Functions of Commercial Banks

Commercial banks are financial institutions that carry out commercial services, accept deposits from the public and advance loans. They are formed with the aim of making profit hence are trading businesses like any other. The major functions of commercial banks include:

1) Accepting Deposits

Commercial Banks play a vital role in an economy by mobilizing domestic savings and enabling efficiency and convenience in transactions by accepting deposits i.e. cash items, warrants, E.F.Ts, night safes etc. Bank account deposits are kept in three main accounts:

    • Current Accounts
      • In a current account, deposits of any amount can be made at any time.
      • Here the deposits may earn interest and the account holder is expected to pay some fee to the bank for services provided e.g. account maintenance.
      • Money deposited in this account is withdrawable on demand by means of cheque.
      • Money can be withdrawn from this account at any time during working hours so long as the account has sufficient funds.
      • No minimum cash balance is required to be maintained.
      • Does not earn interest but instead the bank charges ledger fees for services rendered.
      • The banks may allow customers to withdraw more money than they have in their current accounts and this is known as bank overdraft that carries interest at an agreed rate.
    • Savings Account
      • Savings accounts are accounts operated by people who have the intentions of saving money (small savers).
      • The balance on the account above a certain minimum earns interest.
      • Funds are not withdrawn by use of cheques.
      • Overdrafts are not usually allowed in a savings account. In most cases one is required to maintain a certain amount in account.
      • In a savings account, the withdrawal of money exceeding a certain maximum amount might require a notice to be given by the customer of the intended withdrawal.
      • Ordinarily withdrawals from a savings account can only be made by the account holders themselves.
      • Banks don’t use this money as compared with fixed deposit accounts
    • Time Deposits/Fixed Accounts
      • Time deposits or fixed accounts do not allow withdrawal/addition of money into the account before the end of a fixed pre-determined period.
      • They are appropriate for people who have money that they have no immediate use for
      • Earns interest at an agreed rate and the rate of interest depends on the amount deposit as well as the period taken by the deposit. Usually higher than savings account
      • There is usually a minimum amount that can be allowed for this type of account
      • On expiry of deposit period, the account holder can withdraw all the money together with interest or even renew the contract for another similar different term.
      • If the account holder withdraws the money before the expiry date of the agreed deposit period he/she not only loses the accrued interest but might also be charged for breach of contract.
      • There are no bank charges to the account holders.
      • The money held in fixed deposits can be used as security for getting a loan.

2) Lending money/provide loan facilities:

Another function of a commercial bank is to lend money or provide loans to borrowers. In this case, a bank acts as an intermediary between lenders (depositors) and borrowers. A bank loan can also be offered even in form of overdraft. Other types of loans are short term, medium term or long term; mortgages, car loans, business loans, etc.

3) Safekeeping of valuable items

A commercial bank can act as a custodian of valuable items such as title deeds, share certificates, jewelry and wills for safe keeping for their customers and they provide safety vaults and lockers and a nominal fee is charged.

4) Provides money transfer facilities

Another function of a commercial bank is to allow customers to transfer funds to other individuals, organizations or institutions. Money can be transferred from Nairobi to London via commercial banks. Some employees have their salaries transferred to their accounts from employer’s accounts. This arises mainly through standing orders, credit transfers, telegraphic transfers, cheques, bank overdrafts, letters of credit, credit cards and travelers’ cheques.

5) Provision of foreign exchange/effect foreign exchange payments.

A commercial bank also functions as a forex exchange bureau. A person with foreign currency can convert it into local currency in a bank.

6) Provide financial information

Commercial banks provide information about various financial issues. A bank can act as a financial advisor by giving advice on investment and management of funds. For example, a commercial bank can advice customers about the best shares, saving in a fixed deposit account, as well as information on how to engage in foreign trade.

7) Provide trusteeship (trustee services)

Commercial banks act as managers on behalf of their clients. The bank also act as a trustee on behalf of a client who dies and there is no person to manage his/her business affairs effectively. Also takes into account property estate

8) Act as guarantors and referees:

One important role of a commercial bank is to act as a guarantor or referee for an individual or organization. This usually happens to clients who wish to engage in credit transactions to secure loans from other financial institutions or get goods on credit from new suppliers.

9) Act as intermediary between savers and borrowers:

A commercial bank can function as a link is created between savers and borrowers of money and through such a link, economic activities are facilitated. It ensures that money is distributed to important sectors of the economy to facilitate economic activities.

10) Discounts bills of exchange

Commercial banks discount bills of exchange and accept promissory notes from their trusted clients. Discounting a bill means that the bank accepts a bill from its customer and exchanges it for less cash than the amount on the bill because the bill has not yet matured.

11) Provides safer means of payment

Commercial banks also provide safe and reliable means of payment such as cheques, bank overdrafts, credit transfers and other means that are used to make payments.

12) Credit creation

Credit creation refers to the process of creating money from the deposits in the customers’ accounts. In this regard, customers deposits to advance loans to borrowers, as long as there is a minimum reserve.

13) Helps in financing international trade

Commercial banks help in financing international trade by offering mediums of exchanges, promissory notes and letters of credit.

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