Commercial Banks - Lecture notes 1 PDF

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Commercial Banks...

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What is Commercial Bank? A commercial bank is a kind of financial institution that carries all the operations related to deposit and withdrawal of money for the general public, providing loans for investment, and other such activities. These banks are profit-making institutions and do business only to make a profit. The two primary characteristics of a commercial bank are lending and borrowing. The bank receives the deposits and gives money to various projects to earn interest (profit). The rate of interest that a bank offers to the depositors is known as the borrowing rate, while the rate at which a bank lends money is known as the lending rate.  Commercial banks offer consumers and small to mid-sized businesses with basic banking services including deposit accounts and loans.  These banks make money from a variety of fees and by earning interest income from loans.  Banks have traditionally been located in physical locations, but a growing number now operates exclusively online.  Commercial banks are important to the economy because they create capital, credit, and liquidity in the market.

How Commercial Banks Work Commercial banks provide basic banking services to the general public—to both individual consumers and small to mid-sized businesses. As mentioned above, these services include checking and savings accounts, loans and mortgages, basic investment services such as CDs, as well as other services such as safe deposit boxes. Banks make money from service charges and fees. These fees vary based on the products, ranging from account fees (monthly maintenance charges, minimum balance fees, overdraft fees, non-sufficient funds (NSF) charges), safe deposit box fees, and late fees. Many loan products also contain fees in addition to interest charges. Banks also earn money from interest they earn by lending out money to other clients. The funds they lend comes from customer deposits. However, the interest rate paid by the bank on the money they borrow is less than the rate charged on the money they lend. For instance, a bank may offer savings account customers an annual interest rate of 0.25%, while charging mortgage clients 5.75% in interest annually.

Commercial banks have traditionally been located in buildings where customers come to use teller window services and automated teller machines (ATMs) to do their routine banking. With the rise in technology, most banks now allow their customers to do most of the same services online that they could do in person including transfers, deposits, and bill payments. Many institutions are online-only banks. Because these banks don't have any brick-and-mortar locations, they can offer a wider range of products and services at a lower cost—or none at all—to their customers. A growing number of commercial banks operate exclusively online, where all transactions with the commercial bank must be made electronically. Commercial banks are an important part of the economy. Not only do they provide consumers with an essential service, but they also help create capital and liquidity in the market. This entails taking money that their customers deposit for their savings and lending it out to others. Commercial banks play a role in the creation of credit, which leads to an increase in production, employment, and consumer spending, thereby boosting the economy. As such, commercial banks are heavily regulated by central banks. For instance, central banks impose reserve requirements on commercial banks. This means banks are required to hold a certain percentage of their consumer deposits at the central bank as a cushion if there's a rush to withdraw funds by the general public.

Special Considerations Customers find commercial bank investments, such as savings accounts and CDs, attractive because they are insured by the Federal Deposit Insurance Corporation (FDIC), and money can be easily withdrawn. Customers have the option to withdraw money upon demand and the balances are fully insured up to $250,000, therefore, banks do not have to pay much for this money.1 Many banks pay no interest at all on checking account balances, or at least pay very little, and pay interest rates for savings accounts that are well below U.S. Treasury bond (T-bond) rates. However, these investments traditionally pay very low interest rates compared with mutual funds and other investment products. In some cases, commercial bank deposits, such as checking account deposits, pay no interest at all. Consumer lending makes up the bulk of North American bank lending, and of this, residential mortgages make up by far the largest share. Mortgages are used to buy

properties and the homes themselves are often the security that collateralizes the loan. Mortgages are typically written for 30 year repayment periods and interest rates may be fixed, adjustable, or variable. Although a variety of more exotic mortgage products were offered during the U.S. housing bubble of the 2000s, many of the riskier products, including pick-a-payment mortgages and negative amortization loans, are much less common now. Automobile lending is another significant category of secured lending for many banks. Compared to mortgage lending, auto loans are typically for shorter terms and higher rates. Banks face extensive competition in auto lending from other financial institutions, like captive auto financing operations run by automobile manufacturers and dealers. Credit cards are another significant lending type. Credit cards are, in essence, personal lines of credit that can be drawn down at any time. Visa and MasterCard run the proprietary networks through which money is moved around between the shopper's bank and the merchant's bank after a transaction. Not all banks engage in credit card lending and the rates of default are traditionally much higher than in mortgage lending or other types of secured lending. That said, credit card lending delivers lucrative fees for banks—interchange fees charged to merchants for accepting the card and entering into the transaction, late-payment fees, currency exchange, over-the-limit, and other fees for the card user, as well as elevated rates on the balances that credit card users carry from one month to the next.

Function of Commercial Bank:

The functions of commercial banks are classified into two main divisions.

(a) Primary functions Accepts deposit: The bank takes deposits in the form of saving, current, and fixed deposits. The surplus balances collected from the firm and individuals are lent to the temporary requirements of the commercial transactions. There are various products offered by the bank to the customers for the deposit of their money, which includes savings account, current account, fixed deposit and recurring deposit.

Provides loan and advances: Another critical function of this bank is to offer loans and advances to the entrepreneurs and business people, and collect interest. For every bank, it is the primary source of making profits. In this process, a bank retains a small number of deposits as a reserve and offers (lends) the remaining amount to the borrowers in demand loans, overdraft, cash credit, short-run loans, and more such banks.

Credit cash: When a customer is provided with credit or loan, they are not provided with liquid cash. First, a bank account is opened for the customer and then the money is transferred to the account. This process allows the bank to create money.

(b) Secondary functions Discounting bills of exchange: It is a written agreement acknowledging the amount of money to be paid against the goods purchased at a given point of time in the future. The amount can also be cleared before the quoted time through a discounting method of a commercial bank. Overdraft facility: It is an advance given to a customer by keeping the current account to overdraw up to the given limit. Purchasing and selling of the securities: The bank offers you with the facility of selling and buying the securities. Locker facilities: A bank provides locker facilities to the customers to keep their valuables or documents safely. The banks charge a minimum of an annual fee for this service.

Paying and gathering the credit : It uses different instruments like a promissory note, cheques, and bill of exchange.

Types of Commercial Banks:

There are three different types of commercial banks. Private bank –: It is a type of commercial banks where private individuals and businesses own a majority of the share capital. All private banks are recorded as companies with limited liability. Such as Housing Development Finance Corporation (HDFC) Bank, Industrial Credit and Investment Corporation of India (ICICI) Bank, Yes Bank, and more such banks. Public bank –: It is a type of bank that is nationalized, and the government holds a significant stake. For example, Bank of Baroda, State Bank of India (SBI), Dena Bank, Corporation Bank, and Punjab National Bank. Foreign bank –: These banks are established in foreign countries and have branches in other countries. For instance, American Express Bank, Hong Kong and Shanghai Banking Corporation (HSBC), Standard & Chartered Bank, Citibank, and more such banks.

Role of Commercial Banks: Commercial banks of Pakistan play an important role leading towards the economic growth. It is analyzed that most of the well reputed Commercial banks performing functional operation activities in term of persons, institutions operating in the financial markets are linked under the laws, policy and procedure of communications networks that form an externally visible financial market structure. The main objective of the research is to examine and investigate the impact of the commercial banks in bringing improvement in the business conditions of Pakistan through loan facility. The research is quantitative in nature. The questionnaire is utilized to collect the data from the respondents. The data

collected is deeply analyzed and various tests are applied to analyze effective results. The outcome has reflected that the commercial banks have the positive impact in bringing improvement in the business conditions of the Pakistan through the loan facility.

Examples: 1. Allied Bank Limited 2. Askari Bank 3. Bank Alfalah 4. Bank AL Habib 5. Barclays Bank Pakistan 6. Citibank Pakistan 7. Faysal Bank 8. First Women Bank 9. Habib Bank Limited 10.HSBC Pakistan 11.JS Bank 12.KASB Bank Ltd 13.MCB Bank Limited 14.MyBank 15.National bank of Pakistan 16.NIB Bank Pakistan 17.Royal Bank of Scotland Pakistan 18.Standard Chartered Bank Pakistan 19.Silkbank Limited 20.Soneri Bank 21.Summit Bank 22.United Bank Limited

Importance Of Commercial Banks: There is acute shortage of capital. People lack initiative and enterprise. Means of transport are undeveloped. Industry is depressed. The commercial banks help in overcoming these obstacles and promoting economic development. The role of a commercial bank in a developing country is discussed as under.

1. Mobilizing Saving for Capital Formation: The commercial banks help in mobilizing savings through network of branch banking. People in developing countries have low incomes but the banks induce them to save by introducing variety of deposit schemes to suit the needs of individual depositors. They also mobilize idle savings of the few rich. By mobilizing savings, the banks channelize them into productive investments. Thus, they help in the capital formation of a developing country. 2. Financing Industry: The commercial banks finance the industrial sector in a number of ways. They provide short-term, medium-term and long-term loans to industry. In India they provide short-term loans. Income of the Latin American countries like Guatemala, they advance medium-term loans for one to three years. But in Korea, the commercial banks also advance long-term loans to industry. In India, the commercial banks undertake short-term and medium-term financing of small scale industries, and also provide hire- purchase finance. Besides, they underwrite the shares and debentures of large scale industries. Thus they not only provide finance for industry but also help in developing the capital market which is undeveloped in such countries. 3. Financing Trade: The commercial banks help in financing both internal and external trade. The banks provide loans to retailers and wholesalers to stock goods in which they deal. They also help in the movement of goods from one place to another by providing all types of facilities such as discounting and accepting bills of exchange, providing overdraft facilities, issuing drafts, etc. Moreover, they finance both exports and imports of developing countries by providing foreign exchange facilities to importers and exporters of goods.

4. Financing Agriculture: The commercial banks help the large agricultural sector in developing countries in a number of ways. They provide loans to traders in agricultural commodities. They open a network of branches in rural areas to provide agricultural credit. They provide finance directly to agriculturists for the marketing of their produce, for the modernization and mechanization of their farms, for providing irrigation facilities, for developing land, etc. They also provide financial assistance for animal husbandry, dairy farming, sheep breeding, poultry farming, pisciculture and horticulture. The small and marginal farmers and landless agricultural workers, artisans and petty shopkeepers in rural areas are provided financial assistance through the regional rural banks in India. These regional rural banks operate under a commercial bank. Thus the commercial banks meet the credit requirements of all types of rural people. 5. Financing Consumer Activities: People in underdeveloped countries being poor and having low incomes do not possess sufficient financial resources to buy durable consumer goods. The commercial banks advance loans to consumers for the purchase of such items as houses, scooters, fans, refrigerators, etc. In this way, they also help in raising the standard of living of the people in developing countries by providing loans for consumptive activities. 6. Financing Employment Generating Activities: The commercial banks finance employment generating activities in developing countries. They provide loans for the education of young person’s studying in engineering, medical and other vocational institutes of higher learning. They advance loans to young entrepreneurs, medical and engineering graduates, and other technically trained persons in establishing their own business. Such loan

facilities are being provided by a number of commercial banks in India. Thus the banks not only help inhuman capital formation but also in increasing entrepreneurial activities in developing countries. 7. Help in Monetary Policy: The commercial banks help the economic development of a country by faithfully following the monetary policy of the central bank. In fact, the central bank depends upon the commercial banks for the success of its policy of monetary management in keeping with requirements of a developing economy. Thus the commercial banks contribute much to the growth of a developing economy by granting loans to agriculture, trade and industry, by helping in physical and human capital formation and by following the monetary policy of the country....