Commercial banks are financial intermediaries. They accept deposits from the public and lend them in the form of short-term loan to traders and manufacturers. They provide working capital to the business in the form of overdraft and cash credit. Besides, they perform a number of subsidiary services like collection of bills, cheques and drafts, buying and selling of securities etc.
Primary functions of Commercial Banks in Lending Money
Money mobilized by bankers through accepting deposits is disbursed to the needy persons for productive purposes. This function is very important because the economic development of the country mainly depends on the credit schemes of banks. Banks lend money in different forms. They can be either secured or unsecured. The most popular forms of lending are:
- Cash Credits.
- Loans and Advances.
- Discounting of Bills of Exchange.
An overdraft is an arrangement by which the customer is permitted to draw money over and above the credit balance in his account. This facility is provided only to holders of current accounts. It is granted against some collateral security. However the customers have to pay interest for the overdrawn amount.
2. Cash Credit
Cash credit is a short-term credit given to the businessmen for meeting their working capital requirements. It is normally made against certain security. Entire amount of loan will not be given at one particular time. The banker opens the cash credit account in the name of the borrower and permits him to withdraw money from time to time up to a certain limit fixed by the value of stocks kept in the go-down of the borrower. The go-down remains in the possession of the bank.
The borrower takes money from the cash credit account as per his requirements. He cannot at any time exceed the credit limit allowed to him. Here interest is charged only on the amount actually withdrawn by the account holders from the account. This type of loan is very popular among businessmen in India.
3. Loans and Advances
These are direct loans given to all type of customers. These loans are given against the security of the movable and immovable properties. The amount of loan is paid as cash, or customer’s account is credited with it so that he can withdraw the amount from his account at any time. The interest is charged on the full amount of the loan irrespective of the amount of cash withdrawn by him.
The loan is repayable in a lump sum on the expiry of the term for which loan was given. Banks themselves are permitted to determine the rate of interest to be charged on direct loans. However, banks are asked to observe the minimum rate known as Prime Lending Rate while fixing the interest rate here.
4. Discounting of Bills of Exchange
Discounting of bills of exchange is another type of lending by the modern banks. If the holder of bill of exchange needs money immediately, he can get it discounted by the bank. The bank pays the value of the bill to the holder after deducting its commission. When the bill matures, the bank gets payment from the party, which had accepted the bill. By discounting the bills, the banker actually converts a future claim into present money, which enables the holder to carry on his business smoothly. The banker should protect himself against bogus bills. Otherwise he will incur a heavy loss.