The Reserve Bank of India (RBI), which is the central bank of India, regulates the banking sector. According to the RBI,banks that may be scheduled or non-scheduled, but operate on a “for profit” principal and are essentially engaged in acceptance of deposits and extending loans to the public, businesses, and government are called commercial banks.
Commercial banks play a crucial role in a country’s economy. In India, the RBI makes rules and regulations that are to be adhered to by all banks. Apart from accepting deposits and lending money, commercial banks play an important role in the monetary policies of the RBI to regulate the flow of money in the economy.
Commercial banks assume several roles and responsibilities in the economy of a country. Let us take a closer look at how the commercial banks contribute towards our country’s economy:
Capital Formation: As one of its primary functions, a commercial bank accepts deposits from the public. These days, banks offer various attractive schemes to encourage its customers to save as much of their income as possible. While doing so, these banks mobilise small savings of the customers and spread them across the country with the help of a large network of branches. Banks then make these savings available for more productive purposes by converting them into loans and advances to the industries.
Credit Creation: Another major function of commercial banks is to advance loans and credit. When a bank advances a loan to its customer or buys securities from the government, or discounts a bill, it makes a deposit for that particular amount into an account instead of giving cash. These deposits are called derivative deposits, and this power of commercial banks to expand deposits through loans etc. is called credit creation. Credit creation leads to an increase in production, which in turn increases employment, raises the purchasing power, and elevates demand,thereby boosting sales. An increase in sales leads to an increase in prices, which further leads to an increase in production, and this is how the cycle goes on.
Investments:In a developing country such as India, where the per capita income is very low, a majority of individual savings are too small to play any significant role at a macro level. Commercial banks, after accepting deposits from a large number of customers, pool these small savings and invest in various sectors in the form of loans, securities, etc. Such investments reap profits for these banks and at a macro level, boost the economy by increasing the monetary flow in the industrial sector.
Monetary Policies:The RBI regularly updates its monetary policies according to the economic conditions of the country. Commercial banks are right in the middle of such policies. Such banks help the RBI to regulate the flow of money in the market. Through these banks, the general public takes loans; if there is a need to reduce the flow of money in the market, loans at commercial banks are made unfavorable by increasing the rate of interest and vice versa.
Monetisation of Debts: Banks contribute to the production process by honoring instruments such as bills of exchange and other types of promissory notes. A manufacturer who sells goods on credit cannot produce more unless the buyer repays what he/she owes. A commercial bank intervenes and converts the promise of the buyer to pay at a later date into cash that can be readily used by the manufacturer to produce more goods.
Lending to The Government: In a developing country such as India, the government plays a very important role in the promotion of industrial growth. Commercial banks advance long-term monetary aid to the government by investing in government securities and short-term loans by purchasing treasury bills.
Banking Industry:The banking industry employs millions of people at different levels from all over the country (from metropolitan cities to the smallest of villages).It is in fact among the top paying industries in the country today. As the industry has extended employment opportunities to a huge population base, commercial banks are in a way directly contributing to the development of the country.
Rural and Remote Areas: Rural areas have one of the highest rate of bad debts. However, it is crucial for the economy that rural and remote areas receive the benefits of the services of commercial banks. In the past, most people from rural and remote areas of our country relied upon exploitative moneylenders for their loans; these money lenders charged very high rates of interests and barely provided any regulations for the protection of the borrower. Complying with government regulations, commercial banks have been set up in such regions and now serve as an alternative source for loans which are more affordable, transparent and easily available.
Project Support:Commercial banks play an important role in promoting entrepreneurship. These banks identify projects which are economically viable and technically feasible by considering the local conditions, the economic state of the country, social practices, etc.They then formulate project ideas and encourage new entrepreneurs to take up these projects by offering them the managerial and technical assistance they need to start a business and provide 100% credit for such projects.
Unarguably, commercial banks are the major contributors to a country’s economy. They play a vital role in directing the flow of money to the right sectors to boost the economic condition of a nation. Commercial banks are extremely important for the growth of developing nations like ours. While they help overcome obstacles such as acute shortage of funds, lack of enterprises and undeveloped means of transport, they also play a crucial role in developing a country and improving its economic state. It, hence, won’t be wrong to state that commercial banks are one of the key holding pillars of a nation’s economic system.