Economics » Financial Institutions » Types and Functions of Financial Institutions

Commercial and Merchant Banks

The commercial and merchant banks are profit-making enterprises, as well as the major financial intermediaries through which the monetary authorities facilitate effective distribution of money in the economy.

Functions of Commercial Banks

  1. Accepting Deposits of Money: Commercial banks, as savings institutions, provide facilities for the mobilisation of savings by accepting deposits from households, firms and government. They use current accounts, saving accounts and fixed deposit accounts to accept demand deposits, saving deposits and time deposits respectively.
  2. Creating Demand-deposit Money: By lending out the money i.e. deposits that they collected from some customers, commercial banks create additional purchasing power in the economy.
  3. Acting as Agents of Payment: Commercial banks’ customers keep current accounts from which they can draw for settlement of debts and for payments for goods and services. They also transfer funds on behalf of their customers through collection of standing orders and direct debiting.
  4. Providing Brokerage Services: Commercial banks undertake to buy and sell stocks and shares on behalf of their customers.
  5. Granting Loans and Advances: The most profitable function of commercial banks is extending credits to worthy borrowers while charging interest rate higher than the rate they pay on deposits. Short-term credit facilities are extended to customers using special loan accounts or in the form of overdrafts using current accounts. It may also take the form of loan syndication whereby two or more banks agree to finance a large project.
  6. Providing International Trade Services: Commercial banks are involved in the financial aspects of international trade, especially by discounting bills of exchange for their customers who are exporters and opening letters of credit in favour of their customers who are importers. A letter of credit is an undertaking by the bank accepting to redeem the liability of its customers on an import contract.
  7. Safekeeping of Valuable Items: Commercial banks undertake to keep, for their customers, valuable items such as government stock, share certificates, academic certificates, certificate of occupancy, jewelleries, insurance policies, etc.
  8. Equipment Leasing: This is the activity of banks in financing purchases of fixed assets by their customers (mostly business enterprises) and allowing repayment over an agreed period of time. The bank is the lessor, while the beneficiary is the lessee.
  9. Foreign Exchange Services: Commercial banks act as intermediaries between the Central Bank or authorized foreign exchange dealers and their corporate customers to process foreign exchange allocation. They also provide traveller’s cheque to their customers who are travelling out of the country.

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