Question

How do banks differ from other financial institutions? Critically explain the key functions of banks.

Answer 1

Banks differ from other financial institutions in the sense that while a bank can accept deposits from its customers – into different accounts like savings accounts and demand deposit accounts the other financial institutions cannot do so. Other financial institutions (otherwise known as non-banking financial institutions) can borrow and lend in the same manner as a bank but they cannot provide the demand deposit facility like a bank can.

So we can say that banks are mostly concerned with direct saving and lending while other financial institutions are also deals with insurance, investments, and other financial activities. So while a bank will primarily earn its revenue from the different in the interest rates that it charges for credit accounts and rates paid to the depositors. This is known as ‘net interest income (or NII)’ for a bank. On the other hand other financial institutions mainly earn their revenue from fees, commissions, and other such line items.

The key functions of a bank can be divided into primary functions and secondary functions. Primary functions are accepting deposits and granting advances. Deposits that can be accepted are into saving deposits, fixed deposits, and current deposits. Granting advances can be in the form of overdraft, cash credit, loans, bills discounting etc. Secondary functions are agency functions and utility functions. Agency functions include transfer of funds, portfolio management, etc. Utility functions includes providing lockers, underwriting services, etc.