by Banks play a crucial role in the modern economy by acting as financial intermediaries between savers and borrowers. Their primary purpose is to mobilize public savings and allocate these funds towards productive uses, thereby supporting economic growth, development, and financial stability.
The primary functions of banks include accepting deposits, such as savings, current, and fixed deposits, from individuals, businesses, and institutions. They use these deposits to extend loans and advances for personal, commercial, and industrial needs, earning interest as their main source of income. Banks also facilitate credit creation, which expands the money supply and supports greater economic activity.
Another essential function is providing payment and settlement services. Banks issue cheques, demand drafts, pay orders, debit and credit cards, and offer electronic transfers like NEFT, RTGS, and IMPS, making the transfer of funds efficient and secure.
Beyond these, banks perform secondary functions like agency services (collecting payments, paying bills), general utility services (locker facilities, forex services), and advisory roles (investment advice, portfolio management, underwriting securities). They also help in credit rating, offer safe custody of valuables, and support foreign trade through letters of credit and guarantees.
Primary Functions of Banks
- Accepting Deposits
The most basic and crucial function of banks is accepting deposits from individuals, businesses, and institutions. Banks provide different types of deposit accounts such as savings accounts, current accounts, fixed deposits, and recurring deposits, each designed for specific customer needs. Savings deposits encourage individuals to save money and earn interest, while current accounts help businesses with frequent transactions. Fixed and recurring deposits help customers earn higher interest over time. By collecting deposits, banks pool funds for lending and investment activities, contributing to capital formation in the economy. This function also helps promote financial inclusion by bringing unbanked individuals into the formal financial system.
- Providing Loans and Advances
Banks lend money to individuals, businesses, and governments to support various needs such as personal expenses, home purchases, education, business expansion, or infrastructure development. Types of loans include personal loans, housing loans, vehicle loans, commercial loans, working capital loans, and project finance. Advances like cash credit and overdrafts help businesses meet short-term liquidity needs. Banks charge interest on loans, which is a primary income source. By providing credit, banks stimulate economic activities, generate employment, and increase production. Proper loan evaluation, credit appraisal, and risk management are critical to ensuring responsible lending and maintaining the financial system’s stability.
- Credit Creation
Credit creation is a unique feature of banks, allowing them to multiply the money supply beyond their actual cash reserves. When a bank lends money, it credits the borrower’s account rather than handing out physical cash, effectively creating new deposits in the system. This process increases the purchasing power in the economy, enabling more spending, investment, and production. However, excessive credit creation can lead to inflation, while restricted credit can stifle economic growth. Therefore, banks must balance credit expansion with monetary policy guidelines and maintain adequate capital reserves to support the created credit.
- Issuing Cheques, Drafts, and Pay Orders
Banks provide customers with cheque books, demand drafts, and pay orders to facilitate non-cash transactions. A cheque allows an account holder to instruct the bank to pay a certain sum to another party. Demand drafts are prepaid negotiable instruments guaranteeing payment, commonly used in business transactions and education fee payments. Pay orders work similarly for local payments. These instruments reduce the risks of carrying cash and promote safe and convenient transfers. By offering such services, banks improve payment efficiency, foster trust in financial transactions, and support the formalization of the financial system.
- Fund Transfers and Remittance Services
Banks play an essential role in facilitating money transfers across cities, states, and countries. Domestically, they offer electronic fund transfer services such as NEFT (National Electronic Funds Transfer), RTGS (Real-Time Gross Settlement), and IMPS (Immediate Payment Service). For international transactions, banks use systems like SWIFT (Society for Worldwide Interbank Financial Telecommunication). These services enable businesses to settle invoices, families to send remittances, and governments to distribute subsidies or pensions. Secure, efficient fund transfer systems strengthen economic integration, support business operations, and promote global trade connectivity, making them indispensable to modern economic functioning.
- Discounting Bills of Exchange
Banks offer bill discounting services, where they purchase trade bills or promissory notes from sellers at a discounted value before maturity. This service provides immediate liquidity to businesses that would otherwise have to wait for payment from buyers. Discounting improves cash flow, ensures uninterrupted operations, and reduces working capital pressures. The bank earns a discounting fee, and the buyer settles the bill on maturity. This function plays a vital role in trade financing by helping businesses maintain a steady financial position, handle short-term obligations, and strengthen supplier relationships.
- Safekeeping and Custody Services
Banks provide safekeeping services by offering lockers and safe deposit boxes where customers can store valuable items such as jewelry, important documents, and certificates. This service ensures security against theft, fire, or damage at home. Banks charge a nominal fee for locker services and maintain confidentiality and access control. By offering custody services, banks build customer trust, promote long-term relationships, and extend their role beyond traditional financial transactions. This function also indirectly strengthens the financial system, as customers using lockers are more likely to engage in other banking services.
Secondary Functions of Banks
- Agency Functions
Banks perform various agency services on behalf of their customers. They collect cheques, drafts, dividends, and interest payments and pay utility bills, taxes, and insurance premiums. They handle standing instructions for regular payments and act as trustees, executors, or representatives in managing assets or estates. By providing these services, banks save customers time and effort, adding convenience and reliability. Agency functions also offer banks cross-selling opportunities, helping them promote other products such as loans, credit cards, or investment services. Overall, agency functions deepen customer relationships and enhance the bank’s role as a financial partner.
- General Utility Services
Apart from deposits and loans, banks offer general utility services such as issuing traveler’s cheques, foreign currency exchange, debit and credit cards, and safe custody of securities. They also provide internet banking, mobile banking, and ATM facilities, enabling 24/7 access to financial services. Banks issue letters of credit and guarantees, crucial in international trade. Portfolio management, mutual fund distribution, and wealth advisory services cater to high-net-worth clients. These utility services generate fee-based income for banks, broaden their service offerings, and improve competitiveness in a dynamic financial marketplace.
- Investment and Portfolio Services
Many commercial banks help customers manage their investments by offering portfolio management services. Banks analyze client needs, risk tolerance, and financial goals to recommend suitable investment products such as mutual funds, bonds, stocks, insurance plans, and retirement schemes. They help customers diversify their investments, optimize returns, and manage risks effectively. Banks also manage institutional investments, ensuring efficient asset allocation. By providing such services, banks support long-term wealth creation for customers and generate additional non-interest income streams for themselves. Investment advisory services position banks as trusted financial consultants.
- Credit Rating and Credit Information
Banks collect and maintain records on the creditworthiness of borrowers. They evaluate borrowers’ credit histories, repayment patterns, and financial stability to assess loan risks. Banks also share customer credit information with credit bureaus like CIBIL, Equifax, or Experian, helping create a national credit database. A robust credit rating system reduces the chances of loan defaults and ensures that credit flows to eligible and responsible borrowers. This function strengthens the overall financial system, enhances market transparency, and promotes responsible borrowing behavior among individuals and businesses.
- Underwriting of Securities
Banks, particularly investment banks, assist companies in raising funds from capital markets by underwriting securities such as shares, debentures, or bonds. Underwriting involves guaranteeing the purchase of unsold shares in a public offering, reducing the issuer’s financial risk. By providing this service, banks ensure that companies can successfully raise the necessary funds for expansion, new projects, or debt refinancing. Banks earn underwriting fees and strengthen their position in the capital market. This function supports the smooth functioning of primary markets and encourages capital formation in the economy.
- Foreign Exchange Services
Banks authorized to deal in foreign exchange offer a wide range of services related to cross-border trade, travel, and investment. They facilitate currency conversion, issue forex cards, handle wire transfers, and provide hedging products like forward contracts and options. Banks also assist businesses with export and import financing by issuing letters of credit, bank guarantees, and trade documentation. By providing reliable foreign exchange services, banks promote international trade, attract foreign investments, and contribute to a healthy balance of payments. These services also generate valuable fee and commission income.
- Advisory and Consultancy Services
Banks offer specialized advisory services to corporate clients, small businesses, and high-net-worth individuals. This includes business restructuring, project financing, mergers and acquisitions (M&A), taxation advice, legal compliance, and financial planning. Banks deploy teams of experts to provide tailored solutions, helping clients achieve operational efficiency and financial success. These consultancy services help banks build long-term partnerships, earn consultancy fees, and expand their influence in the business ecosystem. Advisory services also reinforce banks’ reputations as knowledgeable and trustworthy financial institutions, giving them a competitive edge in the market.
- Promoting Financial Inclusion
A critical secondary function of banks, especially in developing countries like India, is promoting financial inclusion. Banks open zero-balance accounts, provide small savings schemes, offer microcredit, and expand their branch and ATM networks into rural and underserved areas. Digital banking initiatives, mobile banking, and government schemes like Jan Dhan Yojana aim to bring marginalized populations into the formal financial system. By promoting financial inclusion, banks help reduce poverty, empower individuals, and contribute to inclusive economic growth. Financial inclusion also increases the deposit base, giving banks more resources for productive lending.
