Commercial Banks in India: Functions & Types

What Is a Commercial Bank?

A commercial bank is a financial institution authorized by law to receive deposits from businesses and individuals, and lend money to them. Commercial banks serve the public by offering banking services to individuals, institutions, and businesses. Most people interact with commercial banks regularly, making them the most familiar type of banking institution.

In India, commercial banks are regulated by the Reserve Bank of India (RBI), in compliance with the Banking Regulation Act, 1949, and the Payment and Settlement Systems Act, 2007. Banks are also subject to federal and state laws depending on how they are structured and what services they offer.

Primary Functions of Commercial Banks

The two most distinctive features of a commercial bank are borrowing and lending—that is, accepting deposits and lending money to earn interest (profit). These form the core of a bank’s business model.

1. Accepting Deposits

A commercial bank accepts deposits in the form of current, savings, and fixed accounts. By collecting the surplus balances of individuals and firms, banks finance temporary and long-term business needs. Deposits are the lifeblood of banking operations.

The three main types of deposits are:

(i) Current Account Deposits

• Payable on demand with no withdrawal limits
• No interest paid by the bank
• Cheque facilities provided
• Typically used by businesses, traders, and industrialists who make large payments through cheques

(ii) Fixed Deposits (Time Deposits)

• Deposits locked in for a fixed period (days to years)
• Not withdrawable on demand; no cheque facility
• Higher interest rates compared to savings accounts
• Recurring deposits (regular fixed deposits) are also a variant
• Not counted as part of money supply

(iii) Savings Account Deposits

• Designed for individual household savers
• Combine features of current and fixed deposits
• Withdrawable by cheque with restrictions (e.g., 4–5 cheques per month)
• Interest paid, but lower than fixed deposits

Key difference—Demand vs. Time Deposits:

• Demand deposits: Withdrawn anytime, no interest, highly liquid, cheque-enabled (e.g., current accounts)
• Time deposits: Withdrawn only after maturity, fixed interest, less liquid, no cheque facility

2. Providing Loans and Advances

The second major function is lending money to borrowers (primarily businessmen and entrepreneurs) at interest. This is the bank’s main source of income. Banks maintain a reserve portion of deposits and lend the rest to borrowers in various forms:

(i) Cash Credit

An eligible borrower is sanctioned a credit limit. They can withdraw amounts within this limit against security (usually current assets). Interest is charged only on the drawn amount.

(ii) Demand Loans

A loan recalled on demand with no fixed maturity. The entire amount is disbursed in a lump sum. Security brokers and others with fluctuating credit needs typically use these loans.

(iii) Short-Term Loans

Given against security for working capital or priority-sector advances. Repayment is made in one or multiple installments over the loan period.

3. Investment in Securities

Commercial banks invest surplus funds in three types of securities to earn interest:

• Government securities
• Approved securities
• Other marketable securities

Secondary Functions of Commercial Banks

Beyond deposit-taking and lending, commercial banks perform several secondary functions that support commerce and trade.

4. Discounting Bills of Exchange

A bill of exchange is a written promise to pay a fixed sum on a specified future date. Instead of waiting until maturity, the holder can present the bill to a bank for discounting. The bank deducts a commission and pays the present value immediately. When the bill matures, the bank collects payment from the debtor.

Example: Seller B receives a bill from buyer A for goods sold. B needs immediate cash, so B discounts the bill with the bank. The bank pays B the present value, then collects from A later.

5. Overdraft Facility

An overdraft allows a current-account holder to withdraw more than their account balance up to an agreed limit. It is essentially a short-term borrowing facility.

Overdraft vs. Loan:

• Overdraft: Often unsecured on current accounts; borrower pays interest only on daily balance; flexible borrowing
• Loan: Always given against security; interest charged on full sanctioned amount; fixed repayment schedule

6. Agency Functions

Banks act as agents for customers and earn commission on these services:

• Fund transfers: Demand drafts, mail transfers, telegraphic transfers
• Fund collection: Cheques, bills, demand drafts on customer behalf
• Bill payments: Taxes, insurance premiums, utilities per customer instructions
• Securities trading: Buy, sell, and safeguard shares and securities
• Dividend collection: Collect dividends and interest on customer securities
• Trustee services: Act as executor or trustee for customer property
• References: Provide economic standing information to traders

7. General Utility Services

Banks also offer convenience services to customers:

• Traveller’s cheques and gift cheques
• Safe-deposit lockers for valuables and documents
• Security underwriting for government and private issuers
• Foreign exchange (forex) trading and remittance

Types of Commercial Banks in India

Commercial banks in India are classified into two main categories based on RBI regulation:

Scheduled Banks

Scheduled banks are listed in the Second Schedule of the Reserve Bank of India. They must have paid-up capital and reserves of at least Rs 5 lakh. RBI provides special facilities and credit support to scheduled banks.

Examples include:

• State Bank of India (SBI) and its subsidiaries
• Nationalised banks (public sector)
• Private sector banks
• Foreign bank branches operating in India

Non-Scheduled Banks

Non-scheduled banks are not included in RBI’s Second Schedule. They have paid-up capital and reserves of less than Rs 5 lakh and operate on a limited scale with restricted services.

Specialized Commercial Banks

Beyond scheduled and non-scheduled categories, India has several specialized bank types:

• Industrial Banks: Finance industrial concerns through equity subscriptions, debentures, and long-term loans for machinery and plants
• Foreign Exchange Banks: Branches of foreign banks that facilitate international transactions through forex bills and cross-border payments
• Agricultural Banks: Provide long-term agricultural credit for tractors, irrigation, and farm development
• Saving Banks: Focus on mobilizing small savings through savings accounts (e.g., Post Office Saving Bank)
• Cooperative Banks: Organized by communities for collective benefit; advance loans to members at fair rates

Significance of Commercial Banks in the Economy

Commercial banks play a vital role in economic development and financial inclusion:

• Promote savings: Encourage public savings and accelerate capital formation
• Finance credit: Provide credit and finance for trade, industry, and commerce
• Regional development: Expand banking reach to backward and underbanked areas
• Enable innovation: Support entrepreneurs through credit, driving economic growth
• Priority sectors: Finance agriculture, small-scale industry, retail trade, and exports
• Credit creation: Expand money supply by lending more than their cash reserves allow
• Operational expansion: Enable businesses to scale and diversify
• Resource optimization: Allocate capital efficiently across the economy

FAQs: Commercial Banks in India

What is the minimum paid-up capital for a scheduled bank in India?

A scheduled bank must have paid-up capital and reserves of at least Rs 5 lakh and be listed in the Second Schedule of the RBI.

What is the difference between current and savings accounts?

Current accounts offer unlimited withdrawals and cheque facilities but no interest; savings accounts offer limited cheque facilities, restrictions on withdrawals, and interest on balances.

Can a bank charge interest on an overdraft daily balance?

Yes. Unlike loans (where interest is charged on the full sanctioned amount), overdraft interest is calculated and charged only on the daily drawn balance, making it more flexible.

What are the main secondary functions of a commercial bank?

Secondary functions include bill discounting, overdraft facilities, agency services (fund transfers, bill collections), and general utility services (lockers, traveller’s cheques, forex trading).