Commercial Bank

Commercial Banks are the most common types of banks. These are the chiefly engaged in receiving deposits, advancing loans and discounting bills. They lend money for short period against easily marketable securities. They finance internal trade, deal with credit instrument and render other numbers of services to their customers and play a vital role in the commercial development of the country.

Businessman and salaried persons are provided the facility of operating bank accounts. They settle their accounts by issuing cheques. Those commercial banks who become the member of the central bank are known as scheduled banks.

Methods of Issuing Currency

Various methods have been tried during last hundred years or so to make the system elastic and scientific. Following are some important methods or systems of note issue which were prevalent in different countries of the world in different times:

1. Fixed Fiduciary Reserve System: Under it, currency is issued up to a certain amount without any reserve of gold, but against government securities. However, when currency is needed more than the fixed level it must be backed up by gold penny for penny. This method was adopted by Japan and Norway in early twentieth century.

2. Proportional reserve system: This system calls for a proportionate gold and silver reserve to the total issue of currency. It allows increase or decrease of the ratio as the need be. Due to strong benefits it has become internationally accepted currency-issuing system.

3. Minimum Reserve System: This system was adopted by Holland and the Union of South Africa. This system prescribes merely a minimum percentage of gold reserves against notes and deposits and makes the notes a first charge on all the assets of the central bank.

Clearing House

Dr. D. Cock Says, “Clearing house is that department of central bank where the representative of member banks and financial institutions gather to clear their accounts.”

Clearing house is a place at the central bank or any other leading bank of the locality where the representatives of the member banks come at fixed time and exchange cheques or drafts drawn on each other and settle the resulting balances through entries in the books of the bank acting as clearing house.

The central bank manages and supervises the clearing house to facilitate the clearing of cheques between banks. Every bank usually receives number of cheques drawn on other banks from his customers as deposits.

Bank Deposit Accounts

The first function of commercial bank is to receive deposits. Usually, the customers can deposit their money in several kinds of bank accounts. Some of them are as follows:

1) Fixed Deposit Account: This account is opened for a definite period of time without the expiry of which the amount cannot be withdrawn. The rate of interest is higher than that of savings account. The greater the period for which money is deposited the higher the interest rate is offered.

2) Savings Account: It was introduced by the banks for those who have low incomes and small savings. Those who open it include students, salaried persons, and small traders.

3) Current Account: It is the most popular form of bank account. Current account is operated by businessman. In this account the customer is authorized to deposit or withdraw money any time in or from the bank. The bank does not pay any interest.

How Credit is Created

Now suppose, a person deposits $1000 with a bank, ten percent of which will go to the central bank as such reserve requirement. Hence the commercial bank is left with $900 to be used for advancing loans. The party ‘A’ that borrows this $900 will either buy goods from or make payment to the other party B. The party B will receive the cheque for $900 and deposit it its account with the same commercial bank. Now the bank receives the deposit of $900. Ten percent of this amount ($90) will as usual go to the central bank and the rest of the amount ($810) will be utilized in advancing loans. At this stage the bank has net deposit of $1710 ($900+ $810), though the original deposit is $1000. In this fashion the credit money will go on increasing at every transaction. If the original deposit is $1000 the extent of credit expansion will be $10,000.

Economic Wants

Economic wants means desire for goods and services. The attempt to satisfy wants forms the basis of all economic activity. A desire of a person cannot become want until he has money to purchase and is also willing to give away for that good. Economic wants are fulfilled by consumptions of goods and services.

Necessities of life are basic needs of a person, without which our life is not possible. These include ordinary food, clothing and shelter. Comforts of life make life easy and comfortable. These wants increase efficiency of a person. These wants include better food, comfortable bed and transport facilities. Luxuries of life are neither necessary nor they increase efficiency of a person. These wants include an expensive car, big bungalow etc. These wants are for pomp and show and for mental satisfaction of a consumer.

Economic wants are unlimited, after fulfilling one want another want comes up, hence there is no end to them. Wants once fulfilled, never ends, they are repeated again and again. Some wants are felt urgently than others. Some of them cannot be postponed while others can be postponed. Some wants can be fulfilled with the use of alternative goods.

Economic Policy

Economic policy and economic analysis are closely related. All economic policies are adopted on the basis of economic theories. The creation of policies to achieve specific goals is not a simple matter.

First step is to make a clear statement about economic goals. If we say that we want full employment, do we mean that everyone between 16 and 65 years of age should have a job? Or do we mean that everyone who wants to work should have a job? Therefore economic goals must be specific.

Next step is to formulate alternative policies to achieve the goal and determine the possible effects of each policy. This requires a detailed assessment of economic impact, benefits, costs and political feasibility of alternative policies.

After implementing policy we need to check how well it worked. Only through unbiased evaluation we can improve on economic policy. These policies are augmented at a more specific level by measures designed for industrial investment, research and development and to protect consumer’s interests.

Creation of Credit

Creation of credit is one of the most outstanding function of modern banks. The commercial banks create multiple expansion of their bank deposits and due to this say have sometimes been called manufacturers of credit. The notes and currency issued by the central bank is not the only form of money. The supply of money also includes some sort of credit money in addition to real cash money.

The commercial banks extend loans by much more than the amount of cash possessed by them. This tendency of deposit making by customers and lending more loans by bank in excess of its fund is called ‘creation of credit’.

Customer

It is clearly established that the word “customer” generally denotes a relationship resulting from habit or continued dealings, but for a bank customer this habit of dealing is not essential. The person who has an account with a bank is known as an account holder or customer of that bank.

According to Lord Lindly:
“A customer is a person who has some sort of account, either deposits or current account or same other relationship with a banker.”

According to Dr. Hart:
“A customer is one who has an account with a banker or for whom a banker habitually undertakes to act as such.”

Law of Demand

When price of a good goes up, people buy less of it and when prices goes down, people buy more it, other things being unchanged, it is called Law of Demand.

Prof. Alfred Marshall states the law of Demand as under:
“For the higher sale of the amount of a commodity, its price should fall or when the price falls, the quantity demanded increases and on the contrary, when the price rises, the demand falls provided other things remain the same.”

If different factor like consumer’s income, taste of the consumer, traditions, fashion, habits, prices of the substitute goods etc. will change, the Law of Demand will fail to operate.

What is Demand?

The word ‘demand’ is used as a term in Economics. Common meaning of word ‘demand’ is ‘desire’ but there is a difference in ‘desire’ and ‘demand’ as a term in Economics. If any thing is desired only, it will not be called demand in Economics. The desire, to become a demand, should have the backing of purchasing power or money.

The desire to purchase any thing depends on the demanded price of the commodity. The higher is the price, lower will be the demand. On the contrary, the lower is the price lesser will be the demand. No one can decide about the quantity or amount of a commodity to purchase so long he does not know about the price of the same.

The price that a buyer wants to pay for a certain quantity of a commodity is called ‘Demand Price’. The term ‘Demand’ may be defined as “The human desire of a commodity is called Demand which has support of purchasing power.”

Role of Central Bank in Economic Development

The economic stability of a country is solely dependent on the central bank. It is the only financial institution in the country which is responsible for regulating the banking and monetary system of the country. The need of central bank in a country is essentially felt considering the following services rendered by a central bank for economic development of a developing country.

1. Capital Formation: Economic progress of a country requires adequate amount of capital. Capital is required for agriculture, industrial and commercial development. But in a developing country, it is a chronic problem to procure capital. Central bank as a national institution plays prime role in capital formation in the interest of the nation as a whole. As the guardian of the money market, it regulates the capital flow in the country in proper form and suitable time.

2. Credit Control: Credit is one of the most important source of financing trade and industry. The central bank as the controller of credit can encourage a particular sector of economy by adopting selective credit control.

3. Stability in Prices: The central bank keeps the price level stable in the country by controlling money and credit supply.

Weapons of Credit Control (Qualitative Controls)

1. Direct Action: The central bank may take direct action against commercial banks that violate the rules, orders or advice of the central bank. This punishment is very severe of a commercial bank.

2. Moral persuasion: It is another method by which central bank may get credit supply expanded or contracted. By moral pressure it may prohibit or dissuade commercial banks to deal in speculative business.

3. Legislation: The central bank may also adopt necessary legislation for expanding or contracting credit money in the market.

4. Publicity: The central bank may resort to massive advertising campaign in the news papers, magazines and journals depicting the poor economic conditions of the country suggesting commercial banks and other financial institutions to control credit either by expansion or by contraction.

Weapons of Credit Control (General methods)

1. Bank Rate Policy: Bank rate is the rate of interest which is charged by the central bank on rediscounting the first class bills of exchange and advancing loans against approved securities. This facility is provided to other banks. It is also known as Discount Rate Policy.

2. Open Market Operations: The term “Open Market Operations” in the wider sense means purchase or sale by a central bank of any kind of paper in which it deals, like government securities or any other public securities or trade bills etc. in practice, however the term is applied to purchase or sale of government securities, short-term as well as long-term, at the initiative of the central bank, as a deliberate credit policy.

3. Change in Reserve Ratios: Every commercial bank is required to deposit with the central bank a certain part of its total deposits. When the central bank wants to expand credit it decreases the reserve ratio as required for the commercial banks. And when the central bank wants to contract credit the reserve ratio requirement is increased.

4. Credit Rationing: Credit rationing means restrictions placed by the central bank on demands for accommodation made upon it during times of monetary stringency and declining gold reserves. This method of controlling credit can be justified only as a measure to meet exceptional emergencies because it is open to serious abuse.

Objectives of Credit Control

The central bank makes efforts to control the expansion or contraction of credit in order to keep it at the required level with a view to achieving the following ends.

1. To save Gold Reserves: The central bank adopts various measures of credit control to safe guard the gold reserves against internal and external drains.

2. To achieve stability in the Price level: Frequently changes in prices adversely affect the economy. Inflationary and deflationary trends need to be prevented. This can be achieved by adopting a judicious of credit control.

3. To achieve stability in the Foreign Exchange Rate: Another objective of credit control is to achieve the stability of foreign exchange rate. If the foreign exchange rate is stabilized, it indicates the stable economic conditions of the country.

4. To meet Business Needs: According to Burgess, one of the important objectives of credit control is the “Adjustment of the volume of credit to the volume of Business” credit is needed to meet the requirements of trade an industry. So by controlling credit central bank can meet the requirements of business.

Credit Control

Credit control is one of the principal functions of the central bank. Credit money expands through commercial banks by means of cheques. Credit plays an important role in maintaining and changing the price level as a medium of exchange. It is the responsibility of the central bank to regulate the volume of credit and its direction to maintain stability of the price level.

Credit control means, regulating the volume and direction of bank loans. On the volume of credit depends largely the level of employment and the level of prices in the country.

Secondary Functions of Commercial Banks

Secondary functions are two types:
1. Public utility services
2. Agency services

Public Utility Services: The commercial bank renders money services for the general utility of the community. These services may be enumerated as follows:

• Bank drafts and cheques issued on banks are freely used for receipts and payments in the society. These cheques and drafts economies the use of currency notes and coins for transacting business.
• Commercial banks play a significant role in transferring money. This service is reliable, quick, safe, and inexpensive.
• Commercial banks also issue Letter of credit. It is an open latter from a bank requesting the sellers to send the goods to the buyer and promises to pay the sum by itself.
• Banks offer lockers for the safe custody of precious items. The bank also charges some amount.

Agency Services: Commercial banks also perform the duty of an agent. It collects and pays on behalf of their customers in respect of the following:

• Businessman receives cheques in payment from other parties. These cheques may be drawn on other banks than theirs. They deposit these cheques and with their banks and get the payment. The bank also receives payments against electricity, gas, phone bills from customers. It also receives and pays premiums, dividends, interests, and rents on behalf of its clients. This is most valuable service that the bank performs for its clients.
• On the instructions of its clients the bank buys and sells shares and bonds on the stock exchange.

Primary Functions of Commercial Banks

Functions of commercial banks can be divided in to two categories:
1. Primary functions
2. Secondary functions

Primary functions can further be subdivided into the following:
1. Receiving deposits
2. Advancing Loans

1. Receiving Deposits: This is the function of the formation of capital. A commercial bank receives deposits through different types of accounts. Small savers, salaried people, traders, manufacturers and other deposit their money with the bank under the head of savings, current, or fixed deposit accounts and earn interest income.

2. Advancing Loans: The commercial bank finances the need of businessman in meeting their day to day business requirements. Advances form about sixty percent of investment made by a commercial bank. It is most profitable on the part of the bank.

In our next post, we will describe the secondary functions of Commercial banks.

Capital of a Company

The share capital of a company can be of the following divisions:
Authorized Capital: It is the amount, which has been mentioned in the memorandum of association. It is also the amount which is sanctioned by the controller of capital issue. Authorized capital empowers the company to issue share capital up to that limit and not beyond that.

Issued Capital: Issued capital represents the amount of the capital which has been issued.

Subscribed Capital: It is the sum total of applications received from public in response to prospectus issued. The subscribed may be more than, equal to or less than the issued capital.

Called up Capital: It is that part of issued capital which is called up from the applicants / shareholders. The company may call up the whole of the amount or less. In case the company calls less than the face value of the shares, the shares are said to be partly called-up.

Paid-up Capital: Paid-up capital is the amount of which actual payment has been made by the shareholders.

Non-Scheduled Banks

The banks which are not registered in the list of central bank under its charter are known as non-scheduled banks. They are not bound to perform banking services according to the policies and instructions of central bank e.g. Bank of Punjab was a non-scheduled bank.

These banks do not fulfill the required qualifications of a scheduled bank as prescribed by the central bank. They also do not enjoy the public confidence. In many countries, many non-scheduled banks are also working.