Understanding The Banking Functions In Detail
Banks have been in existence since a very long time. Understanding banking functions is the most basic thing that one can start with. Historically, the banks begin their operations with the objective of collecting and safeguarding the money of general public. As the world progressed, it was a necessity for banks to widen their functions to keep up with the world.
Today, banks perform numerous functions apart from collecting and safeguarding the money of general public. Banks are at the heart of an economy, pumping liquidity in the market. But, the banking functions are majorly categorized in to 2 categories:
i. Primary functions
ii. Secondary functions.
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Let us understand both the functions in detail:
Primary Banking Functions:
Primary functions are ones which are at the core of the banking philosophy. These include accepting the deposits from the general public as well as lending the money for a specific interest rate. Lets us understand how the primary banking functions are categorized:
Accepting Deposits From The Public:
Banks accept the deposits from the general public and safeguard it. This is the most basic and primary banking functions. The general public comes up with their hard earned money and entrusts the banks with it. The only expectation is that the money should be kept safe and available for withdrawal when required.
How does a bank accept money from public? Banks have various types of deposit accounts through which we can deposit our money.
These Accounts Are Categorized In To The Following Types:
- Savings deposit account: This is the basic type of deposit account. Anyone who is eligible for saving the money can open this account. Some of the banks put up exclusive eligibility criteria with respect to minimum balance, specific credit score, etc. In general, majority of the public sector banks allow the saving deposit to be opened for free of cost. Once you open a savings account you can start depositing money in it. Depending on the benefits, you will get interest on the money deposited in your savings account.
- Current account: This type of accounts are generally available for businessmen. Not everyone can open a current account. Finally, it is at the discretion of the bank to determine whether the individual or a business entity is eligible for current account. The current accounts come with their own perks and benefits. All of this depends upon the bank, individual businessman, business entity, etc. Generally, the money in current account does not get interest.
- Recurring deposit: Recurring deposits are kind of investment instrument where one can deposit the specific amount at a periodic basis. The period of payment, the maturity period, interest rates, everything is mentioned at the time of initiating the deposit. Recurring deposits are kind of a closed ended investment option. In this you can deposit on a periodic basis but withdrawal can be made only at the time maturity. The interest rates on recurring deposits are decent but fixed. Therefore, conservative investors can opt for this.
- Fixed deposit: Fixed deposits are the ones where one can invest their money for a fixed duration and earn interest for the invested period. The interest rates are decent and higher than the recurring deposits. People who are conservative investors and do not want to take risk still prefer to go for fixed deposits.
Lending Money:
So till now, we have seen how the banks collect money. But, what banks do with all that money? How do they stay in business? The answer to these questions is simple. Bank lend the money for a specific duration at a predefined interest rate. This is how they generate interest. A portion of this interest then gets paid to the people who had deposited the money.
Can the bank lend money to anyone? In theory, yes. But, there are certain criteria, guidelines, and checks in place to determine the eligibility and credibility of the applicant.
What are the different ways through which banks lend money?
There Are Different Ways Of Lending Money. Some Of Them Are As Follows:
- Bank Loans: This is the simplest form of lending money. There are various types of bank loans like home loan, marriage loan, vehicle loan, etc. These types of loans are available for general public. The individual can apply for these loans, the bank officials go through the application, verify details like credit score, employment details, etc. Then they get back to the individual with the eligible amount. This is how the general process works. Money gets distributed as loan, the person is under the obligation of repaying the money with certain interest.
- Cash Credits: Cash credit is something where loan is provided in exchange of a security deposit mainly in terms of a collateral mortgage. The loan is granted generally for a short duration as compared to the loans mentioned above. This facility is available for account holders in the same bank and even for those who do not have an account with the bank.
- Overdraft facility: As the name suggests, overdraft facility is something which is given over and above the available limit. These kind of overdraft amounts are granted for even shorter duration. In addition to that, the interest charged on the amount is calculated on a daily basis till the amount is repaid. Generally, the overdraft facility is ideal for the businessmen rather than general public.
There are few other types through which banks can lend money to specific group of people and even the interest rates vary from loan types as well as banks offering the loans.
Secondary Banking Functions:
Till now we have seen the primary banking functions. But that is not where the banking universe stops, there are certain secondary functions which the banks have to perform. These secondary functions are again categorized in to 2 categories:
Agency Functions:
Apart from accepting and lending money, on the secondary front, banks also act as an agency and facilitates the customers accordingly. What are the functions banks have to perform while acting as an agency? The functions are as follows:
- Transfer of funds: In the present scenario, due to the advancement of technology and such a surge in net-banking, mobile banking it might seem that a simple function like transferring funds from one back to other or within the bank is normal. But in the context transferring funds does not follow under the primary functions. These transfers are made through NEFT (National Electronic Funds Transfer), IMPS (Immediate Payment Service), RTGS (Real Time Gross Settlement), etc.
- Periodic payments/collection: In the past, people had to keep a track of all their payments as well as receipts from various investments they have made. To tackle these challenges banks added few more functionalities in their portfolio. The banks have now started periodic payments as well as periodic receipts in order to cater the increasing customer needs. You can give standing instructions or mandates for auto debit on a specific date. By doing this you can relax, the amount gets deducted on that date and respective bills get paid.
- Collecting and clearing financial instruments: You might have heard about various financial instruments which are exchanged in lieu of monetary payments. These instruments include cheques/checks, DD (Demand Drafts), Bill of Exchange, Credit Notes, etc. Banks perform the function of collecting and clearing them. So, in practice, you can walk in to the bank with these financial documents and get the money in exchange. Though seems like a simple and straightforward function it involves a complex and time consuming process.
Utility Functions:
This might seem like unusual that why did the banks had to get in to utility functions. Because competition in the utility sector was booming and creating issues for the banks to keep up. The customer needs starting increasing and hence came the utility functions. These functions are as follows:
- Providing foreign exchange facility: With increase in global mobility and ease of movement from one country to another and hence came the need of integrating foreign exchange with the banking. As a result we see banks engaging in foreign exchange transactions. Providing international banking facility. This has made the life easy, you can deposit money even while staying abroad or do remittance in a foreign country without taking help from any third party ensuring safety of your transactions.
- Safe keeping important articles like gold and other documents: We have seen in movies where people keep their precious articles in a safe box provided by the banks. This is another service which banks provide. You get a safety deposit for an annual fee. The level of security is supreme just the way we see in the movies. Many people utilize this facility to keep their precious jewellery, important documents, etc in these safety deposits.
- Underwriting of shares and debentures: This is a function which has even a broader spectrum in itself. So typically whenever a company wishes to raise capital by offering shares to the general public, they need to appoint an underwriter. Banks perform the function of underwriting. Underwriting comes in to picture in case the subscription offered by the company to the general public is under-subscribed. The under-subscribed portion is then covered by the appointed underwriter and the capital raised. This is a complex process for which I would try to write a separate blog-post in the future.
Peek In To Futuristic Banking Functions:
The above mentioned banking functions are more towards the traditional approach but what about the future? We are observing the rise of cryptocurrency, countries moving towards cashless transactions, privacy and security concerns, and all the other things. So, how should banks improve their focus on meeting the needs of future?
In the coming time we may witness a completely new era of banking. Here, the focus would steer far away from the traditional operations and functions. With things like crypto currency we may see banks coming up with new ways to simplify the complex procedure for getting your virtual currency.
Regarding, the privacy concerns, we will see banks taking the reign on the security measures and ensuring that the customers get complete privacy and safety in their transactions.
On a pessimistic note, we may witness the collapse of the conventional banking structure that we see today. With the progress of human civilization and technology we may adopt a completely new medium for transacting. Hence, we will get to see another chapter getting added to the history of banking.
