commercial bank, cash reserve

2. Commercial bank
Definition:
A Commercial bank is a type of Bank / Financial
Institution that provides services such as accepting
deposits, making business loans, and offering basic
investment products.
"Commercial bank" can also refer to a bank, or a
division of a large bank, which more specifically
deals with deposit and loan services provided to
corporations or large/middle-sized business

3. Functions of Commercial
Banks
Commercial Banks
 Primary Functions
 Agency Functions
 General Functions

4. Primary Functions
1. RECEIVING DEPOSITS
Commercial banks receive deposits from the people
who have surplus money and willing to deposit with
banks for the purpose of safety and interest etc.
To meet the needs of people the banks offer following
deposit schemes:
O Current Account
O Saving Account
O Fixed Deposit (Term Deposits)
O Profit and Loss Sharing (PLS) accounts
O Foreign Currency Accounts

5. Primary Functions
2. ADVANCING LOANS
Commercial bank lend the money collected from the
people under different accounts, to the borrowers.
The bank provide loans in the following shapes.
O Cash credit
O Over draft
O Call loans
O Discounting of bills
O Investment loans
O Short-term loans
O Medium-term loans
O Long-term loans

6. Functions of Commercial
Banks
Agency Functions
A sales and purchase agreement (SPA) is a binding
and legal contract between two parties that obligates
a transaction between the two parties: the buyer and
the seller. SPAs are typically used for real estate
transactions, but they are found in all areas of
business.
Execution of Standing Instructions
A standing order (or a standing instruction) is
an instruction a bank account holder ("the payer")
gives to their bank to pay a set amount at regular
intervals to another's ("the payee's") account.
The instruction is sometimes known as a banker's
order
.

7. Agency Functions
O Collection of Dividends and Interest on
Securities.
Dividends are a distribution of a corporation's
earnings to its stockholders. ... Interest on
bonds and other debt is an expense of the
corporation. The interest expense will reduce the
corporation's net income and its taxable income.
O Transfer of Funds
O Bank as Guarantor
O Income Tax Facility
O Collection of Zakat- for Muslims

8. Functions of Commercial
Banks
General Utility Functions
Issuance of Letter of Credit: A letter of credit is a
document that guarantees the buyer's payment to the
sellers. It is Issued by a bank and ensures the timely
and full payment to the seller. If the buyer is unable to
make such a payment, the bank covers the full or the
remaining amount on behalf of the buyer
O Discounting of Bills
O Issuance of Traveler’s Cheque
O Lockers Facility
O Foreign Exchange Transactions
O Act as an under writer
O Compile Statistics

9. The role of Commercial Banks in
the Economic Growth &
development of a country
Mobility of savings The banks by initiation a dynamic
campaign both in the villages and cities can mobilize
the
idle savings and can increase the investment rate in
all
sectors which leads to economic growth of a country.

10. O Capital formation
O Generation of savings
O Mobilization of savings
O Credit creation
O Agricultural development
O Industrial development
O Employment
O Trade expansion
O Help to government

11. Help the central bank Promotion of savings
Income distribution :
Commercial banks borrow from the people
of the higher-income group and lend it to the
people of the lower income group.
Poverty alleviation :Commercial bank help
the poor people by lending money so as to
improve their standard of life Creation and
distributors of money:

12. What is cash reserve?
Cash reserve is the liquid form of asset. It is to
be kept by the bank in its vault and with the
central bank of the country in order to meet the
demands of the customers. Cash reserve of the
bank includes three items:
O Cash in hand
O Cash kept with the central bank of the country
O Cash kept with other bank.
Cash reserve is regarded as the bank’s first line
of defense to ward bankruptcy.

13. Factor which govern cash
reserve
O In reality it is not possible to lay down
fixed principles regarding the fixation of
cash reserves to liabilities by a bank. How
much a bank should maintain cash
reserves varies form time to time.
O However the main factors governing cash
resaves, in brief are as under:

14. 1- legal requirement
O The scheduled banks in Pakistan are now
required to hold at the close of business every
day cash reserve ratio at 5% of demand and
time liabilities with the stat bank of Pakistan.
And addition to this the banks are also
required to maintain 3.5% of their total time
and demand liabilities Pakistan with SBP. The
object of legal cash requirements is two fold:
O Firstly it safeguards the deposits of the people
O Secondly it is a credit control weapon with the
SBP.

15. 2- Nature and size of deposits.
O If the clients of the bank are industrialist,
businessman, brokers, the bank will have to
keep large reserve to meet their daily
demands to cash. The size of deposits kept
by the customers also affects the cash
reserve. In case the bank have a few large
deposits of the customers, then a large cash
reserve has to be maintained. In case the
number of depositors of small amount is large,
then lesser amount of cash reserve is to be
hold by the bank.

16. 3-Nature of advance and
investment
O In case the bank user major portion of its
deposits in discounting bills, the cash
reserve ratio will be low if the large portion
of funds is user in advances and loan
which cannot be liquidated easily, larger
cash reserve would be required by the
bank.

17. 4-habbit of customer
O If customers make payment by use of
cheque, then smaller amount of cash
reserve will be kept, in case the payment
are mostly made in cash , then the bank
will keep larger cash reserve.

18. 5- Facilities of clearing house.
O If clearing house facility is available is the
locality then a smaller amount of cash
reserve will be required as the bank will
have to pay the deference of the cheque
drown upon other banks hold by it.
O In the absence of clearing housing, every
transection will be made in case, so a
large amount of cash reserve is to be
maintain.

19. 6- Banking facilities
O If the banking system is well established
in the country, there will be large inflow
and outflow of funds mostly through
cheque.
O The bank will therefore, keep a smaller
portion of cash reserve, in case the
banking system is infancy (start) , then
adequate (satisfactory) cash reserves to
be maintain by the banks.

20. 7- Area of operation.
O The ratio of cash reserve also depend
upon the area where the bank is situated.
A bank situated in a city will keep more
cash reserve, then a bank situated a rural
area where the demand for cash is only
seasonal.

21. 8- Political conditions.
O If there is political stability leading to
economic stability in the country, the bank
will keep lesser cash reserves. The bank
will keep higher reserves in cash of
economic stability.

22. Need for Credit Creation
Commercial banks are called the factories
of
credit.
They advance much more than what the
collect from people in the form of deposits.
Through the process of credit creation,
commercial banks provide finance to all
sectors of the economy thus making them
more developed than before.

23. Credit Creation
The basis of credit money is the bank
deposits.
The bank deposits are of two kinds viz.,
– Primary deposits, and
– Derivative deposits

24. Primary Deposits
Primary deposits arise or formed when cash
or
cheque is deposited by customers.
When a person deposits money or cheque,
the bank will credit his account.
The customer is free to withdraw the
amount
whenever he wants by cheque. These
deposits are called “primary deposits”
or “cash deposits.

25. Primary Deposits
It is out of these primary deposits that the
bank makes loans and advances to its
customers.
The initiative is taken by the customers
themselves. In this case, the role of the
bank is passive. So these deposits are also
called “passive deposits.”

26. Derivative Deposits
Bank deposits also arise when a loan is
granted or when a bank discounts a bill or
purchase government securities.
Deposits which arise on account of granting
loan or purchase of assets by a bank are called
“derivative deposits.”
Since the bank play an active role in the
creation of such deposits, they are also known
as “active deposits.”

27. Process of Credit Creation
The banking system as a whole can create
credit which is several times more than the
original increase in the deposits of a bank.
This process is called the multiple-
expansion
or multiple-creation of credit.
Similarly, if there is withdrawal from any one
bank, it leads to the process of multiple
contraction of credit

28. Process of Credit Creation
The process of multiple credit-expansion
can
be illustrated by assuming
– The existence of a number of banks, A, B,
C
etc., each with different sets of depositors.
– Every bank has to keep 10% of cash
reserves, according to law, and,
– A new deposit of Rs. 1,000 has been
made with
bank A to start with.

29. Process of Credit Creation
Suppose, a person deposits Rs. 1,000 cash in
Bank A. As a result, the deposits of bank A
increase by Rs. 1,000 and cash also increases
by Rs. 1,000. The balance sheet of the bank is
as fallows:

30. Process of Credit Creation
Under the double entry system, the amount
of
Rs. 1,000 is shown on both sides.

31. Process of Credit Creation
Suppose X purchase goods of the value of Rs. 900 from Y
and pay cash. Y deposits the amount with Bank B.
The deposits of Bank B now increase by Rs. 900 and its
cash also increases by Rs. 900. After keeping a cash
reserve of Rs. 90, Bank B is free to lend the balance of Rs.
810 to any one.
Suppose bank B lends Rs. 810 to Z, who uses the amount
to pay off his creditors. The balance sheet of bank B will be
as follows:

32. Process of Credit Creation
Suppose Z purchases goods of the value of
Rs. 810 from S and pays the amount. S
deposits the amount of Rs. 810 in bank C.
Bank C now keeps 10% as reserve (Rs. 81)
and lends Rs.729 to a merchant. The
balance sheet of bank C will be
as follows:

33. Process of Credit Creation
Thus looking at the banking system as a
whole, the position will be as follow:

34. Limitation on Credit
Creation
Amount of Cash: The power to create credit depends
on the cash received by banks. If banks receive more
cash, they can create more credit.
Cash Reserve Ratio: All deposits cannot be used for
credit
creation. Banks must keep certain percentage of
deposits
in cash as reserve.
The Banking Habits of the People: The loan
advanced to a customer should again come back into
banks as primary deposit.
Nature of Business Conditions in the Economy:
Credit creation will be large during a period of
prosperity, while it will be smaller during a depression.

35. Limitation on Credit
Creation
Leakages in Credit-Creation: The funds may not flow smoothly
from one bank to another. Some people may keep a portion of
their amount as idle cash.
Sound Securities: A bank creates credit in the process of
acquiring sound and profitable assets, like bills, and government
securities.
Liquidity Preference: If people desire to hold more cash, the
power of banks to create credit is reduced.
Monetary Policy of the Central Bank: The extent of credit
creation
will largely depend upon the monetary policy of the Central Bank
of the country. The Central Bank has the power to influence the
volume of money in circulation and through this it can influence the
volume of credit created by the banks.

36. OThank you