chap 6 commercial banks.ppt

7/29/2019 Chap 6 Commercial Banks.ppt

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9/12/2013 tohidul alam sr lecturer asaub 1

Commercial Banks


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Definition A Commercial Bank is essentially meant for providing short term

credit to trade and industry. Commercial Bank is called the lender ofborrowed money. The main purpose of these banks is to earn profit.It collects the surplus money of people and lends that money thedeficit group. By transferring the deposited money between twogroups, Commercial Bank earns profit.

Commercial Bank generally deals with short term loan. The majorportion of lending money comes from the deposit of people. So, bymaximum utilization of this deposited money of people CommercialBank earn profit. The purpose of providing loan to different

industrial and business areas are to keep the countrys economiccondition smooth and running.


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To define commercial bank Prof. ROGER stated The bank which deals with money and moneys

worth with a view to earn profit is known ascommercial bank.According to New Encyclopedia Britannica- A

commercial banker is a dealer in money insubstitutes for money, such as cheques or bill ofexchanges

A clear concept can be derived from the comment ofProf. Holding on commercial bank. He stated Acommercial bank is defined as a dealer in short

term credit. The aim of the commercial bank is toearn profit. It accepts deposits from a group ofpeople and is a lender of the borrowed funds.


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Objectives of Commercial Bank:1. Profit: The main purpose of Commercial Bank is to earn

profit. Like other business organization, Commercial Bank isonly concern about profit.

2. Media of Exchange: To create easy media of exchange,

Commercial Bank has developed the use of cheque, bill ofexchange etc.

3. Capital Formation: By accumulating the scattered savings from

different sources, formation of capital is one of the mainobjectives of these banks.


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4. Public Welfare: Other than profit earning, one of the objectivesof Commercial Bank is to ensure public welfare. By providing

various types of banking services and by participating indifferent national welfare activities, these banks ensure publicwelfare.

5. Help in Planning: For the development of the country thesebanks provide information to take right decision. It givesinformation about the countrys money and credit market,which help to take accurate plans.

6. Employment Creation: By providing loan and expandingindustrial and business sectors, Commercial Banks help tocreate employment opportunities.


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7. Savings Propensity: Ensuring satisfactory interest rate andproviding various services, Commercial Banks encourage thepeople to save.

8. Economic Stability: One of the objectives of Commercial Bank isto keep the countrys economy stable by providing loan andmeeting the demand of money in the market.

9. Development of Industry and Commerce: Facilitating thedomestic and international exchange, especially helping inexport-import business, Commercial Bank ensure thedevelopment of industry and commerce.

10. Development of Standard of Living: Creating employmentopportunity, Commercial Bank has increased the income levelas well as the living standard of people.


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Differences between central bank and commercial

Banks

Distinction between central bank and commercialbank are existent. Their ways and thinking arequite different. The central bank thinks of graternational interest on the other hand commercial

bank thinks of maximization of profit.Consequently some differences are noticed in theirobjectives, nature of works, methods ofmanagement and other fields. Some of theirdifferences are given below.


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Formation It is established by a

special law orordinance

Such bank is established with

the approval of the govt. onthe basis of existing companylaw under private or publicownership.

Ownership Generally this bankis established undergovt. ownership butsometimes it isestablished underprivate ownership

In most of the cases, it isestablished under privateownership.

Objective Its basic objective isnot to give profitbut grater publicwelfare.

Its basic objective is to gainprofit.


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No. of banks There is only onecentral bank in acountry.

There is more thanone commercial bankin a country.

Control It is totally control andrun by the government.

It is controlled andrun by the owner orshareholders

Govt. influence There is direct govt.influence over it.

There is indirectinfluence of thegovernment over itthrough central bank.

Agent It works as an agent ofthe state.

Sometimes it worksas an agent of theclient.


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State inmoneymarket

It is the organizer,controller and directorof money market.

It is only a member of themoney market under controlof the central bank.

Relation withthe govt.

There is direct relationwith the govt.

There is no directrelationship with the govt.But there is relation with thegovt. through central bank.

Competition It does not engage inany competition and ithave on competitorwithin the country

It is engaged in toughcompetition and survivesthrough competition.

Foreignbranches

Generally it does nothave any foreignbranch.

It may have foreign branches


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Note issue Central bank has theauthority to issue notes.

Commercial banks havenot the power to issuenotes.

Credit control It controls credit byincreasing or decreasingcurrency supply.

Commercial banks onlyhelp the central bank inthis respect.

Clearing house As the head of clearinghouse it settlestransaction amongdifferent banks.

As the members ofclearing house theysettle transactionsamong themselvesthrough theintermediary of thecentral bank.


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Lender of thelast resorts.

It acts as the lender ofthe last resort during

monetary crisis of thegovt. or commercialbanks.

At the time of monetarycrisis they take shelter of

the central bank.

Discountingauthority

Central bank has theauthority to discount

class 1 bills ofcommercial banks.

One commercial bankcannot discount bills of

another commercialbank. But they haveauthority to discountbills of clients.

.Customer The govt. is the main

customer of the centralbank. Commercial banksare also treated ascustomer as they takeloan from it.

The customers of

commercial banks arechiefly the generalpeople and the businessorganization.


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Principles of Commercial Bank:1. Principle of Liquidity.

2. Principle of Safety.

3. Principle of Profit earning.4. Principle of Solvency.5. Principle of Cost Control.6. Principle of Savings Collection.7. Principle of Investment.

8. Principle of Service.

9. Principle of Secrecy.

10. Principle of Confidence.11. Principle of Goodwill.

12. Principle of Publicity.

13. Principle of Efficiency.

14. Principle of Commitment to Economic Development.


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Lending Principles of commercial Banks:

1. Safety

a) Character

b) Capital

c) Capacity

d) Collateral

e) Condition

2. Liquidity3. Convertibility

4. Use of credit

5. Profit

6.Type of loan

7. Diversification of credit8. Source of return

9. Amount of Allotment

10. Legal status

11. Guide of central Bank

12. National interest


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Lines of Defense of Commercial Banks:1. Cash on Primary Reserve

2. Money at call & short notice

3. Reserve of near cash

4. Security

5. Investment

6. Cash credit, overdraft

Source of Commercial Bank Fund:1. Paid-up Capital

2. Reserve Fund

3. Deposit

4. Borrowing


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Source of Income of Commercial Bank1. Interest on Loan

2. Investment

3. Discounting of Bill4. Advance

5. Bank Draft, Travelers cheque

6. Underwriting

7. Mail Transfer

8. Locker rent9. Telegraphic Transfer

10. Agency Services

11. Intermediation of Sales & Purchase of Shares

12. Foreign Exchange

13. Import & Export Trade

14. Consultancy Commission

15. Letter of Credit

16. Trustee

17. Rent

18. Sale of Assets


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Functions of Commercial Banks:

Commercial bank holds a special contributionon the development of total economy of acountry and doing a lot of significant and

necessary functions fulfills this contribution.We can discuss the functions of commercialbank under different viewpoints as statedbelow:


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A. General functions:1. Receiving deposits: The most important function of a commercial

bank is to collect its funds mainly through deposit mobilization. Itpools the scattered savings of different community and thus servesas the reservoir of the communitys savings.

2. Disburse loans and advances: The other major function of acommercial bank is to disburse loans and advances to

businessman, traders and others for a short period with a specificrate of interest.

3. Creation of deposit through loan: The most distinctive function ofa commercial bank is to create deposit by lending money. That iscommercial bank asks the client to open an account with the bankto withdraw the sanction loan and bank deposits the loan amount

in that account. Then the borrower draws money in different timesfrom the bank by issuing cheques on that account. Thus, for ashort period some amount remains stay on bank account. In thisway commercial bank creates deposits through loandisbursement.


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4. Create medium of exchange: Through issuing different types ofcheques, promissory notes, bill of exchange etc. commercial bankcreates easy and low expensive medium of exchange to fluctuate

the economy.

5. Formation of capital and investment: The formation of capital fortrade, industry through collection of savings is an importantfunction of a commercial bank. And commercial bank invests the

deposited money in different sectors for the development of thecountrys economy.

6. Assists in credit control: As the member of money marketcommercial bank assists the central bank in implementing the

credit control mechanisms introduced by them and thus establish asmooth economy in the country.

7. Discounting Bills: Commercial bank helps businessmanfinancially through discounting bills, hundi etc. prior to maturity.


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B. Agency Services:1. Transfer of money: Commercial bank transfers money from one

place to another through electronic transfer, mail transfer,

telegraphic transfer, travelers cheques, bank draft etc.2. Settlement of transaction: Commercial bank pays the money of

bill of exchange, cheque etc. on behalf of client. Again it receivesaccounts receivable, bank draft, bill of exchange on behalf ofclients.

3. Purchase and sell of share: Commercial bank purchases and sellsshares, debentures bond etc. on behalf of clients for a sum ofcommission.

4. Trustee: Commercial bank acts as trustee in sometime and takesthe responsibility to maintain the assets of clients.

5. Other functions: Commercial bank pays and receives house rentof clients, takes dividend, pension and receives insurance

premium on behalf of clients.


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C. Utility Services:1. Appreciate on savings: It is an important task for commercial bank to

appreciate on savings through different means. Because with these

saved money, commercial bank maintains their business.2. Advisor: Commercial bank gives necessary advice on payment of tax,

insurance premium etc. for their clients.

3. Foreign exchange: Commercial bank helps people through buying andselling foreign currency.

4. Business consultancy: Commercial bank gives valuable advice tocommercial and industrial organizations on technical and otherimportant factors.

5. Underwriter: For formation of capital for the industrial organizations ofcountry, commercial bank many times takes the liability to underwriteof shares, debentures etc. of different companies.

6. Help in traveling: Through issuing travelers cheque, travelers note,drafts etc. commercial bank gives chance and advantages to travelers.

7. Safe-custody: Commercial bank helps its clients by reserving its clientsvaluable assets like ornaments, bonds, document etc. in its locker.

8. Secret information: Some time commercial bank gives secret financial

information of his clients competitor business organization.


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9/12/2013 tohidul alam, sr lecturer, asaub 22

Credit CreationThe commercial bank has the power to expand deposit

through expanding their loans and advances is known ascredit creation.

Bank credit refers to bank loans and advances and credit creation literallymeans the multiplication of loans and advances.

As every bank loan creates an equal deposit, credit creation by banksimplies also multiplication of bank deposits.

The word creation implies that banks are unique institutions and that theycan create bank deposits or create bank money (by giving loans andpurchasing bills and bonds) out of nothing.


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Technique of Credit CreationLet us explain, in a highly simplified manner, the

technique or the process of credit creation by

assume

(a) the existence of a number of banks, A, B, C, D etc., each withdifferent sets of depositors;

(b) Every bank to keep 20 percent of cash reserves, according to law;

and

(C) a new deposits of Tk. 1,000/= has been made by a depositor with

bank A start with.


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Liabilities Assets

New Deposit Tk. 1,000 New Cash Tk. 1,000

Total Tk. 1,000 Tk. 1,000

Balance Sheet of Bank A

After the new deposits of Tk. 1,000/= hasbeen made in Bank A, the balance sheet of Ais as follows:


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Liabilities Assets

New Deposit Tk. 1,000 New Cash Tk. 200

Loan to Mr. X Tk. 800

Total Tk. 1,000 Tk. 1,000

Balance Sheet of Bank A

In legal terms Bank A keep only 20% cashreserves and gives a loan of Tk. 800/= to Mr.X. Now the balance sheet of Bank A as

follows:


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Liabilities Assets

New Deposit Tk. 800 New Cash Tk. 800

Total Tk. 800 Tk. 800

Balance Sheet of Bank B

Now creditors of Mr. X who got Tk. 800/=from Bank A, assumed to deposit in Bank B.The balance sheet of Bank B will be as

follows:


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Liabilities Assets


Bill of exchange Tk. 640


Balance Sheet of Bank B

In legal terms Bank B keep only 20% cashreserves and buys bills of exchange worth ofTk. 640 from the market. The balance sheet of

Bank B will be as follows:


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Liabilities Assets



Balance Sheet of Bank C

We can assume that the seller of bills of BankB who received of Tk. 640/= depositing theamount in Bank C. The Bank Cs balance sheet

will be as follows:


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Liabilities Assets


Government bonds Tk.

512


Balance Sheet of Bank C

In legal terms Bank C keep only 20% cash reserves and buyslong term bonds from Mr. Y worth of Tk. 512/= from themarket. The balance sheet of Bank C will be as follows:

Now, Mr. Y who sold the bonds to bank C for Tk. 512/= maybe expected to deposit the amount with his bank, in tern ,will keep 20% as cash reserve and lend the rest.


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This process of a deposit becoming a loan or an investment which,

in turn, becoming a new deposit, goes on and on till the original

deposit of Tk. 1000/= is completely exhausted.

In other words, the original deposits of Tk. 1,000 becomes

additional deposits of Tk. 800, 640, 512, 410, 328 etc. If you add

up all these deposits, the total amount to 5000.


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Let us now summarize what we have explainedabove:

(a) Bank credit is expanded by banks lending more andbuying more assets;

(b) Bank credit eventually comes back to the bankingsystem in the form of new deposits to become the basisfor new bank credit, and so on.

Bank credit Creates Bank deposits

become the basis ofBank credit

Creates Bank deposits

become the basis ofBank credit

etc.


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Essentially, therefore, two processes aretaking place in the banking system

simultaneously:

(a) Bank credit is created and as a result.

(b) Bank deposits are multiplied.

These two processes are called creditcreation on the one side and depositmultiplication on the other. Credit creationis the cause and deposit multiplication is

the effect.


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chap 6 commercial banks.ppt

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