Commercial Banking | UGC NET Economics – Notes

Introduction

• Financial intermediaries (FIs) refer to those institutions that serve the money and capital markets. They act as middlemen between lenders and borrowers, creating and issuing financial obligations or claims against themselves to acquire profitable financial claims against others. A chief function of an intermediary is to provide liquidity.

• Financial intermediaries (FIs) can be broadly classified into:

  1. (Commercial banks.

  2. Non-banking financial institutions (NBFIs).

• Commercial Banks are the dominant financial intermediaries. Bank deposits form the dominant portion of the financial savings of the household sector, and bank credit is the most important source of external finance. Commercial Banks can be distinguished from other financial intermediaries in terms of the special power to issue liabilities that are accepted as a means of payment.

• Commercial banks play an important role in the economic development of any country. In this unit, you will learn about the Commercial banks, the functions of commercial banks, the method of credit creation by commercial banks, and the role of Commercial banks in the economic development of a country.

Meaning and Role of Commercial Banks in Economy Development

What is a Commercial Bank?

• The term ‘Bank’ has been defined differently by different economists. A Commercial bank is a profit-seeking institution which pays interest at a low rate to the depositors and charges a higher rate of interest from the borrowers and in this way, the bank earns a profit. Commercial Banks are dealers in debt, and this more aptly describes their activities. A deposit is a debt which the commercial bank owes to the depositor; a banknote is a sort of promissory note — an acknowledgement of the issuing bank’s debt to whomsoever may be the bearer of it; using loans and overdrafts a bank creates debts to itself. All Commercial banks deal in money and credit instruments.

• In the words of Paul Samuelson, “The primary economic function of commercial banks is to hold demand deposits and honour cheques drawn on them — in short, to provide us, the economy with the most important component of our money supply.” It is to be noted that banking is a business like any other business. A Commercial bank is a relatively simpler business concern. It provides certain services for customers (depositors and borrowers) and in return receives payment from them in one form or another. It tries to earn a profit. Acceptance of chequeable deposits from the public is only a necessary, but not a sufficient, function of a bank. It must also lend to others.

• It is difficult to define the term ‘bank’ as the concept itself is rapidly changing given changes in social-economic conditions, government policies, priorities, etc. For example: We see the new trends of digital banks, neo banks, post payments banks, small finance banks, etc. emerging in the country.

• Thus, one can say that a bank is a financial institution that deals in debts and credits. It accepts deposits, lends money and creates money. It bridges the gap between the savers and borrowers. As R. S. Sayers has emphasised, “banks are not merely purveyors of money but also in an important sense manufacturer of money”. From the above, it can be deduced that the bank is a financial institution.