Bank Management

Chapter-2: Commercial Bank

Commercial Bank: Generally the bank which collects deposits according to the nature of
accounts & gives loan from the deposits and gain profit or interest is called commercial bank.
That is, commercial bank is a financial institution which is authorized by law to receive money
from business & individuals and lend money to them. Commercial banks are open to the public
and serve individuals, institutions and business. The inception of modern banking is the outcome
commercial bank. The main element of commercial bank is money and its main objective is to
earn profit. Commercial bank is called “The mother of modern bank”.
According to prof. Roger, “The bank which deals with money and money’s worth with a view to
earn profit is known as commercial bank”.
According to prof. Ashutoshnath, “commercial bank is an intermediary profit making
institution.”

So at last we say that Commercial bank

• Is an intermediary institution of capital and money market

• By various accounts it collects deposits on small rate of interest.
• Gives short-term loan to others on higher rate of interest.
• Main objective is to earn profit.

Inflow and Outflow of Commercial Bank’s Funds:

Inflows of bank funds:

• Increase in deposits
• Increase in borrowing
• Undistributed profit
• Loan recovery
• Return of invested funds on maturity
• Sales proceeds of other assets: if any.
Outflows of bank funds:

• Increase in loans and advances

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• Increase in investment
• Increase in the cash in hand
• Withdrawal of deposits
• Repayment of borrowing
• Payment of dividends
• Increase in other assets

Comparison of different sources of bank funds: Deposits is the principal source of fund for
bank. In addition to deposits, a bank has many other sources of funds. The major sources of bank
funds are discussed below:
Paid-up-capital:

Reserve and retained earnings: Reserves and retained earnings are created out of profits earned
by banks. Unless profits can be increased by maximizing business, rising of reserve base is
particularly impossible.
Call money: Usually this source is utilized by banks to meet emergency needs. Banks which
have excess liquidity usually lend in call money market and banks having shortage of liquidity
borrow. As a source it is neither stable nor desirable from the view point of liquidity and
profitability. Continuous borrowing from call money market gives a wrong signal to other banks
about the bank borrowing such fund. On the other hand, rate of interest in call money market
also many times tend to be very higher.
Inter-bank deposits: Banks do not keep their funds idle for long time. But some banks might
have excess liquidity for the time being. It is possible that they may, under the circumstances,
keep fund with other banks for a shorter period. However, this is not a dependable source of fund
since it may be withdrawn at the will of the depositing bank.
Loan from central bank: This is another ground window of getting funds. Central bank
sometimes provides finance to commercial banks through rediscounting of bills of commercial
banks and counter-finance for specified items. But this source is subject to many limitations and
restrictions. This is not always a welcome method of generating fund.
Deposits: Deposit is the most important and major source of funds of a bank. There is no limit up
to which a bank may raise its deposit level. Sometimes because of operation of restrictive
measures pursued by the central bank, deposit rising may be subject to limits.
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Functions of Commercial Bank:

Principal functions:
Accepting deposits: The first and foremost function of commercial bank is to receive or collect
deposit from the individuals, business houses, public authorities. Generally deposits are collected
through various accounts e.g. current, savings, term deposits accounts. No interest is charged in
the current accounts, lower rate of interest charged in the savings account and comparatively
higher interest rates given in fixed deposits. In this way commercial banks are able to collect
fund and thereby developing customers’ network.
Lending of money: A major portion of the deposits received by a bank is lent by it. This is the
main source of income of a bank. The business of lending is usually done in the form of loans,
overdraft, cash credit, purchase and discounting bill of exchange, financing foreign trade etc.

• Loan: When an advance is made in a lump sum repayable either in fixed monthly
installments’ or in lump sum by way of interest, incidental charges etc. it is called a loan.
• Overdraft: When a customer requires temporary accommodation, he may be allowed to
overdraw on his current account, usually against collateral security and pay interest on
the amount actually used by him.
• Cash credit: A cash credit is an arrangement by which a banker allows his customer to
borrow money against pledge of goods, either in bank’s go down under effective control.
This type of facility is more freely grand by banks than any other advances.
• Purchase and discounting of bill of exchange: Purchase and discounting of bill of
exchange is another way employing the bank’s funds. These bills of exchange are
classified into demand bills and usance bills. Where a bill is payable on demand then it is
called demand bill. If the bill matures for payment after a certain period of time it is
called usance bill.
• Financing of foreign trade: Commercial banks have been playing an important role in
providing adequate financing facilities to both exporters and importers in order to place
our economy in sound footing. Besides commercial banks also undertake to issue
guarantees of various types on behalf of their customers to support trading transactions
both in inland and foreign trade.
Subsidiary Services by Commercial Bank: Besides performing the two essential functions of
accepting deposits and lending & investing its funds modern commercial banks cover a wide
range of financial and non-financial services to their customers and general public. The services
and facilities provided by modern banker may be classified as:

• Agency services.
• General utility or miscellaneous services.
Agency services: Following are the agency services provided by commercial banks to their
customer:
ü Collection and payment: Commercial bank collects and pays values of cheque, bill of
exchange, promissory notes, pension, dividends, insurance premium, and interest on
behalf of the clients.
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ü Purchase and sale of share & securities: Banks undertake to purchase and sell of shares
and debentures of joint stock Company on behalf of its customer only whenever the
customers delegate the work, the bankers should get clear and precisely instruction for
this purpose. In executing the sale or purchase, the bankers act as an agent of the
customer.
ü Execution of standing instructions: A customer may leave standing instructions with
his banker for the payments of sums to various persons or institutions against his account.
Such orders may usually be given in respect of payment of insurance premium,
subscription of club/ society, payment of rent and salaries and similar payments of a
regular recurring nature. The bank may charge small fee for rendering such services.
ü Maintenance of secrecy: Maintenance of secrecy is one of the most important functions
of commercial bank. That is, commercial banks do not disclose information about
customer without his consent.
ü Act as a trustee: Commercial banks act as a trustee on behalf of the customers.
ü As executor and administrator:
ü Remittance of funds: In this competitive world all commercial banks have a network of
branches thought the country. With this facility banks can conveniently provide the
service of transferring funds from one place to another. Important methods of transferring
funds are:
v Mail Transfer (M T): Banks provide the facility of sending money through mail transfer
to any at any place where the bank has a branch and the person has an account in any
other branch of the same bank.
v Telegraphic Transfers (T T): if the money is to be sent urgently, the bank may be
requested for telegraphic transfer on payment of a nominal charge and telegraphic
charges. Such facility is available at selected branches.
v Demand draft (D D): Demand draft is an order from one branch to another branch of the
same bank to pay a specified sum of money to a person named therein or his order. The
draft is payable on demand.
General utility or miscellaneous services: Commercial banks also provide a variety of general
utility services which are briefly discussed below:
Letter of credit: This is a non-fund facility provided by banks to its customers. It is generally
used in international trade.
Traveler’s cheques: Traveler’s cheques, a sort of cash substitute, are universally accepted
method of payment for overseas travelers. It is very useful to persons who frequently travel
abroad. It can be purchased by any one. He needs not be a customer of the bank.
Safe custody of valuables: A bank undertakes the safe custody of a client’s valuables and
important documents against theft and fire. There are two ways through which a banker ensures
safety of its customers’ valuables:

• Safe custody
• Safe deposits vaults (lockers)
When a bank takes care of important documents or other valuable possessions for someone, in
return for a regular charge then it is called safe custody.
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An area, usually found in a bank or other financial institution, which is a safe and secure place
for storing items of value. Vaults are usually used to store cash, as well as customers' safe
deposit boxes.

Bank giro: A method of transferring money by instructing a bank to directly transfer funds from
one bank account to another without the use of checks. Giro transfers have become a more
accepted payment method than checks because they provide security when lost or stolen, and
they can be processed more quickly than a standard check.

Credit card: Credit cards are issued by the banks to good customers having current and savings
accounts, free of charge. The cards enable a customer to purchase goods or services from certain
retail and service establishments up to a certain limit without making immediate payment

Debit card:

Acting as a referee: A bank sometimes acts as a referee as to the responsibility and financial
standing of his customers. This is very valuable service to businessmen.

Information and other services: As a part of their comprehensive banking services, many
banks act as a major source of information on overseas trade in all aspects. Some banks produce
regular bulletin on trade and economic conditions at home and abroad, their special reports on
commodities and markets.

Consultancy service:

Sound Banking Principles: A successful and ideal commercial bank follows some principles in
order to ensure smooth running of banking business. To cope with the prevailing competition, to
provide better services to the clients and to gain competitive advantages commercial banks have
to be careful about their services. The important sound principles of commercial bank are as
follows-

Principles of liquidity: Deposits are the life blood of the commercial bank. Deposits are
repayable of demand or after expiry of a certain period. Everyday depositors either
deposits or withdraw cash. To meet the demand for cash all commercial banks have to
keep certain amount of cash in their custody.
Principles of profitability: The driving force of commercial enterprise is to generate
profit. So it is true in case of commercial banks.
Principles of solvency: Commercial banks should have financially sound and maintain a
required capital for running the business.
Principles of safety: While investing the fund, banks are to be cautious because bank’s
money is the depositor’s money. Unless the money lent out is safe, the banks can’t pay
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depositors money back. So banks must greatest care and vigilance in the matter of
investing the funds received from public in the form of deposits.
Loan and investment policy: The main earning sources of commercial banks are lending
and investing money to the viable projects. So commercial bank always tries to earn
profit through sound investment.
Principles of Economy: Commercial banks never go for any unnecessary expenditure.
They always try to maintain their functions with economy that increase their yearly
profit.
Principles of Secrecy: Commercial bank maintains and keeps the clients accounts
secretly. Nobody except the legitimized person is allowed to see the accounts of the
clients.
Principles of Modernization: It is the age of science and technology. So to cope up with
the advance world the commercial bank has to adopt modern technical services like
online banking, credit card etc.
Principles of Specialization:
Principles of Publicity: If commercial banks would like to earn more money, they have
to give more advertisement through various media. In that case, commercial banks follow
this kind of principle to increase their customer.

Factors and trends influencing determination of cash balances: Some of the important factors
and trends which influence the determination of the amount of cash balances maintained by a
banker are as follows:

• Banking habits: The need to maintain large amount of liquid cash will not be there if the
customers are highly banking mined. In advance countries where people have cheque
habit, the use of cash is very much reduced. All transactions are settled through cheques.

• Local business and economic conditions:

• Nature of the account: Average size of deposits also determine amount of cash reserve.
If the accounts are of a fluctuating nature, a higher cash reserve may be required.
• Nature of advances: The nature of different types of advances made by the banker and
the refinancing facilities provided by Bangladesh Bank also affect the cash reserve. The
Bangladesh Bank provides advances and rediscounting facilities to banks. A banker may
employ more funds in discounting of bills and rediscounting the same bills from
Bangladesh Bank and thereby keep less cash reserve.
• Statutory cash reserve with Bangladesh Bank:
• Level of operation:
• Efficiency of clearing house
• Location of the bank
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Clearing House System: Generally clearing house is an establishment maintained by banks for
settling mutual claims and accounts. More especially clearing house a bankers' establishment
where cheques and bills from member banks are exchanged, so that only the balances need be
paid in cash. That is, clearing house is an arrangement for the banks to mutually settle their claim
over each other arising out of deposit transfer from one bank to another by their respective
customers. For the purpose of collection of cheques and drafts bank have devised a system called
clearing house where all banks have their accounts. That is, clearing house is an organization of
banks which settles inter-bank liabilities due to transfer of deposits by customers from one bank
to another. In Bangladesh, BB performs the functions of clearing house wherever is has its
offices. At places where the BB does not have its offices, the Sonali bank manages the business
of clearing houses.
The mechanisms of clearing house are as follows:

• Each member bank of the clearing house prepares a bank wise list of cheques and drafts
received from its customers and drawn on different banks.
• Representative of each bank visits the clearing house with the cheques and their list in the
morning and delivers the cheques and drafts to the representatives of the respective
banks. Similarly he also receives the same things from others.
• The representative returns to their respective banks to meet again in the afternoon.
• The representative of each bank computes the final balance payable or receivable his
bank from other banks after taking into account the various amounts of receipts and
payments.
• The final settlement is affected by the supervisor of the clearing house by debiting or
crediting the accounts of the respective banks.
RTGS: The term real-time gross settlement (RTGS) refers to a funds transfer system that
allows for the instantaneous transfer of money and/or securities. RTGS is the continuous
process of settling payments on an individual order basis without netting debits with credits
across the books of a central bank. Once completed, real-time gross settlement payments are
final and irrevocable. In most countries, the systems are managed and run by their central
banks. RTGS is one of the fund transfer systems which facilitate the real-time transfer of funds.
RTGS is considered to be the fastest fund transfer method offered by the banks. RTGS system is
an electronic way of transferring funds and does not need any exchange of money physically.
The RTGS is suited for high-value transactions that require immediate clearing. It is an instant
transfer and the bank that is supposed to receive the funds from the remitting bank, has it
remitted in seconds. It is expected of the bank to deposit the funds within 30 minutes of the
transfer message. RTGS also allows setting up the transfer at a later point in time. The value date
of the transaction shall be analysed and the transfer is made from the queue.
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Electronic Fund transfer system (EFTN/S): Transferring money from one bank account to
another in an electronic mode is called Electronic Fund Transfer. The bank accounts may belong
to the same or different banks. It is a computer-based transaction that is done in an electronic
fashion. Electronic banking is the other name for EFT transactions. EFT creates a paper-free
environment and also most sought by the people for its ease and convenience. Electronic Fund
Transfer is also done through the ACH network. Electronic Funds Transfer is considered secured
because of the usage of PIN (Personal Identification Number) and the login details which are
known only to the customer. The money is transferred faster through EFT and the cost involved
also is less. Ideally, this method helps save cost and effort in printing cheque leaves. Normally,
cannot stop an EFT payment after initiating it, in case need to stop payment or refund amount
then it’s between you and the person paid. However, we might able to stop scheduled payment
such utility bills, recurring by notifying the financial institution to before 3 business working
days.
RTGS VS Electronic Fund transfer system (EFTS):
Ø The main difference between EFT and RTGS is that EFT is based on net-settlement,
meaning that the transactions are completed in batches at specific times; all transfers
will be held up until a specific time. While RTGS is real-time and happens
individually.
Ø EFT usually involves smaller value transactions and the maximum amount can be 2
Lakhs INR for the transactions. Whereas RTGS’ minimum value for transaction starts
from 2 Lakhs INR.
Ø The process of EFTN is one working day, while RTGS processes in real-time (‘push’
transfer) EFT is slower, fewer transaction charges compared to RTGS.
Ø EFT is best for small value transactions and RTGS which is appropriate for a large
amount of transactions.
Ø EFT takes time to transfer funds and it depends on the bank’s transaction timelines,
but RTGS is an instant fund transfer mechanism.

Non-Performing Assets: Generally, non-performing assets refers to an asset which is not

producing income. That is, non-performing assets means an assets which has ceased to generated
income for the bank. Assets become non-performing when the interest or installment of principal
is delayed and not received before the stipulated time. Banks usually classify as nonperforming
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assets any commercial loans which are more than 90 days overdue and any consumer loans
which are more than 180 days overdue. Non-performing assets are problematic for financial
institutions since they depend on interest payments for income as well as inevitable burden on
the banking industry. Accumulation of non-performing assets is the direct result of deterioration
in the quality of loan portfolio. Today the success of the bank depends upon the method of
managing NPAs and keeping them within a tolerable level.

Factors contributed to non-performing assets: Following are the factors which contribute to
non-performing assets:
Internal factors: Internal factors may be

• Diversion of funds for other purposes like expansion/modernization or for taking up new
projects rather than the purpose for which it was borrowed.
• Diversion of funds for assisting or promoting other associate concerns.
• Time or cost overrun during the project implementation stage.
• Defective lending process.
• Improper SWOT analysis.
• Inadequate credit appraisal system.
• Absence of regular industry visit and monitoring.
• Business failures due to product failure, failure in marketing etc.
• Inefficiency in management.
• Alleged corruption.
• Inadequate network and linkage.
• Deficiency in re-loaning process.
External factors:

• Recession in the economy as a whole.

• Input or power shortage.
• Price escalation of inputs.
• Exchange rate fluctuation.
• Accidents and natural calamities.
• Changes in the govt. policies relating to excise and imports duties, pollution control
orders etc.
• Govt. loan waiver scheme.
• Alleged political interference.
• Ineffective legal framework and weak recovery tribunal.
Others:

• Liberalization of economy like reduction of tariff, removal of restriction etc.

• Sudden crashing of capital markets and failure to raise adequate funds.
• Granting of loan to certain sectors on the basis of govt.’s directives rather than
commercial imperatives.
• Mismatch of funding i.e. using loans granted for short terms for long term transactions.
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• High leverage and high cost of borrowing.

• Willful defaults sensing that the legal recourse available to collect debts is very slow.
Roles of Commercial Bank in the economy of Bangladesh:

1. Mobilizing Saving for Capital Formation: The commercial banks help in mobilizing
savings through network of branch banking. People in developing countries have low
incomes but the banks induce them to save by introducing variety of deposit schemes to
suit the needs of individual depositors. By mobilizing savings, the banks channelize
them into productive investments. Thus they help in the capital formation of a developing
country.
2. Financing Industry: Commercial banks finance the industrial sector in a number of
ways. They provide short-term, medium-term and long-term loans to industry. In
Bangladesh, the commercial banks undertake short-term and medium-term financing of
small scale industries, and also provide hire- purchase finance. Besides, they underwrite
the shares and debentures of large scale industries.
3. Financing Trade: Commercial banks help to finance both internal and external trades.
The banks provide loans to retailers and wholesalers to stock goods in which they deal.
They also help in the movement of goods from one place to another by providing all
types of facilities such as discounting and accepting bills of exchange, providing
overdraft facilities, issuing drafts, etc. Moreover, they finance both exports and imports
of developing countries by providing foreign exchange facilities to importers and
exporters of goods.
4. Financing Employment Generating Activities: Commercial banks provide financing
facilities to employment generating activities in developing countries like Bangladesh.
They provide loans for the education of young person’s studying in engineering, medical
and other vocational institutes of higher learning. They advance loans to young
entrepreneurs, medical and engineering graduates, and other technically trained persons
in establishing their own business. Such loan facilities are being provided by a number of
commercial banks in Bangladesh. Thus the banks not only help inhuman capital
formation but also in increasing entrepreneurial activities in developing countries.
5. Help in Monetary Policy: The commercial banks help the economic development of a
country by faithfully following the monetary policy of the central bank. In fact, the
central bank depends upon the commercial banks for the success of its policy of monetary
management in keeping with requirements of a developing economy.
6. Assistance in transfer of money: Commercial bank transfers money from one place to
another. It reduces the risk of carrying money & makes the transaction easy and
comfortable that expands the business.
7. Maintaining economic stability: To maintain the economic stability commercial bank
follows the credit control method of central bank.