Commercial Banking in India, Classification, Role Function

Commercial Banks are the most important components of the whole banking system. Commercial bank is a profit-based financial institution that grants loans, accepts deposits, and offers other financial services, such as overdraft facilities and electronic transfer of funds.

According to Culbertson, “Commercial Banks are the institutions that make short make short term bans to business and in the process create money.”

Commercial banks play a significant role in fulfilling the short-term and medium- term financial requirements of industries. They do not provide, long-term credit, so that liquidity of assets should be maintained. The funds of commercial banks belong to the general public and are withdrawn at a short notice; therefore, commercial banks prefers to provide credit for a short period of time backed by tangible and easily marketable securities. Commercial banks, while providing loans to businesses, consider various factors, such as nature and size of business, financial status and profitability of the business, and its ability to repay loans.

Classification of Commercial banks

1. Public Sector Banks

Refer to a type of commercial banks that are nationalized by the government of a country. In public sector banks, the major stake is held by the government. In India, public sector banks operate under the guidelines of Reserve Bank of India (RBI), which is the central bank. Some of the Indian public sector banks are State Bank of India (SBI), Corporation Bank, Bank of Baroda, Dena Bank, and Punjab National Bank.

2. Private Sector Banks

Refer to a kind of commercial banks in which major part of share capital is held by private businesses and individuals. These banks are registered as companies with limited liability. Some of the Indian private sector banks are Vysya Bank, Industrial Credit and Investment Corporation of India (ICICI) Bank, and Housing Development Finance Corporation (HDFC) Bank.

3. Foreign Banks

Refer to commercial banks that are headquartered in a foreign country, but operate branches in different countries. Some of the foreign banks operating in India are Hong Kong and Shanghai Banking Corporation (HSBC), Citibank, American Express Bank, Standard & Chartered Bank, and Grindlay’s Bank. In India, since financial reforms of 1991, there is a rapid increase in the number of foreign banks. Commercial banks mark significant importance in the economic development of a country as well as serving the financial requirements of the general public.

Role of Commercial Banks:

• Mobilization of Savings

Commercial banks encourage individuals, businesses, and institutions to save money by offering various deposit schemes like savings accounts, fixed deposits, and recurring deposits. By pooling these savings, banks create a reservoir of funds that can be utilized for productive purposes, fueling economic growth.

• Credit Creation

One of the primary functions of commercial banks is to create credit by extending loans and advances to individuals, businesses, and industries. Through this process, banks inject money into the economy, facilitating investments, consumption, and overall economic activity. This credit creation is a vital mechanism for boosting economic development.

• Facilitating Trade and Commerce

Commercial banks provide critical financial services such as letters of credit, bill discounting, and trade financing that support domestic and international trade. They ensure the smooth functioning of commerce by offering payment mechanisms like cheques, demand drafts, and electronic fund transfers.

• Promoting Industrial Development

By providing short-term, medium-term, and long-term loans, commercial banks support industrial growth. Financing projects for setting up industries, expanding operations, and adopting new technologies significantly contributes to the development of the industrial sector.

• Supporting Agricultural Sector

Commercial banks play a pivotal role in rural development by offering credit facilities tailored for farmers, agricultural enterprises, and rural industries. Loans for purchasing equipment, seeds, fertilizers, and irrigation systems enhance agricultural productivity, which is critical for an agrarian economy like India.

• Enhancing Entrepreneurship

By offering financial assistance in the form of startup loans, working capital loans, and project financing, commercial banks encourage entrepreneurship. They enable individuals to establish and expand businesses, contributing to innovation, job creation, and economic dynamism.

• Promoting Financial Inclusion

Commercial banks ensure that financial services are accessible to all, including marginalized and underserved communities. Through initiatives such as rural banking, microfinance, and digital banking, they help reduce poverty, empower communities, and promote balanced economic development.

• Providing Investment Opportunities

Banks offer investment options like fixed deposits, mutual funds, and government securities, enabling individuals and institutions to grow their wealth. By managing these investments, commercial banks play a vital role in capital formation and resource allocation in the economy.

Primary Functions of Commercial Banks:

• Accepting Deposits from the public in savings account, current account, fixed deposits, recurring deposits, deposits from NRIs.
• Lending money to the public for their various purposes like personal loans, housing loans, vehicular loans, etc.
• Providing overdraft facility to the credit card holders and under any schemes by the government like in Pradhan Mantri Jan Dhan Yojana Scheme.

Secondary Functions or Para banking Activities of the Commercial Banks:

• Issue debit, credit and prepaid cards.
• Issue Letter of Credit and Bank Guarantee.
• Collect amounts through cheques and other instruments.
• Sale and purchase of shares and debentures.
• Act as investment bank for Initial Public Offering (IPO) by a private company.
• Help in anti-money laundering through KYC process.
• Become an intermediary between its customers and other institutions, like payment of insurance premium, payment of various bills, direct benefit transfer (DBT) scheme of government, etc.

• Provide facilities such as Electronic Clearing Service, transfer of funds domestically and internationally, locker facilities, foreign exchange, etc.