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Classwork Exercise and Series (Economics- SS3): Commercial Banks

Definition of a bank

A bank is a financial institution licensed as a receiver of deposits. It is a commercial institution that performs financial activities. A bank is also an institution that creates money and give out loans to people. It is a place where money and other valuables are kept.

Meaning of commercial banks

A commercial bank can be defined as the financial institution that accepts deposits and other valuables from the public for safe keeping with the main aim of making profit.

A commercial bank is a type of bank that provides services such as accepting deposits, making business loans, and offering basic investment products.

Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses, as opposed to individual members of the public (retail banking).

A commercial bank is a financial institution that performs the services of holding people’s money with the aim of using such money to make business or serves as loan to other people with the aim of making profit. Commercial banks are limited liability companies. Examples of commercial banks in Nigeria are Guaranty Trust Bank, First Bank of Nig. Diamond Bank, Zenith Bank plc etc.

Characteristics of commercial banks

The following points below are the features/ characteristics of commercial banks

  1. The motive of any commercial bank is to make profit
  2. Commercial bank is a limited liability company
  • They accept deposits and other valuables
  1. Commercial banks are members of the money market
  2. Commercial banks are incorporated i.e they are united in one body
  3. Commercial banks are financial entities that accept deposits and provide loans for individuals and businesses.
  • Commercial banks are owned by private individuals or collections of private individuals acting as shareholders. They are regulated by government institutions and must follow all applicable laws, but they are not owned by the government.
  • Commercial banks are operated with the objective of making a profit. Their fee structure and interest rate is designed with the intention of making money for owners and shareholders.

Functions of commercial banks

Commercial banks perform the following functions;

Commercial Banks: Primary and Secondary Functions of Commercial Banks!

(1) Primary Function:

  1. Accepting Deposits:

It is the most important function of commercial banks.

They accept deposits from the people with the hope of keeping it for them; it is the oldest function of the commercial banks.

  1. Such deposits do not enjoy cheque-able facility.
  2. These deposits carry a high rate of interest.
Basis Demand Deposits Fixed Deposits
Cheque facility They are chequeable deposits. They are non-chequeable deposits.
Interest payments They do not carry any interest. They carry interest which varies directly with the period of time.
Number of transactions The depositor can make any number of transactions for deposit or with drawl of money. Depositor generally makes only two transactions: (i) Deposit of Money in the beginning;(ii) Withdrawal of money on maturity.
Number of transactions The depositor can make any number of transactions for deposit or with drawl of money. Depositor generally makes only two transactions: (i) Deposit of Money in the beginning;

(ii) Withdrawal of money on maturity.

(iii) Saving Deposits:

These deposits combine features of both current account deposits and fixed deposits:

  1. The depositors are given cheque facility to withdraw money from their account. But, some restrictions are imposed on number and amount of withdrawals, in order to discourage frequent use of saving deposits.
  2. They carry a rate of interest which is less than interest rate on fixed deposits. It must be noted that Current Account deposits and saving deposits are chequable deposits, whereas, fixed deposit is a non-chequable deposit.
  3. Advancing of Loans:

The deposits received by banks are not allowed to remain idle. So, after keeping certain cash reserves, the balance is given to needy borrowers and interest is charged from them, which is the main source of income for these banks.

Different types of loans and advances made by Commercial banks are:

(i) Cash Credit:

Cash credit refers to a loan given to the borrower against his current assets like shares, stocks, bonds, etc. A credit limit is sanctioned and the amount is credited in his account. The borrower may withdraw any amount within his credit limit and interest is charged on the amount actually withdrawn.

(ii) Demand Loans:

Demand loans refer to those loans which can be recalled on demand by the bank at any time. The entire sum of demand loan is credited to the account and interest is payable on the entire sum.

(iii) Short-term Loans:

They are given as personal loans against some collateral security. The money is credited to the account of borrower and the borrower can withdraw money from his account and interest is payable on the entire sum of loan granted.

(2) Secondary Functions:

  • Overdraft Facility:

It refers to a facility in which a customer is allowed to overdraw his current account up to an agreed limit. This facility is generally given to respectable and reliable customers for a short period. Customers have to pay interest to the bank on the amount overdrawn by them.

  • Discounting Bills of Exchange:

It refers to a facility in which holder of a bill of exchange can get the bill discounted with bank before the maturity. After deducting the commission, bank pays the balance to the holder. On maturity, bank gets its payment from the party which had accepted the bill.

3. Agency Functions:

Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients.

Some of the agency functions are:

(i) Transfer of Funds:

Banks provide the facility of economical and easy remittance of funds from place-to-place with the help of instruments like demand drafts, mail transfers, etc.

(ii) Collection and Payment of Various Items:

Commercial banks collect cheques, bills,’ interest, dividends, subscriptions, rents and other periodical receipts on behalf of their customers and also make payments of taxes, insurance premium, etc. on standing instructions of their clients.

(iii) Purchase and Sale of Foreign Exchange:

Some commercial banks are authorized by the central bank to deal in foreign exchange. They buy and sell foreign exchange on behalf of their customers and help in promoting international trade.

(iv) Purchase and Sale of Securities:

Commercial banks buy and sell stocks and shares of private companies as well as government securities on behalf of their customers.

(v) Income Tax Consultancy:

They also give advice to their customers on matters relating to income tax and even prepare their income tax returns.

(vi) Trustee and Executor:

Commercial banks preserve the wills of their customers as trustees and execute them after their death as executors.

(vii) Letters of Reference:

They give information about the economic position of their customers to traders and provide the similar information about other traders to their customers.

  1. General Utility Functions:

Commercial banks render some general utility services like:

(i) Locker Facility:

Commercial banks provide facility of safety vaults or lockers to keep valuable articles of customers in safe custody.

(ii) Traveller’s Cheques:

Commercial banks issue traveler’s cheques to their customers to avoid risk of taking cash during their journey.

(iii) Letter of Credit:

They also issue letters of credit to their customers to certify their creditworthiness.

(iv) Underwriting Securities:

Commercial banks also undertake the task of underwriting securities. As public has full faith in the creditworthiness of banks, public do not hesitate in buying the securities underwritten by banks.

(v) Collection of Statistics:

Banks collect and publish statistics relating to trade, commerce and industry. Hence, they advice customers on financial matters. Commercial banks receive deposits from the public and use these deposits to give loans. However, loans offered are many times more than the deposits received by banks. This function of banks is known as ‘Money Creation’

(vi) Safe keeping of valuables: They help customers in keeping of their valuables like gold, jewelries, documents etc.

(vii) Foreign exchange transactions: commercial banks help to make foreign currencies available to customers and help in solving problems relating to foreign exchange.

Test and exercise

  1. The major motive of any commercial bank is to (a) make interest (b) make profit (c) keep people’s money and valuables (d) make collection of statistics.
  2. All of these are characteristics of commercial banks except (a) the motive is profit making (b) they accept deposits and other valuables (c) they falsifies and encourage stealing (d) they are members of the money market.
  3. All the following are examples of commercial banks except (a) First Bank of Nigeria (b) Central Bank of Nigeria (c) Guaranty Trust Bank (c) Zenith Bank PLC.
  4. All of these are functions off commercial banks except (a) acceptance of deposits (b) issuance of traveler’s cheque (c) issuing money to anybody (d) safe keeping of valuables.
  5. Types of loans made by commercial banks are these except (a) demand loan (b) supply loan (c) short term loan (d) cash credit.

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