Commercial banks

1. Meaning, functions and economic significance

Commercial banks connect savers with borrowers while providing a widely used means of payment. Their distinguishing feature is the acceptance of withdrawable deposits from the public for lending or investment. The Banking Regulation Act, 1949 provides the principal statutory framework for banking companies, alongside the Reserve Bank of India Act, 1934 and institution-specific legislation. The RBI licenses and regulates banks; deposit-taking and lending alone do not automatically make every financial institution a bank.

Primary functions include accepting current, savings and term deposits and extending loans, overdrafts, cash credit and bill finance. Current accounts primarily support frequent business transactions and generally do not earn interest. Savings accounts combine liquidity with interest income. Fixed and recurring deposits support planned saving over specified periods. Banks also provide remittances, collections, guarantees, letters of credit, lockers and authorised foreign-exchange services.

Banks perform maturity transformation by funding longer-duration assets partly through shorter-duration liabilities. They also pool small savings, screen borrowers and monitor credit use. These functions support investment and economic growth, but expose banks to liquidity and credit risks. A solvent bank can still face liquidity stress if deposit withdrawals occur faster than its assets can be converted into cash.

• Financial intermediation channels household savings towards productive investment.
• Agency and payment services need not involve a fresh loan.
• Commercial banks differ from the RBI, which issues currency, conducts monetary policy and acts as banker to banks.

2. Types of commercial banks in India

Banks can be classified by ownership, statutory status and permitted activities. Public sector banks have majority government ownership; examples include State Bank of India and Bank of Baroda. Private sector banks include HDFC Bank and ICICI Bank. Foreign banks operate through permitted structures such as branches or wholly owned subsidiaries. Ownership classification must not be confused with scheduled status.

A scheduled bank is listed in the Second Schedule to the RBI Act, 1934 after satisfying statutory conditions. Scheduled banks include commercial and cooperative categories. Therefore, not every scheduled bank is a commercial bank. Likewise, a private or foreign bank can be a scheduled bank. Cooperative banks have distinct ownership and legal characteristics and should not be treated as another ownership subgroup of commercial banks.

Regional Rural Banks were created under the Regional Rural Banks Act, 1976 to serve rural credit needs, especially those of weaker sections. Small finance banks are differentiated banks permitted to accept deposits and lend, with an inclusion-oriented mandate. Payments banks primarily provide small savings and payment services: they cannot lend or issue credit cards, although they may issue debit cards. Local Area Banks operate within restricted geographical areas.

• Public ownership, scheduled status and universal banking are different concepts.
• Small finance banks and payments banks have different licensing conditions and business models.

3. Balance sheets, income and credit creation

A bank balance sheet records sources and uses of funds. Deposits, borrowings and shareholders’ funds appear on the liabilities-and-equity side. Cash, balances with the RBI, investments and loans appear on the assets side. Deposits are liabilities because the bank owes money to depositors. A loan is an asset because it represents a claim on a borrower. Interest earned on loans and securities is a major revenue source; banks also earn fees.

The difference between interest income and interest expenditure is net interest income. Net interest margin expresses net interest income relative to average earning assets. Neither measure is identical to net profit, which also reflects operating expenses, provisions, taxes and other income. The CASA ratio measures current and savings account deposits as a share of total deposits; a larger low-cost deposit base can improve funding economics.

When a bank grants a loan by crediting a borrower’s account, it creates a corresponding deposit. Subsequent payments redistribute deposits and reserve balances across banks. Credit creation is nevertheless constrained by capital, liquidity requirements, credit demand, borrower quality and risk management. The textbook multiplier, expressed as the reciprocal of a reserve ratio, assumes away cash leakage and excess reserves; it is not an automatic description of actual lending.

• Banks create deposit money, not sovereign currency.
• Loan repayment normally extinguishes the corresponding deposit money, other things remaining equal.

4. RBI regulation and monetary transmission

The cash reserve ratio requires banks to maintain a prescribed proportion of their net demand and time liabilities as cash balances with the RBI. The statutory liquidity ratio requires prescribed holdings of eligible liquid assets, including cash, gold and unencumbered approved securities. SLR assets are maintained by banks, not necessarily deposited with the RBI. Both ratios are policy variables; their prevailing numerical values should be checked against current RBI notifications.

Capital adequacy requirements provide a loss-absorbing buffer relative to risk-weighted assets. Capital is not the same as cash reserves: a bank can be adequately capitalised yet face a temporary shortage of liquid funds. Basel III also emphasises capital quality, leverage control and liquidity standards. RBI supervision examines asset quality, governance, risk concentration and compliance, while corrective restrictions may be imposed when banks breach specified regulatory thresholds.

Commercial banks transmit monetary policy through deposit and lending rates, credit availability and financial conditions. A repo-rate change can influence bank funding costs and loan pricing, but transmission may be delayed by deposit repricing, stressed balance sheets or weak credit demand. Monetary policy therefore operates through banks rather than mechanically determining every loan rate. Regulatory requirements and administered interventions should be distinguished from market-driven commercial decisions.

• CRR, SLR and capital adequacy serve different purposes.
• Liquidity support cannot permanently cure an insolvent institution without loss recognition and restructuring.

5. Asset quality, depositor protection and inclusion

Credit risk arises when borrowers fail to repay. Generally, a term loan becomes a non-performing asset when interest or principal remains overdue for more than 90 days; agricultural advances have crop-season-linked rules. NPAs are classified as substandard, doubtful or loss assets. Banks must recognise impaired assets and make provisions. Gross NPAs indicate the stock of recognised bad loans before relevant deductions; net NPAs reflect the position after specified provisions and adjustments.

Recovery mechanisms include the SARFAESI Act, 2002, Debt Recovery Tribunals and the Insolvency and Bankruptcy Code, 2016. Their applicability depends on statutory conditions and the borrower or asset involved. A write-off is an accounting action and does not necessarily waive the borrower’s repayment obligation. Restructuring modifies loan terms; it does not automatically establish that the underlying borrower has become financially sound.

DICGC protection covers eligible deposits up to ₹5 lakh per depositor per bank in the same right and capacity, aggregating principal and interest across branches. Different banks receive separate coverage. Inclusion is promoted through priority sector lending, basic savings accounts, business correspondents and Pradhan Mantri Jan-Dhan Yojana. However, opening an account is only the beginning: meaningful inclusion also requires regular use, accessible credit, consumer protection and effective grievance redress.

• Deposit insurance is not unlimited protection for every financial product.
• Priority sector lending is directed credit, not necessarily subsidised credit.
• Digital convenience must be accompanied by fraud awareness and secure authentication.

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