Solution Manual for Principles of Corporate Finance 14th Edition by Richard B...
Commercial banks & its functions
1. COMMERCIAL BANKS &
ITS FUNCTIONS
GUIDED BY :- PRESENTED BY :-
SHREE VAISHNAV INSTITUTE OF
MANAGEMENT
2. Commercial Bank is an institution which performs the functions of
accepting deposits, granting loans and making investments with the
aim of earning profits.
They are also called ‘DEPOSIT BANKS’ .
The amount of money earned by a commercial bank is determined
by the SPREAD which is the difference of the interest it pays on
deposits and the interest it earns on loans.
3. Household Bank Firm
Deposit Loans
Interest Interest
Interest that a bank earn on loan is higher than the interest that it pays to
depositors.
Ex.:- Suppose a customer(say A) deposits Rs. 10,000 in a commercial bank at
an annual interest rate of 2% & on the same day a customer (say B) take a
loan of Rs. 10,000 from the same bank at an annual interest rate of 5%. At
the end of a year, the bank pays Rs. 200 as interest to Customer A &
receives Rs. 500 as interest from the Customer B. Hence, Rs. 300(500-200)
is the SPREAD.
9. Acceptance of Deposits
Commercial banks receive deposits from the people
who have surplus money and willing to deposit with
banks for the purpose of safety and interests etc.
The main types of deposits are:-
Current Deposits
Savings Deposits
Fixed Deposits
10. Current Account
Usually open by
businessmen
No interest received
Unlimited cheques
Unlimited transactions
Deposits
Saving Account
Minimum balance
Restrictions on
withdrawal
Interest received
Limited cheques
Limited transactions
Fixed Deposits
Minimum balance
No withdrawal
Higher interest on
longer tenor
deposits
No cheques
Only 2 transactions
11. The deposits received by banks are not allowed to
remain idle. So, after keeping certain cash reserves, the
balance is given to needy borrowers and interest is
charged from them, which is the main source of
income for commercial banks.
Bank advances loans to all types of persons,
businessmen and investors, against personal security,
gold, silver, stock of goods & other assets.
Advancing Loans
12. a) Overdraft Facilities: In this case, the depositor in a current account is
allowed to draw over and above his account up to a previously agreed
limit. The bank allows the customer to overdraw his account through
cheques. The bank, however, charges interest only on the amount
overdrawn from the account.
b) Term Loans: Banks give term loans to traders, industrialists and now
to agriculturists also against some collateral securities. Term loans are
so-called because their maturity period varies between 1 to 10 years.
Sometimes, two or more banks may jointly provide large term loans to
the borrower against a common security. Such loans are called
participation loans or consortium finance.
13. c) Money at Call: Bank also grant loans for a very short period, generally
not exceeding 7 days to the borrowers, usually dealers or brokers in stock
exchange markets against collateral securities like stock or equity shares,
debentures, etc., offered by them. Such advances are repayable
immediately at short notice hence, they are described as money at call or
call money.
d) Consumer Credit: Banks also grant credit to households in a limited
amount to buy some durable consumer goods such as television sets,
refrigerators, etc., or to meet some personal needs like payment of
hospital bills etc. Such consumer credit is made in a lump sum and is
repayable in instalments in a short time.
14. Credit creation is most significant function of
commercial banks. While sanctioning a loan to a
customer, they do not provide cash to the borrower.
Instead, they open a deposit account from which the
borrower can withdraw. In other words, while
sanctioning a loan, they automatically create deposits,
known as a credit creation from commercial banks.
Creation of credit
15. : Money lend by bank
: Deposit of bank
Bank
Firm A
Firm B
Firm C
Rs. 90
Rs. 90
Rs. 81
Rs. 81
Rs. 72.9
Rs. 72.9
Rs. 100
Initial deposit
Credit : Rs. 100 + 90 +81 + 72.9 + ……. >
initial deposit of Rs 100
16. It is the process of moving a cheque from the bank in
which it was deposited to the bank on which it was
drawn, and the movement of the money in the opposite
direction. This process is called the clearing cycle and
normally results in a credit to the account of bank of
deposit, and an equivalent debit to the account at the
bank on which it was drawn.
Clearing of cheques
18. Banks act as agents to their customers in different ways:
a) It collect cheques, rent, interest etc & pay insurance
premium, mutual funds, rent, water taxes, electricity bills
etc of their customers.
b) Collection of dividend on shares purchased by customers.
c) Buy and sell shares, securities on behalf of their
customers.
d) Purchase & sale of foreign exchange.
Agency services
19. Banks act as agents to their customers in different ways:
e) Acts as Correspondent: Sometimes banks act as
representative and correspondents of their customers.
They get passports, traveller’s tickets etc for their
customers.
f) Acts as Trustee and Executor: Banks preserve the ‘Wills’
of their customers and execute them after their death.
g) Income-tax Consultancy: Banks may also employ income
tax experts to prepare income tax returns for their
customers and to help them to get refund of income tax.
Agency services
20. Commercial banks also provide certain services of general
utility to the society:
a) Locker facilities: The customers can keep their valuables,
such as gold and silver ornaments, important documents.
b) Banks issue traveller’s cheque or credit cards to their
customers so that they may be spared from the risk of
carrying cash during the journey.
c) Business information & statistics.
d) Banks underwrite the shares and debentures issued by
the Government, public or private companies.
General utility services
21. Commercial banks also provide certain services of general
utility to the society:
d) Acting Referee: Banks may act as referees with respect to
the financial standing, business reputation and
respectability of customers.
e) Merchant Banking: Some commercial banks have opened
merchant banking divisions to provide merchant banking
services.
f) Gift Cheques: Some banks issue cheques of various
denominations to be used on auspicious occasions.
General utility services
