Functions and Services of Commercial Banks

Overview

A commercial bank is a financial intermediary: it collects surplus funds as deposits and lends them to borrowers. Section 49(1) of the Banks and Financial Institutions Act, 2073 (BAFIA) lists what a class A bank may do.

Primary functions

1. Accepting deposits and paying them back with or without interest.
2. Granting loans and advances, including hire-purchase, leasing, housing loans and overdrafts.

Types of deposit (definitions from Section 2 of BAFIA)

Call deposits and recurring deposits are variants used in practice. Under Section 112, deposits left unclaimed for ten years must be reported to NRB within the first month of each fiscal year.

Loans and advances

• Overdraft: the customer may draw more than the balance in a current account, up to an approved limit; interest is charged only on the amount used and for the days used.
• Term loan: for fixed assets, repaid in instalments over a set period.
• Working capital or demand loan: short-term finance for stock and receivables.
• Hypothecation loan: lent against stock that stays in the borrower's possession (BAFIA definition). In a pledge the goods are handed to the bank.
• Mortgage loan: lent against immovable property.
• Leasing: the bank keeps ownership and the customer gets only the right to use the asset for a period against scheduled payments.
• Consortium financing: several banks lend to one project and share the collateral on a pari passu basis.

Worked example (overdraft interest). A customer is overdrawn by Rs 500,000 for 73 days at 12 percent a year on a 365-day basis. Interest = 500,000 x 12/100 x 73/365 = Rs 12,000.

Non-fund-based business

Here the bank lends its name, not its cash. BAFIA calls these off-balance-sheet transactions: letters of credit, letters of guarantee, acceptances, commitments, swaps, options and forward foreign exchange contracts.

• Bank guarantee: the bank promises to pay the beneficiary if its customer fails to perform or pay. Common types are bid bond, performance bond and advance payment guarantee.
• Letter of credit (LC): the importer's bank (issuing bank) undertakes to pay the exporter when documents that comply with the LC are presented. Banks deal with documents, not goods.

The bank earns commission, and the liability turns into a funded loan only if the customer defaults.

Agency and general utility functions

Agency functions are done on the customer's instruction: collecting cheques, bills, interest and dividends; paying bills and premiums on standing instruction; buying and selling securities; remitting funds.

General utility functions serve the public at large: safe deposit lockers, foreign exchange, drafts and traveller's cheques, cards and electronic banking, government transactions, and exchange of credit information.

Banker and customer relationship

Secrecy. Section 109 of BAFIA forbids disclosure of customer information to anyone other than the person concerned. It is not a breach to give information to NRB, to a court in a case, to authorised investigators, to the auditor during audit, or between BFIs when exchanging credit information.

Exam pointers

• Primary functions are deposit taking and lending; everything else is secondary.
• Current account: withdrawable on demand. Fixed account: locked for a term.
• Hypothecation leaves goods with the borrower; pledge gives possession to the bank.
• Guarantees and LCs are non-fund-based (off-balance-sheet) facilities.
• In an LC, banks examine documents only.
• Deposit makes the bank a debtor; a loan makes it a creditor.
• Unclaimed deposits: ten years (Section 112); secrecy: Section 109.