Commercial banks play an important role in the country's Financial Institution System. Commercial banks are profit-making institutions that accept deposits from the general public and lend money (loans) to individuals such as households, entrepreneurs, and businessmen. The primary goal of these banks is to make money through interest, commissions, and other means. The Reserve Bank of India, India's central bank and supreme financial authority, regulates the operations of all commercial banks.

What is a Commercial Bank?

• Commercial Banks operate under the Banking Companies Act, 1956.
• Any banking organization that deals with the deposits and loans of businesses are referred to as a commercial bank.
• Commercial banks issue bank checks and drafts and accept term deposits.
• Through installment loans and overdrafts, commercial banks also serve as moneylenders.
• Commercial banks also provide a variety of deposit accounts, including checking, savings, and time deposits.
• These institutions are run for profit and are owned by a group of people.
• A commercial bank's main source of income is the difference between the two rates which it charges borrowers and pays depositors.

Commercial Banks – Historical Background

• Commercial banks are India's oldest and largest banking institutions. Some of them are more than a century old.
• Their branches can be found all over the country and have even made their way into the countryside.
• Since India's independence, commercial banking has gone through three distinct phases.
• From 1955 to 1970, the period saw the emergence of the public sector in Indian banking, beginning with the establishment of the State Bank of India in 1955 and ending with the nationalization of 14 major banks in 1969.
• The two decades following bank nationalization, namely the 1970s and 1980s, saw the transformation of class banking into mass banking.
  • Branch expansion occurred on a large scale during this time period, followed by the recruitment of a large number of bank employees, expansion of priority sector advancements, particularly for the poor and underserved sectors.
• The post-nationalization era was not without its complications.
  • Poor training reduced employee efficiency and productivity, exacerbated the problem of loan non-recovery, and increased pre-emption of funds in meeting statutory requirements, resulting in lower bank profitability.
• This was the case in 1991 when the government announced new economic policies.
  • Under the Chairmanship of Shri M. Narashimham, a Financial Sector Committee was formed, which proposed far-reaching measures to improve bank efficiency, productivity, and profitability.

Classification of Commercial Banks

• Commercial banks in India are classified into two broad categories based on ownership and management control, namely:
  • Public Sector Banks
  • Private Sector Banks
• Public sector banks account for the majority of the banking business in India and are divided into two types:
  • State Bank of India
  • Nationalized Banks

Public Sector Banks

• These are banks in which the Government of India owns a majority stake.
• This group includes the State Bank of India, India's largest commercial bank.
• The State Bank of India Act, 1955, established the State Bank of India by converting the then-existing Imperial Bank of India into the State Bank of India.
• Following the formation of the State Bank of India in 1955, another 14 banks were nationalized between 1969 and 1991. These were the banks with more than 50 crores in national deposits.
• Another six banks were nationalized in 1980, bringing the total to twenty.
• The formation of the State Bank Group was intended to accelerate the expansion of banking facilities in rural areas.
• The decision to nationalize the major commercial banks was made with the goal of opening a large number of branches throughout the country, particularly in rural areas and mobilizing large amounts of deposits for the purpose of lending to productive purposes.
• Currently, there are a total of 12 Nationalised Banks in India.

Private Sector Banks

• There are two types of private sector banks – Old Private Sector Banks and New Private Sector Banks.

• Old Private Sector Banks are those private sector banks that existed at the time of nationalization.
• No new banks could be established in India prior to 1993.
• The Reserve Bank of India issued guidelines for the establishment of new private sector banks in India in 1993.
• The majority of a bank's share capital is held by private individuals. These banks are set up as limited-liability corporations.
• Private sector banks include ICICI Bank, Axis Bank, HDFC, and others.

Regional Rural Banks

• Regional Rural Banks were established in accordance with the provisions of an Ordinance promulgated on September 26, 1975, and the RRB Act, 1976, with the goal of ensuring adequate institutional credit for agriculture and other rural sectors.
• RRBs can only operate in the areas that have been designated by Gol as covering one or more districts in the state.
• RRBs are jointly owned by Gol, the relevant State Government, and Sponsor Banks; the issued capital of an RRB is divided among the owners in the proportions of 50%, 15%, and 35%, respectively.

Foreign Banks

• These banks are registered and have their headquarters in another country, but they have branches in our country.
• As of now, there are approximately 46 foreign banks operating in India in 2021.
• Foreign banks in India include HSBC, Citibank, Standard Chartered Bank, and others.

Non scheduled commercial Banks

• These banks are not added in the Second Schedule of the Reserve Bank of India Act, 1934.
• Non scheduled commercial banks in India include Capital Local Area Bank Ltd - Phagwara (Punjab), Krishna Bhima Samruddhi Local Area Bank Ltd, Mahbubnagar (Andhra Pradesh), Subhadra Local Area Bank Ltd., Kolhapur (Maharashtra), and others.

Functions of Commercial Banks

Primary Functions

1. Accepts Deposits

• A commercial bank's first primary function is to accept deposits in the form of current, savings, and fixed deposits.

2. Gives Loans and Advances

• The second major function of a commercial bank is to make loans and advances, primarily to businessmen and entrepreneurs, and to earn interest on those loans and advances.
• This is, in fact, the bank's primary source of revenue.
• A bank reserves a portion of its deposits and lends the remainder to borrowers in the form of cash credit, demand loans, short-term loans, and overdrafts.
• Cash Credit – An eligible borrower has first sanctioned a credit limit in this function of a commercial bank, and within that limit, he is allowed to withdraw a certain amount on a given security.
• Demand Loans - In this function of a commercial bank, the entire loan amount is paid in one lump sum by crediting it to the borrower's loan account.
• Short-term Loans - In this commercial bank function, short-term loans are made against collateral as personal loans to finance working capital or as priority sector advances. The entire amount is repaid in one installment or in a series of installments over the loan period.

Secondary Functions

1. Discounting Bills of Exchange

• Bill discounting is a service provided by commercial banks to their depositors.
• A bill of exchange is a promise to pay a specific amount of money at a specific point in the future.
• It can also be encashed earlier by using a commercial bank's discounting process.

2. Credit Creation

• Commercial banks use this function to accept deposits and advance loans by keeping small amounts of cash on hand for day-to-day transactions.
• When a bank advances a loan, it opens an account in the customer's name and does not pay him in cash, but instead allows him to withdraw funds by cheque as needed.

3. Financing Foreign Trade

• Commercial banks offer their customers the option of financing foreign trade by accepting foreign bills of exchange and collecting them from foreign banks.
• These banks also conduct other foreign exchange transactions, such as buying and selling foreign currency.

4. Overdraft Facility

• An overdraft is a loan that allows a customer with a current account to overdraw his account up to a predetermined limit.
• In this function of a commercial bank, the bank allows a depositor to withdraw an amount greater than the balance in his account.

5. Agency Functions of Bank

• The bank acts as a customer's agent and receives a commission for performing agency functions, such as:
  • Collection and transfer of funds
  • Payments of various items
  • Purchase and sale of shares and securities
  • Collection of dividends and interest
  • Letters of reference

6. General Utility Services

• Customers can also get a variety of general utility services from banks. These are as follows:
  • Banks provide travelers and gift cheques to their customers.
  • Customers can keep their ornaments and important documents safe in lockers.
  • It allows you to underwrite securities issued by government, public, or private entities.

Significance of Commercial Banks

• They encourage saving and increase the rate of capital formation.
• They are a source of finance and credit for a country's a trade and industry.
• By establishing branches in backward and remote areas of a country, they promote balanced regional development.
• Bank credit enables entrepreneurs to innovate and invest in large and small-scale industries, accelerating a country's economic development process.
• They contribute to the growth of priority sectors such as agriculture, small-scale industry, retail trade, and export.
• They assist a country's commerce and industry in expanding their field of operation.

Limitations of Commercial Banks

• Banks were asked to open branches in rural and underserved areas where basic infrastructure such as roads, communication, transportation, education, and safe buildings for bank operations do not exist.
• There is a problem with even the security of bank employees in some places.
• Because all public sector banks provide the same service, there has been fierce competition in deposit mobilization.
• There are several financial institutions that provide financing to the same borrowers, including commercial banks, cooperative banks, regional rural banks, and state financial corporations.
  • Because of these numerous organizations and the lack of coordination among these institutions, duplicate financing, over-financing, or under-financing has occurred.
• Though commercial banks have made spectacular efforts to meet the financial needs of the agricultural sector and its allied activities, a more vigorous effort is still required, as commercial banks' total assistance to the agricultural sector is not even 10% of their needs.
• The number of banks in rural areas is quite inadequate in comparison to the need for banking services, as evidenced by the fact that only 5% of villages are served by banks.
• Commercial banks have branches in various parts of the country, but they are not evenly distributed.
  • Around half of the branches are concentrated in the Southern and Western regions.
  • States like Assam, Jammu & Kashmir, Manipur, Nagaland, Orissa, Tripura, Uttar Pradesh, and West Bengal are underbanked.
• Financing of priority sectors, the opening of branches in rural as well as unbanked and backward areas, granting low-interest loans to weaker sections, increase in salary and establishment costs, and increase in overdue resulted in a decline in the rate of profitability of most commercial banks in India.
• The banking industry has been subjected to all of the constraints of the public sector as a result of its nationalization which has resulted in its low efficiency.
  • These include managers' bureaucratic attitudes, a lack of initiative, red-tapism, excessive delays, a lack of commitment, responsibility, and indifference to work, among other things.
• Bank nationalization has resulted in political interference and political pressure at all levels of the banking system.
• The liberal credit policy, which is necessary to meet the credit needs of the weaker sections, the agricultural sector, and so on, has resulted in the insecurity of bank funds and, ultimately, depositors' money.
• A loose credit policy has also resulted in a sluggish recovery.
• Many nationalized banks have multiple branches in the same area. As a result, each of them faces unfair and unnecessary competition in deposit mobilization.

Conclusion

• Commercial banking in India is a one-of-a-kind system found nowhere else in the world.
• Customers' deposits, the issuance of certificates of deposit, and reserves from retained profits are the primary sources of funds for a commercial bank.
• However, deposits are the most important source of funds for commercial banks. They are the lifeline of commercial banks because they are the primary source of bank funds and account for roughly 90% of bank liabilities.