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Commercial Banking

Hey Mumbai University SYBA IDOL students!  Today, we’re diving into the fascinating world of Macro Economics , exploring the chapter – “Commercial Banking“. Here’s what we are going to cover:

First, we’ll understand the meaning of a commercial bank and explore its role in the economy. We’ll then explain the functions of commercial banks, such as accepting deposits, granting loans, and facilitating payments.

Next, we’ll explain the concept of multiple credit creation. We’ll see how commercial banks can create money through the process of lending, leading to a multiplied effect on the money supply.

Finally, we’ll discuss the development of the commercial banking sector since 1991. We’ll look at how reforms and changes in policies have shaped the modern banking landscape in India, improving efficiency, competition, and customer service.

So, SYBA IDOL Mumbai University students, get ready to unwrap the mysteries of “Commercial Banking” with customized IDOL notes  just for you. Let’s jump into this exploration together.

Commercial Banking

Question 1:- What is the meaning of commercial bank? Explain the functions of commercial bank

 Introduction:

          A commercial bank is a financial institution that deals with money, credit, and financial transactions. It accepts deposits from the public and provides loans to individuals, businesses, and governments. Commercial banks play a crucial role in the economy by facilitating the flow of funds between savers and borrowers.

 Functions of a Commercial Bank:
  1. Accepting Deposits:
  • Types of Deposits: Commercial banks accept various types of deposits from the public, such as savings accounts, current accounts, fixed deposits, and recurring deposits.
  • Interest on Deposits: Customers earn interest on their deposits, and the bank uses these funds to provide loans and earn profits.
  1. Providing Loans:
  • Loans to Individuals and Businesses: One of the primary functions of commercial banks is to lend money to individuals and businesses for various purposes, such as starting a business, buying a home, or investing in projects.
  • Evaluating Creditworthiness: Banks carefully evaluate the creditworthiness of borrowers before granting loans and charge interest on the amount borrowed.
  1. Credit Creation:
  • Multiple Credit Creation: Commercial banks have the ability to create credit through the process of multiple credit creation. By using a fraction of the deposits they hold as reserves, banks can extend loans and create new money in the economy.
  • Stimulating Economic Activity: This process helps stimulate economic activity and growth.
  1. Overdraft Facility:
  • Short-term Financial Flexibility: Commercial banks offer overdraft facilities to their customers, allowing them to withdraw more money than they have in their accounts.
  • Interest on Overdrawn Amount: Customers pay interest only on the amount overdrawn, providing them with short-term financial flexibility.
  1. Agency Services:
  • Acting as Agents: Commercial banks act as agents for their customers by providing services such as collecting cheques, buying and selling securities, and carrying out financial transactions on behalf of clients.
  • Efficient Financial Management: These services help customers manage their finances efficiently.
  1. Utility Services:
  • Diverse Financial Services: In addition to traditional banking services, commercial banks offer utility services like underwriting facilities, locker facilities, foreign exchange dealings, and acting as guarantors for transactions.
  • Catering to Financial Needs: These services cater to the diverse financial needs of customers.

 Conclusion:

     Commercial banks play a vital role in the economy by mobilizing savings, providing credit, facilitating transactions, and supporting economic growth. Their functions are essential for maintaining financial stability and promoting economic development. By accepting deposits, providing loans, creating credit, offering overdraft facilities, acting as agents, and providing utility services, commercial banks ensure the smooth functioning of financial activities and contribute to the overall economic prosperity.

Question 2 :- Explain the concept of multiple credit creation

 Introduction:

      Multiple credit creation is a fundamental concept in banking that explains how commercial banks can create new money and credit in the economy. By using a portion of the deposits they hold as reserves, banks can expand the money supply and stimulate economic activity.

 Key Points about Multiple Credit Creation:
  1. Primary Deposits:
  • Deposits from Customers: Commercial banks receive deposits from customers, known as primary deposits. These deposits form the base for the credit creation process.
  1. Reserve Requirement:
  • Holding Reserves: Banks are required by regulatory authorities to hold a certain percentage of their deposits as reserves. This is known as the reserve requirement.
  • Available for Lending: The remaining portion of the deposits is available for lending and investment activities.
  1. Credit Creation Process:
  • Extending Loans: When a bank receives a deposit, it can use a portion of that deposit to extend loans to borrowers.
  • New Deposits: The borrower may deposit the loan amount in another bank, creating a new deposit.
  • Cycle of Loans: This new deposit can then be used by the bank to create additional loans, further expanding the money supply.
  1. Multiplier Effect:
  • Example of Multiplier Effect: If a bank receives a deposit of $100 and has a reserve requirement of 10%, it holds $10 as reserves and can lend out $90. If this $90 is deposited in another bank with a 10% reserve requirement, that bank can lend out $81, and so on.
  • Chain Reaction: This chain reaction leads to the creation of new money in the economy.
  1. Impact on Economic Activity:
  • Increasing Liquidity: Multiple credit creation helps increase liquidity in the economy, making funds available for investment, consumption, and other economic activities.
  • Economic Growth: It plays a significant role in fueling economic growth and development.
  1. Regulation and Control:
  • Monitoring by Central Banks: Central banks and regulatory authorities closely monitor the credit creation process to ensure financial stability.
  • Preventing Excessive Risk: Measures such as reserve requirements and capital adequacy ratios are implemented to control the expansion of credit and maintain the stability of the financial system.

 Conclusion:

       Multiple credit creation is a vital mechanism through which commercial banks contribute to the expansion of the money supply and support economic growth. By leveraging a fraction of their deposits as reserves, banks can create new money, increase liquidity, and stimulate economic activities. Understanding this concept is essential for grasping the functioning of the banking system and its impact on the broader economy.

Question 3 :- Explain the development of commercial banking sector since 1991

 Introduction:

        Since 1991, the commercial banking sector in India has undergone significant changes due to economic reforms aimed at liberalizing the economy and enhancing banking efficiency. These reforms have transformed the sector by promoting competition and expanding banking services across the country.

 Key Aspects of the Development of Commercial Banking Sector since 1991:
  1. Expansion of Branches and Services:
  • Increased Accessibility: The number of bank branches has grown significantly, improving access to banking services for people across India.
  • Promoting Financial Inclusion: This expansion has helped in reaching underserved areas, promoting financial inclusion and economic development.
  1. Growth in Deposits and Credit:
  • Rising Deposits: Banks have seen a notable increase in deposits, reflecting higher savings rates and improved financial awareness among the population.
  • Credit Expansion: Banks have extended more credit, supporting economic activities such as investments and business growth.
  1. Changes in Ownership Structure:
  • Mergers and Consolidation: There has been a decrease in the number of banks due to mergers aimed at improving operational efficiency.
  • Diverse Ownership: The sector now includes public sector banks, old and new private sector banks, and foreign banks, creating a diverse banking landscape.
  1. Focus on Profitability:
  • Enhanced Financial Performance: Banks are focusing more on profitability by expanding their operations and adopting modern banking practices.
  • Competitive Market: This shift has made banks more competitive in the market, driving efficiency and customer service improvements.
  1. Impact of Reforms on Governance:
  • Improved Standards: Reforms have led to better governance, risk management systems, and incentives in banks.
  • Resilience: These improvements have made banks more resilient during global financial crises, ensuring stability in the banking sector.
  1. Challenges and Concerns:
  • Decline in Rural Branches: Despite progress, there has been a decrease in rural branches, affecting banking services in rural areas.
  • Urban Dominance: Urban-focused banks, including private and foreign banks, raise concerns about financial inclusion for rural and semi-urban populations.

 Conclusion:

     The development of India’s commercial banking sector since 1991 has been shaped by reforms that aimed to enhance efficiency, promote competition, and expand services. While the sector has made significant strides in profitability and governance, challenges such as rural banking access remain. Overall, the sector continues to evolve to meet the diverse needs of India’s growing economy and population

 Important Note for Students :– Hey everyone! All the questions in this chapter are super important!

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