UNIT – COMMERCIAL BANK

Meaning
Bank is an institution authorized by a government to accept deposits, pay interest, clear cheques,
issue loans, act as an intermediary in financial transactions and provide other financial services
to its customers.

Meaning of Commercial Bank

Commercial bank is a financial institution that accepts deposit from account holders and lends
money who wants to implement for productive purposes.
Example: State Bank of India, ICICI, IDBI, Vijaya Bank, Bank of India etc. are the Commercial
Banks in India.

Significance of Commercial Banks

Commercial Banks play a vital and dynamic role in the economic life of the nation as they keep
the wheels of trade, commerce and industry. They mobilize the dormant funds into a productive
channel. The significance of the Commercial Banks can be summarized as follows:

a) Capital Formation: Banks facilitate capital formation by promoting savings.

b) Innovation: Bank credit enables the enterprises to innovate and invest and thus uplift
economic activity.

c) Monetary Policy: A well-developed banking system is required to promote economic

development by controlling a period of inflation and deflation.

d) Credit Creations: Credit creation enables the expansion of business and mitigation of
unemployment and raises production.

e) Encouragement of Trade and Industry: Banking system encourages trade and industry
by providing long-term loans to traders and industrialists at low rates.

f) Promotion of Habit of saving: Banks encourage savings habit by accepting, deposits and
giving interests on it.

g) Volume of Production: Production volume can be increased by expansion of credit by

banks.

h) Technology: Commercial banks use and update the latest technology and providing the
better services to customers.

Role of Commercial Bank

Commercial banks play an important and active role in the economic development of a country. If
the banking system in a country is effective, efficient and disciplined it brings about a rapid growth
in the various sectors of the economy. The following is the significance of commercial banks in the
economic development of a country:

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Assistant Prof. of Commerce
 1. Promotion of capital formation: Commercial banks accept deposits from individuals and
businesses, these deposits are then made available to the businesses which make use of them for
productive purposes in the country.

2. Encourage to Invest in new enterprises: Businessmen normally hesitate to invest their

money in risky enterprises. The commercial banks generally provide short and medium term
loans to entrepreneurs to invest in new enterprises and adopt new methods of production. The
provision of timely credit increases the productive capacity of the economy.

3. Promotion of trade and industry: With the growth of commercial banking, there is vast
expansion in trade and industry. The use of bank draft, check, bill of exchange, credit cards and
letters of credit etc., has revolutionized both national and international trade.

4. Development of agriculture: The commercial banks particularly in developing countries are

now providing credit for development of agriculture and small-scale industries in rural areas.
The provision of credit to agriculture sector has greatly helped in raising agriculture productivity
and income of the farmers.

5. Balanced development of different States: The commercial banks play an important role in
achieving balanced development in different states of the country. They help in transferring
surplus capital from developed regions to the less developed regions.

6. Influencing economic activity: The banks can also influence the economic activity of the
country through its influence on a. Availability of credit b. The rate of interest If the commercial
banks are able to increase the amount of money in circulation through credit creation or by
lowering the rate of interest, it directly affects economic development.

7. Implementation of Monetary policy: The central bank of the country controls and regulates
volume of credit through the active cooperation of the banking system in the country. It helps in
bringing price stability and promotes economic growth within the shortest possible period of
time.

8. Encourage for Export promotion: In order to increase the exports of the country, the
commercial banks have established export promotion cells. They provide information about
general trade and economic conditions both inside and outside the country to its customers. The
banks are therefore, making positive contribution in the process of economic development.

Functions of Commercial Bank

Important functions of Commercial Banks are given below:
1. PRIMARY FUNCTIONS
Primary banking functions of the commercial banks include:

I. ACCEPTANCE OF DEPOSITS
Commercial bank accepts various types of deposits from public especially from its clients. These
deposits are payable after a certain time period. Banks generally accept three types of deposits
viz., (a) Current Deposits (b) Savings Deposits (c) Fixed Deposits and d) Recurring Deposit.

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Assistant Prof. of Commerce
 a. Current Deposits: These deposits are also known as demand deposits. These deposits can be
withdrawn at any time. Generally, no interest is allowed on current deposits, and in case, the
customer is required to leave a minimum balance undrawn with the bank.

b. Savings Deposits: This is meant mainly for professional men and middle class people to
help them deposit their small savings. It can be opened without any introduction. Money
can be deposited at any time but the maximum cannot go beyond a certain limit.

c. Fixed Deposits: These deposits are also known as time deposits. These deposits cannot be
withdrawn before the expiry of the period for which they are deposited or without giving a
prior notice for withdrawal

d. Recurring Deposit: Recurring Deposits are a special kind of Term Deposits offered by
banks in India which help people with regular incomes to deposit a fixed amount every
month into their Recurring Deposit account and earn interest at the rate applicable to Fixed
Deposits. It is similar to making FDs of a certain amount in monthly installments, for
example Rs 1000 every month.

II. ADVANCING LOANS

Loans are made against personal security, gold and silver, stocks of goods and other assets. The
second primary function of a commercial bank is to make loans and advances to all types of
persons, particularly to businessmen and entrepreneurs. The most common way of advancing loans
are given below:
a. Overdraft Facilities: In this case, the depositor in a current account is allowed to draw over
and above his account up to a previously agreed limit. Suppose a businessman has
only Rs. 6,000/- in his current account in a bank but requires Rs. 12,000/- to meet his
expenses. He may approach his bank and borrow the additional amount of Rs. 6,000/-.

b. Cash Credit: Under this account, the bank gives loans to the borrowers against certain
security. But the entire loan is not given at one particular time, instead the amount is
credited into his account in the bank; but under emergency cash will be given. The borrower
is required to pay interest only on the amount of credit availed to him.

c. Discounting Bills of Exchange: This is another type of lending which is very popular with
the modern banks. The holder of a bill can get it discounted by the bank, when he is in need
of money. After deducting its commission, the bank pays the present price of the bill to the
holder. Such bills form good investment for a bank.

d. Money at Call: Banks grant loans for a very short period, generally not exceeding 7 days to
the borrowers, usually dealers or brokers in stock exchange markets against collateral
securities like stock or equity shares, debentures, etc., offered by them. Such advances are
repayable immediately at short notice hence; they are described as money at call or call
money.

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Assistant Prof. of Commerce
 e. Term Loans: Banks give term loans to traders, industrialists and now to agriculturists also
against some collateral securities. Term loans are so-called because their maturity period
varies between 1 to 10 years.

f. Consumer Credit: Banks also grant credit to households in a limited amount to buy some
durable consumer goods such as television sets, refrigerators, etc., or to meet some
personal needs like payment of hospital bills etc. Such consumer credit is made in a lump
sum and is repayable in installments in a short time.

g. Miscellaneous Advances: The other forms of bank advances there are packing credits given
to exporters for a short duration, export bills purchased/discounted, import finance-advances
against import bills, finance to the self-employed, credit to the public sector and credit to the
cooperative sector.

III. CREATION OF CREDIT

Credit creation is the multiple expansions of banks demand deposits. It is an open secret now
that banks advance a major portion of their deposits to the borrowers and keep smaller parts of
deposits to the customers on demand. Even then the customers of the banks have full confidence
that the depositor’s lying in the banks is quite safe and can be withdrawn on demand.

IV. PROMOTE THE USE OF CHEQUES, DD OR ONLINE TRANSACTIONS

The commercial banks render an important service by providing to their customers a cheap
medium of exchange like cheques. It is found much more convenient to settle debts through
cheques rather than through the use of cash. The cheque is the most developed type of credit
instrument in the money market.

V. FINANCING FOR INTERNAL AND FOREIGN TRADE

The bank finances internal and foreign trade through discounting of exchange bills. Sometimes,
the bank gives short-term loans to traders on the security of commercial papers. This discounting
business greatly facilitates the movement of internal and external trade.

VI. REMITTANCE OF FUNDS

Commercial banks, on account of their network of branches throughout the country, also provide
facilities to remit funds from one place to another for their customers by issuing bank drafts, mail
transfers or telegraphic transfers on nominal commission charges. As compared to the postal money
orders or other instruments, bank drafts have proved to be a much cheaper mode of transferring
money and have helped the business community considerably.

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Assistant Prof. of Commerce
 2. SECONDARY FUNCTIONS
Secondary banking functions of the commercial banks include:
i) Agency Services
ii) General Utility Services

I. AGENCY SERVICES
Commercial banks act as attorney for their clients. They buy and sell shares and bonds, receive
and pay utility bills, premiums, dividends, rents and interest for their clients. Banks also perform
certain agency functions for and on behalf of their customers. The agency services are of
immense value to the people at large. The various agency services rendered by banks are as
follows:

a) Collection and Payment of Credit Instruments: Banks collect and pay various credit
instruments like cheques, bills of exchange, promissory notes etc., on behalf of their customers

b) Purchase and Sale of Securities: Banks purchase and sell various securities like shares, stocks,
bonds, debentures on behalf of their customers.

c) Collection of Dividends on Shares: Banks collect dividends and interest on shares and
debentures of their customers and credit them to their accounts.

d) Acts as Correspondent: Sometimes banks act as representative and correspondents of their

customers. They get passports, traveler’s tickets and even secure air and sea passages for their
customers.

e) Income-tax Consultancy: Banks may also employ income tax experts to prepare income tax
returns for their customers and to help them to get refund of income tax.

f) Execution of Standing Orders: Banks execute the standing instructions of their customers for
making various periodic payments. They pay subscriptions, rents, insurance premium etc., on
behalf of their customers.

g) Acts as Trustee and Executor: Banks preserve the ‘Wills’ of their customers and execute them
after their death

II. GENERAL UTILITY SERVICES

General utility services are those services which are rendered by commercial banks not only to
the customers but also to the general public. In addition to agency services, the modern banks
provide many general utility services for the community as given below:
a) Safety Locker Facility
b) Collection of Cheque amount
c) Issuing Letter of Credit
d) Bank Drafts e) ATM
f) Debit Card
g) Credit Card
h) Tele-Banking
i) Internet banking

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Assistant Prof. of Commerce
a) Safety Locker Facility
A bank undertakes the safe custody of the customer’s valuables and documents by providing
a safe deposit vault. These are kept in specially constructed strong rooms. There are lockers
available to the customer on a nominal charge. There are two keys for each locker, one is
given to the customer and the other remains with the Bank Manager. The locker is opened as
well as closed by both the keys one after another.

b) Collection of Cheques
The customers deposit cheques, bills of exchange and promissory note into their accounts
with the banks. These instruments are collected by the bank on behalf of their customers and
credited to their accounts. These services are provided by the cheques, bills and promissory
notes issued on branches out of the city are collected with some nominal charges for postage etc.
this is a very popular and essential service provided by the banks to their customers.

c) Issuing Letter of Credit

A letter of credit is a commercial instrument of assured payment. It is widely used by the
businessman for various purposes. The bank undertakes to make payment to a seller on
production of documents stipulated in the letter of credit. It specifies as to when payment is to
be made which may be either on presentation of documents by the paying bank or at some
future date depending upon the terms stipulated in the letter.

d) Bank Drafts
A bank draft is an order from one branch to another branch of the same bank to pay a
specified sum of money to a person named therein or to his order. A draft is always payable on
demand. Banks issue drafts at the request of the customers on their branches at the place of
destination for remitting money from one place to another place.

e) Automated Teller Machine (ATM)

ATM is a channel of banking service to its customers. It’s traditional and primary use is to
dispense cash upon insertion of a plastic card and its unique PIN i.e. Personal Identification
Number. The banks issue ATM card to their customers having current or savings account
holding a certain minimum balance in their accounts.

f) Debit Card
A debit card is a plastic card that provides an alternative payment method to cash when
making purchases. Functionally, it can be called an electronic check, as the funds are withdrawn
directly from either the bank account or from the remaining balance on the card. In some cases, the
cards are designed exclusively for use on the Internet, and so there is no physical card.

g) Credit Card
A credit card is an instrument of payment. It is a source of revolving credit. The cards are plastic
cards issued by the banks to their customers. The name of the customer, card number and expiry

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Assistant Prof. of Commerce
date are printed on the plastic cards. Some banks also use the photograph of the customers on the
credit card. The cardholder can buy goods or services from various merchant establishments where
such arrangements exist.

h) Tele Banking
Telephone banking is a service provided by a Commercial Banks, which allows its
customers to perform transactions over the telephone. Most telephone banking services use an
automated phone answering system with phone keypad response or voice recognition capability.

i) Internet Banking
Internet is a channel of service to banking customers. The access to account information as
well as transaction is offered through the world-wide-web network of computers on the internet.
Each account holder is provided with a PIN similar to that of ATM or phone banking. The access
to the account is allowed to the customer upon a match of the account details and PIN entered on
the computer system.

Meaning of Credit Creation

Credit creation is the power of commercial banks to expand secondary deposits either through
the process of issuing loans or through investment in securities. Credit creation is the multiple
expansions of banks demand deposits.

Credit Creation by Commercial Banks

The creation of credit or deposits is one of the most vital operations of the commercial
banks. Similar to other corporations, banks aim at earnings profits. For this intention, they accept
cash in demand deposits and advance loans on credit to customers. When a bank advances funds, it
does not pay the amount in currency notes. However, it introduces a current account in the name of
the investor and lets him to withdraw the necessary amount by cheques. By this way, banks create
deposits or credit. The stability of price level is an essential condition for the economic
development. It highly depends upon the demand and supply of money. The supply of money
includes the legal tender money and bank money.

The legal tender money is issued by the Central Bank or the government of the country in
the form of Bank/Currency notes while the bank money is created by the banks.
The bank money consists of bank deposits. Cheques drawn on bank deposits act as the legal tender
money, i.e., with cheques payment obligation can be settled. Thus, banks are not merely purveyors
of money but also the manufacturers of money.

The creation of credit or deposits may be arrived in the following two ways:
1. Primary deposit and 2. Derivative deposits

Primary Deposits
When customer deposits cash to commercial bank, the deposit is called as the primary
deposit. Primary deposits arise or formed when cash or cheque is deposited by customers. When a

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Assistant Prof. of Commerce
 person deposits money or cheque, the bank will credit his account. The customer is free to
withdraw the amount whenever he wants by cheques. These deposits are called “primary deposits”
or “cash deposits

Derivative deposits
Deposits which arise on account of granting loan or purchase of assets by a bank are called
“derivative deposits.” When a bank grants a loan to a customer it does not usually pay the
amount in cash, instead it credits an account with the amount of loan. That is, the bank places a
deposit at the borrower's disposal and he can freely withdraw the amount as he likes. The loan
which a banker grants to a customer usually large corporate creates additional deposits, i.e., by
advancing loans, banks create deposits and thus, create money. So "Money is said to be created
when the banks, through their lending activities, make a net addition to the total supply of money
in the economy".

Techniques of Credit Creation

1. Credit creation by overdraft and 2. Credit creation by purchase of securities

1. Credit creation by overdraft

By over drafting bank creates credit. Secondly bank purchases the securities and pays them with
its own cheques. The holders of these cheques deposit them in the same banks. This creates deposit
which is nothing other than creation of credit.

2. Credit creation by purchase of securities

When loans are advanced, it is not given in cash. The bank opens a deposit account in the
name of the borrower and allows him draw to draw whenever required. The loan advanced by
cheques results in the creation of new demand deposits. Sometimes, a question arises that it
borrowers with draw these deposits for the repayment to other persons, then how the banks
will create credit. The answer is that other persons who receive money may also be the clients of
the bank. Naturally they will also deposit their cash in the bank. The process remains continue.
We can explain it by the following example:
Example
Suppose a person deposits 1,000 in a bank. According to experience bank can keep 20%
cash reserve to meet the demands of the depositors, and can lend the rest safely to the borrowers.
If the entire bank maintains a reserve ratio of 20% then banks can succeed in creating a credit a
credit of Rs. 5000 against an original deposit of Rs. 1,000 in cash.

Meaning of Capital Formation

Capital formation means increasing the stock of real capital in a country. Capital formation
involves making of more capital goods such as machines, tools, factories, transport equipment,
materials, electricity, etc., which are all used for future production of goods.

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Assistant Prof. of Commerce
 Investment Policy of Commercial Bank
Investments form a significant portion of a bank's assets, next only to loans and advances, and
are an important source of overall income. Commercial banks' investments are of three broad types:
(a) Government securities and
(b) other approved securities.
These three are also categorized into SLR (Statutory Liquidity Ratio) investment and non-
SLR investments. SLR investments comprise Government and other approved securities, while non-
SLR investments consist of 'other securities' which comprise commercial papers, shares, bonds and
debentures issued by the corporate sector. Under the SLR requirement, banks are required to invest
a prescribed minimum of their net demand and time liabilities (NDTL) in Government- and other
approved securities under the BR act, 1949. (Note that SLR is prescribed in terms of banks'
liabilities and not assets).
This provision amounts to 'directed investment', as the law directs banks to invest a
certain minimum part of their NDTL in specific securities. While the SLR provision reduces a
bank's flexibility to determine its asset mix, it helps the Government finance its fiscal deficit. It is
the RBI that lays down guidelines regarding investments in SLR and non- SLR securities. Bank
investments are handled by banks through their respective Treasury Department.

Area of Investment Policy

1. Government Security
A Government security is a tradable instrument issued by the Central Government or the State
Governments. It acknowledges the Government’s debt obligation. Such securities are short term
(usually called treasury bills, with original maturities of less than one year) or long term (usually
called Government bonds or dated securities with original maturity of one year or more).

A) Treasury Bills (T-bills)

Treasury bills or T-bills, which are money market instruments, are short term debt instruments
issued by the Government of India and are presently issued in three tenors, namely, 91 days, 182
days, and 364 days. Treasury bills are zero coupon securities and pay no interest. They are issued at
a discount and redeemed at the face value at maturity. For example, a 91-day Treasury bill of
Rs.100/- (face value) may be issued at stay Rs. 98.20, that is, at a discount of say, Rs.1.80 and
would be redeemed at the face value of Rs.100/-

B) Cash Management Bills (CMBs)

Government of India, in consultation with the Reserve Bank of India, has decided to issue a new
short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary
mismatches in the cash flow of the Government. The CMBs have the generic character of T-bills
but are issued for maturities less than 91 days.

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Assistant Prof. of Commerce
C) Bonds
a) Fixed Rate Bonds: These are bonds on which the coupon rate is fixed for the entire life of the
bond. Most Government bonds are issued as fixed rate bonds.
For example: April 22, 2018. Coupon on this security will be paid half-yearly at 4.12% (half yearly
payment being the half of the annual coupon of 8.24%) of the face value on October 22 and April
22 of each year.

b) Floating Rate Bonds: Floating Rate Bonds are securities which do not have a fixed coupon rate.
The coupon is re-set at pre-announced intervals (say, every six months or one year) by adding a
spread over a base rate.

In the case of most floating rate bonds issued by the Government of India so far, the base rate is
the weighted average cut-off yield of the last three 364- day Treasury Bills auctions preceding the
coupon re-set date and the spread is decided through the auction. Floating Rate Bonds were first
issued in September 1995 in India.

For example, a Floating Rate Bond was issued on July 2, 2002 for a tenor of 15 years, thus
maturing on July 2, 2017. The base rate on the bond for the coupon payments was fixed at 6.50%
being the weighted average rate of implicit yield on 364-day Treasury Bills during the preceding six
auctions. In the bond auction, a cut-off spread (markup over the benchmark rate) of 34 basis points
(0.34%) was decided. Hence the coupon for the first six months was fixed at 6.84%.

c) Zero Coupon Bonds: Zero coupon bonds are bonds with no coupon payments. Like Treasury
Bills, they are issued at a discount to the face value. The Government of India issued such
securities in the nineties. It has not issued zero coupon bonds after that.

d) State Development Loans (SDLs)

State Governments also raise loans from the market. SDLs are dated securities issued through an
auction similar to the auctions conducted for dated securities issued by the Central Government.
Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date. dated
securities issued by the Central Government, SDLs issued by the State Governments qualify
for SLR. They are also eligible as collaterals for borrowing through market repo as well as
borrowing by eligible entities from the RBI under the Liquidity Adjustment Facility (LAF).

2. Other approved securities

Bank may invest its surplus funds in any commercial, private & cooperative Banks but if
any such bank provides considerably higher rate of interest then its financial position has to be
analyzed.
Investment of the liquid surplus funds from time to time has to be made in such a way that
there should not be any difficulty in meeting out the funds requirement for daily clearing adjustment
as well as payment of the deposits on due dates of maturity.

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Assistant Prof. of Commerce
 a) Commercial Papers
A commercial paper is an unsecured short-term instrument issued by the large banks and
corporations in the form of promissory note, negotiable and transferable by endorsement and
delivery with a fixed maturity period to meet the short-term financial requirement.

b) Certificate of Deposits
Certificates of deposit are unsecured, negotiable, short-term instruments in bearer form,
issued by commercial banks and development financial institutions.

c) Repurchase Agreement (Repo)

Repo is a money market instrument, which enables collateralized short term borrowing and
lending through sale/purchase operations in debt instruments. Under a repo transaction, a holder of
securities sells them to an investor with an agreement to repurchase at a predetermined date and
rate. It is a temporary sale of debt involving full transfer of ownership of the securities, that is,
the assignment of voting and financial rights.

d) Commercial bill market

Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. It
enhances he liability to make payment in a fixed date when goods are bought on credit.
According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a written instrument
containing an unconditional order, signed by the maker, directing to pay a certain amount of
money only to a particular person, or to the bearer of the instrument.

Meaning of Liquidity
Liquidity is the ability to quickly convert an investment or asset into cash. This is a measure
of the extent to which a person or organization has cash to meet immediate and short-term
obligations or assets that can be quickly converted to do this.

Meaning of Profitability
Profitability is defined as the potential of a company to exceed its overall revenue from its
total expenses which results in profit generation.
A business must achieve profitability in order to sustain its operations. Profitability measures the
efficiency of the company. Profitability is measured as a ratio of profit to revenue.

Profitability of Commercial Bank

Profitability is the ability of a business to earn a profit. A profit is what is left of the
revenue a business generates after it pays all expenses directly related to the generation of the
revenue, such as producing a product, and other expenses related to the conduct of the business'
activities. Equally important is the principle of 'profitability' in bank advance like other
commercial institutions, banks must make profits. Firstly, they have to pay interest on the
deposits received by them. They have to incur expenses on establishment, rent, stationery, etc.

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Assistant Prof. of Commerce
They have to make provision for depreciation of their fixed assets and also for any possible bad
or doubtful debts. After meeting all these items of expenditure which enter the running cost of
banks, a reasonable profit must be made; otherwise, it will not be possible to carry anything to
the reserve or pay dividend to the shareholders. It is after considering all these factors that a bank
decides upon its lending rate. It is sometimes possible that a particular transaction may not
appear profitable in itself, but there may be some ancillary business available, such as deposits
from the borrower's other concerns or his foreign exchange business, which may be highly
remunerative. In this way, the transaction may on the whole be profitable for the bank. It should,
however, be noted that lending rates are affected by the Bank Rate, inter-bank competition and
the Central Bank's directives (e.g. Directives of Reserve Bank of India), if any. The rates may
also differ depending on the borrower's credit, nature of security, mode of charge, and form and
type of advance, whether it is a cash credit, loan pre-shipment finance or a consumer loan, etc.

Factors Affecting the Profitability of Commercial Banks

Various Factors Affecting the Profitability of Commercial Banks are: i)
Level of competition
Increase in competition generally leads to higher operating costs. This leads to lower
profitability.

ii) Cost of funds

Cost of funds are the expenses incurred on obtaining funds from various sources in the form of
share capital, reserves, deposits, and borrowings. Thus, it generally refers to interest expenses.
Lower the cost of funds, higher the profitability.

iii) Level of Non-performing assets (NPAs)

The profitability of a bank is inversely related to the level of NPAs. Hence, over the years, the
NPAs of commercial banks have greatly declined.

iv) Level of technology

Use of upgraded technology normally leads to decline in the operating costs of
banks. This improves the profitability of banks.

v) Risk cost
This cost is associated to the probable annual loss on assets. They include
provisions made towards bad debts and doubtful debts. Lower risk costs increase
the profitability of banks.

vi) Operating Costs: Operating costs are the expenses incurred in the functioning of the bank.
Excluding cost of funds, all other expenses are operating costs. Lower operating costs give rise
to greater profitability of the banks.

vii) Spread
Spread is defined as the difference between the interest received (interest
income) and the interest paid (interest expense). Higher spread indicates more

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Assistant Prof. of Commerce
 efficient financial intermediation and higher net income. Thus, higher spread leads
to higher profitability.

viii) Non-interest income

It is the income derived from non-financial assets and services. It includes commission &
brokerage on remittance facility, rent of locker facility, fees for underwriting and financial
guarantees, etc. This income adds to the profitability of banks.

Regulation and Control of Commercial Banks by RBI

The Financial Institutions includes Development Financial Institutions
(DFIs) and Non-Banking Financial Companies (NBFCs). Following are the
principle guidelines which are related to the Regulation and Control of Commercial
Banks issued by RBI:

1. Licensing Requirements
To do a business of commercial banking in India, whether it is India or Foreign, a license
from RBI is required. Opening of Branches is handled by the Branch Authorization Policy. At
present, Indian banks no longer require a license from the Reserve Bank for opening a branch at a
place with population of below 50,000.
2. Corporate Governance in Banks
One of the policy objectives of RBI is to ensure high-quality corporate governance in banks.
RBI has issued guidelines for ‘fit and proper’ criteria for director of banks. One of these guidelines
is that the directors of the banks should have special knowledge / experience in the various banking
related areas. RBI can also appoint additional directors to the board of a banking company.
3. Interest Rates
The interest rates on most of the categories of deposits and lending transactions have been
deregulated and are largely determined by banks. Reserve Bank regulates the interest rates on
savings bank accounts and deposits of non-resident Indians (NRI), small loans up to rupees two
lakhs, export credits and a few other categories of advances.

4. Prudential Norms
Prudential Norms refers to ideal / responsible norms maintained by the banks. RBI issues
“Prudential Norms” to be followed by the commercial banks to strengthen the balance sheets of
banks. Some of them are related to income recognition, asset classification and provisioning,
capital adequacy, investments portfolio and capital market exposures. RBI has issued its guidelines
under the Basel II for risk management.

5. Disclosure Norms
One of the important tools for marketing discipline is to maintain public disclosure of
relevant information. As per RBI’s directives, the banks are required to make disclosures of their
annual reports and some other documents about their capital adequacy, asset quality, liquidity,
earnings aspects and penalties imposed on them by the regulator.

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Assistant Prof. of Commerce
 6. Para – banking Activities
Para - banking activities are those activities which don’t come under the traditional banking
activities. Examples of such activities are asset management, mutual funds business, insurance
business, merchant banking activities, factoring services, venture capital, card business, equity
participation in venture funds and leasing. The RBI has permitted banks to undertake these
activities under the guidelines issued by it from time to time.

7. Annual Inspection
RBI undertakes annual on-site inspection of banks to assess their financial health and to
evaluate their performance in terms of quality of management, capital adequacy, asset quality,
earnings, liquidity position as well as internal control systems. Based on the findings of the
inspection, banks are assigned supervisory ratings.

8. Anti-Money Laundering Norms

KYC norms (Know Your Customer) Anti- Money Laundering (AML) and Combating
Financing of Terrorism (CFT) guidelines are some of the major issues on which RBI keeps
issuing its norms and guidelines.

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Assistant Prof. of Commerce
 IMPORTANT QUESTIONS
Section A
1. What is Bank?
2. What is commercial bank?
3. State any two roles of commercial bank?
4. Mention any two functions of commercial bank?
5. State any two public or general utility functions of bank.
6. What is creation of credit?
7. What is Primary Deposit?
8. Give the meaning of Derivative Deposit.
9. What is Cash Credit?
10. What is Liquidity?
11. Give the meaning of Profitability.
12. What is Remittance of Funds?
13. What is Letter of Credit?
14. Give the meaning of Investment Policy.
15. What are Government Securities?

Section-B
1. Discuss significance of Commercial Banks.
2. Explain techniques of Credit Creation by Commercial Banks. Dec. 2010
3. What are the agency services of Commercial Bank? Discuss.
4. Discuss about Letter of Credit.
5. Explain various Government Securities.
6. What are the factors affecting the Profitability of Commercial Banks?

Section-C
1. Discuss various roles of Commercial Bank.
2. Explain techniques of Credit Creation.0
3. Discuss Primary and Secondary functions of Commercial Banks.
4. Explain Investment Policy of Commercial Bank.
5. Discuss various factors affecting the Profitability of Commercial Banks.
6. Explain regulation and control of Commercial Banks by RBI.
7. Discuss the main sources of funds for Commercial banks.

UDAY N
Assistant Prof. of Commerce