The Role and Structure of Financial Institutions (Banks)
What is a Bank? Definition and Core Role
A bank is a financial institution that accepts deposits from the public and provides loans and other financial services to individuals, businesses, and the government. It acts as an intermediary between those who have surplus funds (depositors) and those who need funds (borrowers).
In simple terms, a bank mobilizes the savings of the public and channels them into productive uses, thereby promoting economic development. It also provides various facilities such as cheque payment, fund transfer, safe deposit lockers, credit cards, internet banking, etc.
Legal Definition (Indian Banking Regulation Act, 1949)
According to the Indian Banking Regulation Act, 1949:
“A banking company is one which transacts the business of banking, which means accepting, for the purpose of lending or investment, deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order, or otherwise.”
Crucial Functions of a Bank
Thus, the main functions of a bank are:
- Accepting deposits: Savings, current, and fixed deposits.
- Lending money: Loans, overdrafts, and advances.
- Facilitating payment and settlement: Through cheques, drafts, and online transfers.
- Providing agency and utility services: Collection of cheques, payment of bills, etc.
Banks play a crucial role in the economic growth of a country by maintaining financial stability, controlling money supply, and encouraging savings and investments.
Classification of Banks: Major Types
Banks can be classified into several categories based on their functions, ownership, and nature of operations. The major types are:
1. Central Bank
The Central Bank is the apex institution that controls and regulates the entire banking system of a country. In India, the Reserve Bank of India (RBI) is the central bank.
Key Functions of the Central Bank:
- Issues currency notes.
- Controls credit and money supply.
- Regulates and supervises other banks.
- Maintains foreign exchange reserves.
- Acts as banker to the government and commercial banks.
The central bank ensures the stability of the financial system and formulates monetary policy for the country.
2. Commercial Banks
These are profit-making financial institutions that accept deposits from the public and provide short-term and medium-term loans to individuals, firms, and businesses.
Categories of Commercial Banks:
- Public Sector Banks: Owned and controlled by the government. Example: State Bank of India (SBI), Punjab National Bank (PNB).
- Private Sector Banks: Owned by private individuals or corporations. Example: HDFC Bank, ICICI Bank.
- Foreign Banks: Headquartered in foreign countries but operate branches in India. Example: HSBC, Citibank, Standard Chartered.
Commercial banks provide services like savings accounts, business loans, credit cards, and online banking.
3. Cooperative Banks
Cooperative banks are organized on the principles of cooperation, mutual help, and self-help. They primarily serve the rural and semi-urban population.
These banks are owned and managed by their members and aim at providing affordable credit rather than earning profits.
Examples: Urban Cooperative Banks, State Cooperative Banks, District Central Cooperative Banks.
4. Development Banks
Development banks provide long-term finance for industrial and infrastructural development. They promote industrial growth and modernization.
Examples: Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI), and National Bank for Agriculture and Rural Development (NABARD).
5. Regional Rural Banks (RRBs)
RRBs were established in 1975 to meet the credit needs of the rural and agricultural sector. They operate mainly in rural areas but have branches in urban areas as well.
Example: Prathama Bank, Andhra Pradesh Grameena Vikas Bank.
6. Specialized Banks
These banks are set up to meet specific financial needs of certain sectors.
- EXIM Bank: For export and import finance.
- SIDBI: For small-scale and micro industries.
- NABARD: For agriculture and rural development.
7. Payment Banks and Small Finance Banks
These are newly established banks in India to promote financial inclusion.
- Payment Banks: Can accept deposits (up to ₹2 lakh) but cannot give loans. Example: Paytm Payments Bank, Airtel Payments Bank.
- Small Finance Banks: Provide loans and financial services to small business owners, farmers, and low-income individuals. Example: AU Small Finance Bank, Equitas Small Finance Bank.
Detailed Functions of Banks
The functions of a bank can be broadly divided into two categories: Primary Functions and Secondary Functions (which include agency and general utility functions).
1. Primary Functions of a Bank
These are the core and most essential functions that every bank performs.
(a) Accepting Deposits
This is the main function of a bank. Banks accept money from the public in the form of deposits, which can be withdrawn as per the customer’s requirement. The main types of deposits are:
- Savings Deposits: For individuals to deposit small savings and earn interest.
- Current Deposits: For businessmen who need to make frequent transactions; no interest is paid.
- Fixed Deposits (Term Deposits): Deposited for a fixed period and earn a higher rate of interest.
- Recurring Deposits: Customers deposit a fixed amount every month for a specific period.
By accepting deposits, banks promote the habit of saving among the public.
(b) Lending Money
Banks use the deposited money to provide loans and advances to individuals, traders, and businesses. This is how banks earn their main income through interest.
Different types of lending include:
- Loans: A fixed amount lent for a specific time period at an agreed interest rate.
- Cash Credit: The customer can withdraw money up to a certain limit.
- Overdraft: Allowing current account holders to withdraw more than their balance.
- Discounting of Bills of Exchange: Banks buy bills of exchange before the due date and provide immediate funds to customers.
Through lending, banks help in capital formation and the economic development of the country.
(c) Credit Creation
Banks have the unique ability to create credit.
When a bank gives a loan, it does not always give cash — instead, it credits the borrower’s account, which increases the money supply in the economy. This process is called credit creation, and it plays an important role in expanding business and trade activities.
(d) Fund Transfer
Banks help in transferring money from one account or branch to another through instruments like cheques, drafts, NEFT, RTGS, and UPI. This function enables quick and safe movement of funds within and outside the country.
2. Secondary Functions of a Bank
Apart from the primary functions, banks also perform several secondary functions to support customers and the economy. These are divided into Agency Functions and General Utility Functions.
(A) Agency Functions
In these functions, the bank acts as an agent of its customers and performs various services on their behalf.
- Collection of Cheques and Bills: Banks collect cheques, bills, and dividends on behalf of customers.
- Payment of Bills: Banks make payments like insurance premiums, rent, and taxes as instructed by customers.
- Purchase and Sale of Securities: Banks help customers in buying and selling shares, bonds, and debentures.
- Acting as Trustee or Executor: Banks can act as trustees or executors of wills and estates.
- Acting as Representative: Banks act as representatives of clients in various financial matters, such as dealing with government departments.
These functions help customers save time and effort in managing their financial affairs.
(B) General Utility Functions
These are the miscellaneous services that banks provide to promote trade, commerce, and convenience.
- Issuing Letters of Credit and Traveller’s Cheques: Helps traders and travelers make payments safely.
- Providing Safe Deposit Lockers: Banks provide lockers for the safe custody of valuables and important documents.
- Issuing Credit and Debit Cards: Modern banks provide electronic payment services for convenience.
- Dealing in Foreign Exchange: Authorized banks exchange foreign currency and assist in foreign trade.
- Underwriting of Shares and Debentures: Banks help companies raise capital by guaranteeing the sale of new issues.
- Internet and Mobile Banking: Providing online services for fund transfer, bill payment, and account management.
- Merchant Banking Services: Assisting in corporate finance, mergers, and project management.
These services increase customer satisfaction and make banking more accessible and efficient.
3. Development and Promotional Functions (Modern Role)
Modern banks also play an important role in the economic development of a country. These include:
- Promoting Financial Inclusion: Providing banking services in rural and remote areas.
- Encouraging Industrial and Agricultural Growth: Providing loans to industries, farmers, and small businesses.
- Mobilizing Savings for Investment: Encouraging savings and converting them into productive capital.
- Employment Generation: Supporting entrepreneurship and business expansion.
- Implementing Government Schemes: Assisting in schemes like Jan Dhan Yojana, Mudra Loans, etc.
Through these functions, banks act as the backbone of the economy.