Functions and Characteristics of Commercial Banks

Functions and Characteristics of Commercial Banks

Tags:      Gig Economy     Economy     WTO     WTO Public Stockholding     MSP     Economic Growth     Masala Bond     Environmental Performance Index     Forecast of Economic Growth     Functions of the Finance Commission

The functions of commercial banks include financial intermediation, credit creation, and payment system facilitation. Commercial banks act as intermediaries between surplus units (savers) and deficit units (borrowers). They mobilize funds from depositors and direct these funds to borrowers in need of credit. Commercial banks possess the unique ability to create credit through the process of fractional reserve banking. When they receive deposits, they are required to keep a certain percentage of these deposits as reserves and can lend out the remainder. These banks provide various payment services, such as issuing checks, credit and debit cards, etc. These services enable the smooth functioning of the payment system, promoting financial transactions and trade.

The factors affecting credit creation by commercial banks are reserve requirements, economic conditions, and monetary policy. The reserve requirement set by the central bank impacts the credit creation capacity of commercial banks. A lower reserve requirement allows banks to lend a higher proportion of their deposits, leading to increased credit creation. The overall state of the economy, including economic growth, inflation rates, and the demand for credit, influences the lending decisions of commercial banks. The central bank's monetary policy measures, such as interest rates and open market operations, directly impact the cost of borrowing and, subsequently, the demand for credit.

The advantages of commercial banks pertain to economic growth, financial inclusion, and risk diversification. Commercial banks play a vital role in promoting economic growth by providing funds to productive sectors. They support businesses and entrepreneurs by providing the necessary capital for expansion and investment. Commercial banks contribute to financial inclusion by offering banking services to a wide range of customers. By pooling funds from a diverse customer base, commercial banks can spread risks and reduce the impact of potential defaults.