Commercial Banks - Functions and Credit Creation
A bank is an institution that accepts money deposits from the public and these money deposits are then used for lending to households, firms and government.
The various types of banks in an economy are: Commercial Banks, Central Bank, Co-operative Banks, Regional Rural Banks, Exim Banks, Development Banks, etc.
Commercial Banks are the financial Institutions which play a role of mediator between the depositors and borrowers with a motive of earning profits.
The various functions of commercial banks are categorized under following heads: primary functions, secondary functions and developmental functions.
Primary functions include accepting deposits, advancing loans and credit creation. Secondary functions include agency functions and general utility functions. Social or Developmental Functions of commercial bank includes Promotion of Capital Formation, Rural Develoment Programmes, etc.
Commercial banks normally accept following types of deposits:-
Current or Demand Deposits
Home Safe Account Deposits
Commercial banks advance loans in the following ways:
Discounting Bills of Exchange
Short Term Loans
Commercial banks play a major role in creating credit in the economy.
To understand the credit creation process, we need to understand four things: Primary Deposits, Secondary Deposits, Cash Reserve Ratio and Excess Reserve
Commercial banks have a potential to create multiple deposits out of the initial deposits, based on the money multiplier.
The various factors affecting the process of credit creation are: Total Amount of Cash Reserve, Cash reserve ratio, Business Conditions, banking habits of the people, Monetary Policy of central bank, etc.
Commercial Bank plays a significant role in the economy in following ways: Mobilisation of Savings; Assisting Foreign Trade; Promoting Economic Development, etc.