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Money and Banking part 22
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Functions of a commercial bank-2 Credit creation


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This is a great contribution to the socitety and the UPSC aspirants. Can't thank you enough. Good luck to all.
  1. MONEY AND BANKING PART 22


  2. OVER DRAFT Over draft is a facility given to a current account holder to withdraw a amount exceeding the amount in current account upto an agreed limit. Depositors of current account make arrangement with the banks that in case a cheque has been drawn by them which are not covered by the deposit, then the bank should grant overdraft and honour the cheque. It is financed by assets like shares, debentures, life insurance policies of the account holder, etc.


  3. DIFFERENCE S. NO OVER DRAFT LOAN Without security With security 2. Can borrow as much as required Borrower has to pay full interest on the sanctioned amount Pays interest on a daily basis 3. Borrower pays interest on outstanding amount


  4. AGENCY FUNCTIONS 1. Transfer of funds : Cheap and easy remittance of funds from place-to-place through demand drafts, mail transfers, telegraphic transfers, etc. 2. Collection of funds : Collects funds through cheques, bills, bundles and demand drafts on behalf of its customers. 3. Letters of references : It gives information about economic position of its customers to traders and provides similar information about other traders to its customers.


  5. 4. Payment of various items : Bills, insurance premium taxes etc on the direction of the customer. 5. Shares and securities : Buys sells and keeps in safe custody securities and shares on behalf of its customers. 6. Collection: Collection of dividends, interest on shares and debentures is made on behalf of its customers. 7. Trustee: Acts as Trustee and Executor of property of its customers on advice of its customers.


  6. GENERAL UTILITY SERVICES 1. Issues traveller's cheque and gift cheque 2. Provides locker facility 3. Underwriting services 4. Purchase and sale of foreign exchange


  7. CREDIT CREATION Reserve Bank of India produces money and commercial banks help to increase the supply of money by creating credit. This is done in the form of secondary deposits. The total deposit of a bank is of 2 types 1. Primary deposits - Initial deposit by public 2. Secondary deposit - deposits that arise due to loans given by the banks which are assumed to be redeposited in the bank.


  8. CREDIT CREATION Credit creation by a commercial banks depends on 2 factors: 1. Primary deposits Initial deposit by public 2. Legal Reserve Ratio LRR- minimum ratio of deposits which is legally compulsory for the commercial banks to keep as cash in liquid form When a bank receives deposits from the public it keeps a fraction of deposit as cash reserve and uses the remaining amount to extend loans. In this process, banks create through secondary deposits and many times more than the initial deposits.