Functions of banks in an economy

Banks perform these following functions:

  • Collection of the Savings of the Community : Nowadays people do not keep their savings at home. They deposit them in banks. Thereby the risk of loss (from theft, etc.) is avoided. Moreover, some interest is earned. There are different kinds of deposits. Some are current deposits.

The interest paid on such deposits is either very small or nil. Some deposits are withdrawable after a fixed period (one year, two years, etc.) or are subject to certain fraction of the sums deposited, etc.). Such deposits are called time deposits. There are different names for the different varieties of time deposits, e.g., fixed deposits, savings deposits, etc. Time deposits earn higher rates of interest.

  • Loans and Investment: Banks lend money to traders, industrialists, and other persons. Lending is done through a variety of methods. Sometimes an account is opened in the name of the borrower and he is allowed to draw cheques on it.

A man having an account may be given the right to draw more money than what he has in the account. This is known as overdraft facility. A bank may also lend money by discounting a bill of exchange or a Hundi.

Banks invest money on shares and debentures of companies and on Government Promissory Notes. They lend money to industrial concerns against the security of Government Promissory Notes, shares, debentures, gold, goods in course of manufacture, etc. Loans are also given to private individuals against G. P. Notes, shares, debentures, life insurance policies, and gold.

  • Creation of Money : Formerly banks could print and issue notes payable by them on demand. The notes were used as a medium of ex­change. Nowadays only the central bank of the country can issue notes. Banks, however, can give loans in excess of the money deposited with them. Cheques can be drawn against such loans and the cheques can be used as media of exchange. Thus, banks can create money.
  • Other Functions: Commercial banks perform various other functions. For example, they keep valuables in safe custody: lockers, shares, debentures, G.P. Notes, etc., and for the payment of insurance premium, bills, etc. They also, act as executors and trustees of wills; and exchange currencies of different countries for one another.