinction between formal exchange arrangements and a policy of managed floating.

    More Things…

    The central banks in all other countries have very limited responsibilities in the field of exchange rate policy. All central bank acts assign this responsibility’ without qualifications to the government.

    The third element of instrument independence concerns the explicit limitations for central bank lending to the government. This relates exclusively to direct lending to the public sector. It is, therefore, perfectly compatible with the EC Treaty.

    By purchasing government bonds from the commercial banks as part of its open-market policy a central bank can easily bypass the prohibition on deficit financing and conduct its money market management essentially on outright open-market operations.

    In other central bank acts, no similar regulations can find. However, it is ‘conceivable that a monetary policy geared to price stability might guarantee simply by giving a politically independent central bank the power to decide of its own accord when and how much to lend to public sector borrowers’.

    But then there is always the danger of a central bank giving in to political pressure and thus promoting inflationary financing of government-expenditure.

    Personal Independence:

    Even if central bankers are granted instrument and/or goal independence, the government could try to exert some informal pressure on monetary policy. For instance, if the central bank governor could dismiss at any time, and without specific reasons at the discretion of the government, he or she would be in a rather weak position vis-a-vis the minister of finance or the head of the government.

    A strong informal influence on the central bank can also be exerted if only one person, i.e., the governor, is in charge of monetary policy decisions. In this case, it is sufficient that the government sends a depicted partisan to the top of the central bank.

    To sum up, there is an inherent inflation bias mainly due to a short-term time horizon of politicians. This calls for central bank legislation that provides central bankers with independence from politicians and with long-terms of office, which is a very efficient means of insulating central bankers from the government.

  • Explain Primary and Secondary Functions of Commercial Banks!

    The commercial bank is the financial institution performs diverse types of functions. It satisfies the financial needs of sectors such as agriculture, industry, trade, communication, etc. That means they play a very significant role in a process of economic social needs. The functions performed by banks are changing according to change in time and recently they are becoming customer centric and widening their functions. Generally, the functions of commercial banks are divided into two categories viz. primary functions and the secondary functions. Also learned, Explain Primary and Secondary Functions of Commercial Banks!

    Learn, Explain Primary and Secondary Functions of Commercial Banks!

    The two most distinctive features of a commercial bank are borrowing and lending, i.e., acceptance of deposits and lending of money to projects to earn Interest (profit). In short, banks borrow to lend. The rate of interest offered by the banks to depositors is called the borrowing rate while the rate at which banks lend out is called lending rate.

    The difference between the rates is called ‘spread’ which is appropriated by the banks. Mind, all financial institutions are not commercial banks because only those which perform dual functions of (i) accepting deposits and (ii) giving loans are termed as commercial banks. For example, post offices are not the bank because they do not give loans. Functions of commercial banks are classified into two main categories: (A) Primary functions, and (B) Secondary functions.

    Let us know about each of them:

    (A) Primary Functions:

    The Following primary functions below are:

    1. It accepts deposits:

    A commercial bank accepts deposits in the form of current, savings and fixed deposits. It collects the surplus balances of the Individuals, firms, and finances the temporary needs of commercial transactions. The first task is, therefore, the collection of the savings of the public. The bank does this by accepting deposits from its customers. Deposits are the lifeline of banks.

    Deposits are of three types as under:

    (i) Current account deposits:

    Such deposits are payable on demand and are, therefore, called demand deposits. These can be withdrawn by the depositors any number of times depending upon the balance in the account. The bank does not pay any Interest on these deposits but provides cheque facilities.

    These accounts are generally maintained by businessmen and Industrialists who receive and make business payments of large amounts through cheques.

    (ii) Fixed deposits (Time deposits):

    Fixed deposits have a fixed period of maturity and are referred to as time deposits. These are deposits for a fixed term, i.e., the period of time ranging from a few days to a few years. These are neither payable on demand nor they enjoy cheque facilities.

    They can be withdrawn only after the maturity of the specified fixed period. They carry a higher rate of interest. They are not treated as a part of the money supply Recurring deposit in which a regular deposit of an agreed sum is made is also a variant of fixed deposits.

    (iii) Savings account deposits:

    These are deposits whose main objective is to save. The savings account is most suitable for individual households. They combine the features of both current account and fixed deposits. They are payable on demand and also withdrawable by cheque.

    But the bank gives this facility with some restrictions, e.g., a bank may allow four or five cheques in a month. Interest paid on savings account deposits in lesser than that of fixed deposit.

    Difference between demand deposits and time (term) deposits:

    Two traditional forms of deposits are demand deposit and term (or time) deposit:

    • Deposits which can be withdrawn on demand by depositors are called demand deposits, e.g., current account deposits are called demand deposits because they are payable on demand but saving account deposits do not qualify because of certain conditions on withdrawal. No interest is paid on them. Term deposits, also called time deposits, are deposits which are payable only after the expiry of the specified period.
    • Demand deposits do not carry interest whereas time deposits carry a fixed rate of interest.
    • Demand deposits are highly liquid whereas time deposits are less liquid,
    • Demand deposits are chequable deposits whereas time deposits are not.

    2. It gives loans and advances:

    The second major function of a commercial bank is to give loans and advances particularly to businessmen and entrepreneurs and thereby earn interest. This is, in fact, the main source of income of the bank. A bank keeps a certain portion of the deposits with itself as the reserve and gives (lends) the balance to the borrowers as loans and advances in the form of cash credit, demand loans, short-run loans, overdraft as explained under.

    (i) Cash Credit:

    An eligible borrower has first sanctioned a credit limit and within that limit, he is allowed to withdraw a certain amount on a given security. The withdrawing power depends upon the borrower’s current assets, the stock statement of which is submitted by him to the bank as the basis of security. Interest is charged by the bank on the drawn or utilized the portion of credit (loan).

    (ii) Demand Loans:

    A loan which can be recalled on demand is called demand loan. There is no stated maturity. The entire loan amount is paid in lump sum by crediting it to the loan account of the borrower. Those like security brokers whose credit needs fluctuate generally, take such loans on personal security and financial assets.

    (iii) Short-term Loans:

    Short-term loans are given against some security as personal loans to finance working capital or as priority sector advances. The entire amount is repaid either in one installment or in a number of installments over the period of the loan.

    Investment:

    Commercial banks invest their surplus fund in 3 types of securities:

    (i) Government securities, (ii) Other approved securities and (iii) Other securities. Banks earn interest on these securities.

    (B) Secondary Functions:

    Apart from the above-mentioned two primaries (major) functions, commercial banks perform the following secondary functions also.

    3. Discounting bills of exchange or bundles:

    A bill of exchange represents a promise to pay a fixed amount of money at a specific point of time in future. It can also be encashed earlier through the discounting process of a commercial bank. Alternatively, a bill of exchange is a document acknowledging the amount of money owed in consideration of goods received. It is a paper asset signed by the debtor and the creditor for a fixed amount payable on a fixed date. It works like this.

    Suppose, A buys goods from B, he may not pay B immediately but instead give B a bill of exchange stating the amount of money owed and the time when A will settle the debt. Suppose, B wants the money immediately, he will present the bill of exchange (Hundi) to the bank for discounting. The bank will deduct the commission and pay to B the present value of the bill. When the bill matures after the specified period, the bank will get payment from A.

    4. Overdraft facility:

    An overdraft is an advance given by allowing a customer keeping the current account to overdraw his current account up to an agreed limit. It is a facility to a depositor for overdrawing the amount than the balance amount in his account.

    In other words, depositors of current account make the arrangement with the banks that in case a cheque has been drawn by them which are not covered by the deposit, then the bank should grant overdraft and honor the cheque. The security for the overdraft is generally financial assets like shares, debentures, life insurance policies of the account holder, etc.

    Difference between Overdraft facility and Loan:

    • Overdraft is made without security in current account but loans are given against security.
    • In the case of the loan, the borrower has to pay interest on full amount sanctioned but in the case of an overdraft, the borrower is given the facility of borrowing only as much as he requires.
    • Whereas the borrower of loan pays Interest on the amount outstanding against him but the customer of overdraft pays interest on the daily balance.

    5. Agency functions of the bank:

    The bank acts as an agent of its customers and gets the commission for performing agency functions as under:

    1. Transfer of funds: It provides a facility for cheap and easy remittance of funds from place-to-place through demand drafts, mail transfers, telegraphic transfers, etc.
    2. Collection of funds: It collects funds through cheques, bills, bundles and demand drafts on behalf of its customers.
    3. Payments of various items: It makes payment of taxes. Insurance premium, bills, etc. as per the directions of its customers.
    4. Purchase and sale of shares and securities: It buys sells and keeps in safe custody securities and shares on behalf of its customers.
    5. Collection of dividends, interest on shares and debentures is made on behalf of its customers.
    6. Acts as Trustee and Executor of the property of its customers on the advice of its customers.
    7. Letters of References: It gives information about the economic position of its customers to traders and provides similar information about other traders to its customers.

    6. Performing general utility services:

    The banks provide many general utility services, some of which are as under:

    1. Traveler’s cheques. The banks issue traveler’s cheques and gift cheques.
    2. Locker facility. The customers can keep their ornaments and important documents in lockers for safe custody.
    3. Underwriting securities issued by the government, public or private bodies.
    4. Purchase and sale of foreign exchange (currency).

    Primary Functions of Commercial Banks:

    Commercial Banks performs various primary functions some of them are given below

    • Accepting Deposits: Commercial bank accepts various types of deposits from the public especially from its clients. It includes saving account deposits, recurring account deposits, fixed deposits, etc. These deposits are payable after a certain time period.
    • Making Advances: The commercial banks provide loans and advances of various forms. It includes an overdraft facility, cash credit, bill discounting, etc. They also give demand and demand and term loans to all types of clients against proper security.
    • Credit creation: It is the most significant function of commercial banks. While sanctioning a loan to a customer, a bank does not provide cash to the borrower Instead it opens a deposit account from where the borrower can withdraw. In other words, while sanctioning a loan a bank automatically creates deposits. This is known as a credit creation from the commercial bank.

    Secondary Functions of Commercial Banks:

    Along with the primary functions each commercial bank has to perform several secondary functions too. It includes many agency functions or general utility functions.

    The secondary functions of commercial banks can be divided into agency functions and utility functions.

    Agency Functions: Various agency functions of commercial banks are.

    • To collect and clear cheque, dividends and interest warrant.
    • To make payment of rent, insurance premium, etc.
    • To deal in foreign exchange transactions.
    • To purchase and sell securities.
    • To act as trustee, attorney, correspondent, and executor.
    • To accept tax proceeds and tax returns.

    General Utility Functions: The general utility functions of the commercial banks include.

    • To provide a safety locker facility to customers.
    • To provide money transfer facility.
    • To issue a traveler’s cheque.
    • To act as referees.
    • To accept various bills for payment e.g phone bills, gas bills, water bills, etc.
    • To provide merchant banking facility.
    • To provide various cards such as credit cards, debit cards, Smart cards, etc.
  • Commercial Banks: Meaning, Functions, and Significances

    Commercial Banks: Meaning, Functions, and Significances

    Commercial Banks: Banks have developed around 200 years ago. The nature of banks has changed as time has changed. This article explains Banks and their topics – Meaning, Functions, and Significances. The term bank relates to financial transactions. It is a financial establishment that uses, money deposited by customers for investment, pays it out when required, makes loans at interest exchanges currency, etc. however to understand the concept in detail we need to see some of its definitions. Many economists have tried to give different meanings to the term bank.

    Learn, Explain Commercial Banks: Meaning, Functions, and Significances.

    Meaning of Commercial Banks:

    A commercial bank is a financial institution that performs the functions of accepting deposits from the general public and giving loans for investment to earn a profit. Banks, as their name suggests, ax profit-seeking institutions, i.e., they do banking business to earn a profit.

    They generally finance trade and commerce with short-term loans. They charge a high rate of interest from the borrowers but pay much less rate of Interest to their depositors with the result that the difference between the two rates of interest becomes the main source of profit of the banks. Most of the Indian joint stock Banks are Commercial Banks such as Punjab National Bank, Allahabad Bank, Canara Bank, Andhra Bank, Bank of Baroda, etc.

    Definitions of Commercial Banks:

    While defining the term banks it takes into account what type of task performs by the banks. Some of the famous definitions are given below:

    According to Prof. Sayers,

    “A bank is an institution whose debts are widely accepted in settlement of other people’s debts to each other.”

    In this definition, Sayers has emphasized the transactions from debts raised by a financial institution.

    According to the Indian Banking Company Act 1949,

    “A banking company means any company which transacts the business of banking. Banking means accepting for the purpose of lending or investment of deposits of money from the public, payable on demand or otherwise and withdrawable by cheque, draft or otherwise.”

    Nature of Commercial Banks:

    They are an organization that normally performs certain financial transactions. It performs the twin task of accepting deposits from members of the public and making advances to needy and worthy people from society. When banks accept deposits its liabilities increase and it becomes a debtor, but when it makes advances its assets increase and it becomes a creditor. Banking transactions are socially and legally approved. It is responsible for maintaining the deposits of its account holders.

    Functions of Commercial Banks:

    The main functions of commercial banks are accepting deposits from the public and advancing them loans. However, besides these functions, there are many other functions that these banks perform.

    Paul Samuelson has defined the functions of the Commercial bank in the following words: 

    “The Primary economic function of a commercial bank is to receive demand deposits and honor cheques drawn upon them. A second important function is to lend money to local merchants farmers and industrialists.”

    The major functions performed by the commercial banks are:

    Accepting Deposits:

    This is one of the primary functions of commercial banks. The banks accept different types of deposits, the deposits may broadly classify as demand deposits and time deposits. The former refers to the deposits which are repayable by the banks on demand by the depositors, while the time deposits are accepted by the banks for a fixed period before the expiry of which they don’t return the deposit.

    The demand deposits include the current account deposits and savings bank account deposits. These two types of deposits earn a very low rate of interest as they can withdraw at any time. In the case of savings deposits, the depositor did not allow withdrawing more than a fixed number of times or amount over some time.

    More things:

    The time or term deposits include the fixed deposit and recurring deposits. In the former, a sum deposits for a fixed period determined at the time of deposit and never allows to withdrawal before the expiry of the period of deposit. Any such foreclosures will invite a penalty apart from forfeiting the interest.

    Recurring deposits are the type of deposits in which a depositor agrees to deposit a fixed sum of amount every month for several months as determined in advance, and at the end of which the depositor will be repaid his deposit amount along with interest. Every bank will be interested in mobilizing as much deposit as possible as it would improve its liquidity with which the bank can meet its liabilities and expand its business.

    Advancing of Loans:

    They accept deposits and use them for the expansion of their business. The banks never keep the deposits mobilized idle. After keeping some cash reserve, they invest the funds and earn. They also lend loans and advances to the common men after satisfying themselves about the creditworthiness of the borrowers. They grant different types of loans like ordinary loans in which the banks lend money against collateral security.

    Cash credit is another type of loan in which the entire amount sanctioned credits into the borrower’s account and he permits to withdraw only a specified sum at a time. Overdraft is yet another facility under which the customer allows to withdraw an amount subject to the ceiling fixed, from his account and he pays interest on the amount of overdrawn.

    Discounting bills of exchange is another type of advance granted by the banks in which a genuine trade bill discount by the banks and the holder of the bill gives the amount and the banks arrange to collect the due from the drawer of the bill on the date of maturity.

    Investment of Funds:

    One of the main functions of commercial banks is to invest their funds so as learn interest and returns apart from productively utilizing their funds. In India as per the statutes, banks must invest a part of their total investments in government securities and other approved securities to impart liquidity.

    Banks apart from enabling them to earn out of their investments, nowadays have set up mutual funds through which they mobilize funds from the people who invest them in very attractive projects which is a help rendered to the investors who otherwise will not have the benefit of participating in the project. Banks administer these mutual funds through specialists and experts whose services are not available to the common men.

    Agency Functions of Commercial Banks:

    Banks function as the agent of their customers and help them in several ways. For these agency services, the banks charge a nominal amount. The agency services include the transfer of customer’s funds, collection of funds on behalf of the customers, transactions in the shares and securities for their customers, collection of dividends on shares and interest on debentures for their customers, payments of subscriptions, dues, bills, premia on behalf of the customers, acting as the Trustees and Executor of the customers, offering financial and other consultancy services, acting as correspondents of the customers, etc.

    Purchase and Sale of Foreign Exchange:

    The banks account for by far the largest proportion of all trading of both a commercial and speculative nature and operate within what knows as the interbank market. This is essentially a market composed solely of commercial and investments that buy and sell currencies from each other.

    Strict trading relationships exist between the member banks and lines of credit are established between these banks before they are permitted to trade. They are a fundamental part of the foreign exchange market as they not only trade on their behalf and for their customers but also provide the channel through which all other participants must trade.

    They are in essence the principal sellers within the Forex market. One important thing to remember is that commercial and investment banks do not only trade on behalf of their customers but also trade on their behalf through proprietary desks, whose sole purpose is to make a profit for the bank. It should always remember that commercial banks have exceptional knowledge of the marketplace and the ability to monitor the activities of other participants such as the central banks, investment funds, and hedge funds.

    Financing Domestic and International Trade:

    This is a major function of commercial banks. International trade depends to a large extent on the financial and other support given by the banks. Apart from encouraging bills transactions, the banks also issue the letter of credit facilitating the importers to conduct their trade smoothly.

    The banks also process all the documents through consultancy services and reduce the botheration of the traders. They also lend based on commercial bills, warehouse receipts, etc., which help the traders to expand their business.

    Creation of Credit:

    It is worth noting the credit created by the commercial banks. In the process of their lending operations, they create credit. The process involves the following mechanism; whenever the banks lend loans, they do not pay cash to the be borrowers; instead, they credit the accounts of the borrowers and allow them to withdraw from their accounts.

    This means every loan given will create a deposit for the banks. Since every deposit is equal to money, banks are said to be creating money in the form of credit. As a result, the volume of funds required by the trade. The government and the country are met by the banks without any necessity to use actual cash.

    Other Functions:

    Other functions of commercial banks include providing safety vault facilities for the customers, issuing traveler’s cheques acting as referees of their customers in times of need, compiling statistics and other valuable information, underwriting the issue of shares and debentures, honoring the bills drawn on them by their customers, providing consultancy services on financial and investment matters to customers, etc.

    In the process of performing all the above-mentioned services. The banks play a key role in economic development and nation-building. They help the country in achieving its socio-economic objectives. With the nationalization of banks, the priority sector and the needy people provide sufficient funds which helm them in establishing themselves. In this way, the banks provide a firm and durable foundation for the economic development of every country.

    Commercial Banks Meaning Functions and Significances - ilearnlot
    Commercial Banks: Meaning, Functions, and Significances!

    Types of Commercial Banks:

    The following chart depicts the main types of commercial banks in India.

    Scheduled Banks and Non-scheduled Banks:

    Banks classify into two broad categories—scheduled banks and non-scheduled banks.

    Scheduled banks are those banks which include in the Second Schedule of the Reserve Bank of India. A scheduled bank must have a paid-up capital and reserves of at least Rs 5 lakh. RBI provides special facilities including credit to scheduled banks. Some of the important scheduled banks are the State Bank of India and its subsidiary banks, nationalized banks, foreign banks, etc.

    Non-scheduled Banks:

    The banks which did not include in the Second Schedule of RBI are known as non-scheduled banks. A non-scheduled bank has a paid-up capital and reserves of less than Rs 5 lakh. Such banks are small banks and their field of operation also limited.

    A passing reference to some other types of commercial banks will be informative.

    Industrial Banks provide finance to industrial concerns by subscribing (buying) shares and debentures of companies and also giving long-term loans to acquire machinery, plants, etc. Foreign Exchange Banks are commercial banks that are branches of foreign banks and facilitate international financial transactions through buying and selling of foreign bills.

    Agricultural Banks finance agriculture and provide long-term loans for buying tractors and installing tube wells. Saving Banks mobilize small savings of the people in the savings account, e.g., Post office savings bank. Cooperative Banks organizing by the people for their collective benefits. They advance loans to their members at a fair rate of interest.

    The Significances of Commercial Banks:

    Banks play such an important role in the economic development of a country that a modern industrial economy cannot exist without them. They constitute a Nerve center of production, trade, and industry of a country.

    In the words of Wick-sell,

    “Bank is the heart and central point of the modern exchange economy.”

    The following points highlight the significance of commercial banks:

    1. They promote savings and accelerate the rate of capital formation.
    2. They are the source of finance and credit for trade and industry.
    3. It promotes balanced regional development by opening branches in backward areas.
    4. Bank credit enables entrepreneurs to innovate and invest which accelerates the process of economic development.
    5. They help in promoting large-scale production and growth of priority sectors such as agriculture, small-scale industry, retail trade, and export.
    6. They create credit in the sense that they can give more loans and advances than the cash position of the depositor’s permits.
    7. It helps commerce and industry to expand their field of operation.
    8. Thus, they make optimum utilization of resources possible.