What are Sources of Funds in Commercial Banks ?

A commercial bank is a financial institution that helps community members open checking and savings accounts and manage money market accounts. However,here you will get to know about what are Sources of Funds in Commercial Banks. well, as the name implies, a commercial bank also has a broader, business-oriented focus. Most commercial banks offer business loans and trade financing in addition to the more traditional deposit, withdrawal and transfer services. With such a diverse business profile, the sources of funds in commercial banks are varied. Commercial banks make money by providing loans and earning interest income from those loans. The types of loans a commercial bank can issue vary and may include mortgages, auto loans, business loans, and personal loans. A commercial bank may specialize in just one or a few types of loans.


 Having established the pivotal role performed by the banking system in the Indian financial sector and by implication, in the overall financial intermediation process, thus supporting the real sector of the economy. The strong points of the financial system are its ability to mobilize savings, its vast geographical and functional reach and institutional diversity. Between 1965 and 1990, the household sector’s gross savings in the form of financial assets rose from 5.5 per cent to 12.2 per cent of net domestic product. Since 1969 when major banks were nationalized, the number of commercial bank branches increased from about 8,300 to well over 65,000 by 2005.

Sources Of Funds:

Reserve Funds:

A commercial bank builds a reserve fund with deposits so it can pay interest on accounts and complete withdrawals. Ideally, a bank’s reserve fund should be equal to its capital. A bank builds its reserve fund by accumulating surplus profits during healthy financial years so that the funds can be used in leaner times. On average, a bank tries to accumulate approximately 12 percent of its net profit to build and maintain its reserve fund.

Shareholders Capital:

Some commercial banks that trade on the stock exchange can use shareholders’ capital to receive the money it needs to stay in business. For example, if a company sells shares on the market, it increases both its cash flow and its share capital. This process is also known as equity financing. Banks can only report the amount of capital that was initially on their balance sheet. Appreciation and depreciation of shares do not count toward the total sum of a shareholder’s capital.

Retained Earnings:

A lot of commercial banks earn retained earnings or fees to help fund their business. A retained earning can be collected through overdraft fees, loan interest payments, securities and bonds. Banks also charge fees for providing customers with services such as maintaining an account, offering overdraft protection and also monitoring customers’ credit scores.

Fixed deposits (Time deposits):

Fixed deposits have a fixed period of maturity and are referred to as time deposits. These are deposits for a fixed term, i.e., period of time ranging from a few days to a few years. These are neither payable on demand nor they enjoy cheque facilities.

They can be withdrawn only after the maturity of the specified fixed period. They carry higher rate of interest. They are not treated as a part of money supply Recurring deposit in which a regular deposit of an agreed sum is made is also a variant of fixed deposits.

Savings account deposits:

These are deposits whose main objective is to save. Savings account is most suitable for individual households. They combine the features of both current account and fixed deposits. They are payable on demand and also withdraw able by cheque. But bank gives this facility with some restrictions, e.g., a bank may allow four or five cheques in a month. Interest paid on savings account deposits in lesser than that of fixed deposit.

 Overdraft facility:

An overdraft is an advance given by allowing a customer keeping current account to overdraw his current account up to an agreed limit. It is a facility to a depositor for overdrawing the amount than the balance amount in his account.

In other words, depositors of current account make arrangement with the banks that in case a cheque has been drawn by them which are not covered by the deposit, then the bank should grant overdraft and honour the cheque. The security for overdraft is generally financial assets like shares, debentures, life insurance policies of the account holder, etc.

Borrowing from other banks :

The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate (also called the overnight rate if the term of the loan is overnight). A sharp decline in transaction volume in this market was a major contributing factor to the collapse of several financial institutions during the financial crisis of 2007–2008.Banks are required to hold an adequate amount of liquid assets, such as cash, to manage any potential bank runs by clients. If a bank cannot meet these liquidity requirements, it will need to borrow money in the interbank market to cover the shortfall. Some banks, on the other hand, have excess liquid assets above and beyond the liquidity requirements. These banks will lend money in the interbank market, receiving interest on the assets.


Prof. Syers, defined banks as “institutions whose debt—usually referred to as ‘bank deposits’—are commonly accepted in final settlement of other people’s debts”. According to Banking Regulation Act of 1949, “Banking means the accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise”. From the above definitions we can analyze that the primary functions of banks are accepting of deposits, lending of these deposits, allowing deposits to withdraw through cheque whenever they demand. The business of commercial banks is primarily to keep deposits and make loan and advances for short period up to one or two years made to industry and trade either by the system of overdrafts of an agreed amount or by discounting bills of exchange to make profit to the shareholders. From the above discussion, we can say that the following are the functions of commercial banks.

  1. Receiving deposits from the public: The primary function of commercial banks is receiving of deposits in the form of savings bank account, current account and term deposits from the savers usually from the public. People usually prefer to deposit their savings with the commercial banks because of safety, security and liquidity. The aggregate deposits of scheduled commercial banks in India rose rapidly from Rs. 822 crores in 1951 to Rs. 3,763 crores in 1967. The total deposits of commercial banks was Rs. 4,661 crores in 1969 that increased to Rs. 34,237 crores by 735 per cent by 1979. The total deposits of commercial banks increased in the decade of 1981 to 1991 from Rs. 40,413 crores to Rs. 2,00,569 crores by 5 times. Out of which the proportion of current, saving and fixed deposits were Rs. 6,286, Rs.11,805 and Rs. 22,322 crores which is almost 1: 2: 3 ratio increased to Rs. 30,335, Rs. 56,152 and Rs. 114082 crores i.e., almost 5 times during one decade with almost same proportion. The total deposits with commercial banks by the end of 2005 increased to Rs. 21,00,000 crores.
  2.  Giving loans and advances:The second major function of the commercial banks is giving loans and advances to the all types of persons, particularly to businessmen and investors, against personal security, gold and sliver and other movable and immovable assets. The bank advances loans in the form of cash credit, call loans, overdraft and discounting bills of exchange to businessmen. After reforms in banking sector and establishment of new private sector banks and foreign banks, the other commercial banks also started giving loans and advances not only to their traditional businesses but also for vehicles, housing, consumer durables, etc. by increasing the base of lending activities.
  3.  Use of cheque system and credit cards: The commercial banks will allow the depositors of the bank to withdraw and make payment of their amount in their bank account through cheques. Now the banks are allowed to use debit and credit cards for making their payments.
  4. Credit creation: Credit creation is one of the most important functions of the commercial banks. Like other financial institutions, they aim at earning profits. For this purpose they accept deposits and advance loans by keeping small cash in reserve for day-to-day transactions. When a bank advances a loan, it opens an account in the name of the customer and does not pay him in cash but allows him to draw the money by cheque according to his needs. By granting a loan, the bank creates credit or deposit. 
  5. Financing foreign trade: The commercial banks finance foreign trade of its customers by accepting foreign bills of exchange and collecting them from foreign banks. It also transacts other foreign exchange business and buys and sells foreign currency. 
  6. Transfer of funds: Commercial banks will help the customers to transfer their money from one account to another account, from one place to another place through cheques. Now the transfer of funds from one place to another place, or from one party account to another party account or one bank to another bank is done through Electronic Fund Transfer (EFT). This facility helps in transfering funds from one bank to another bank or to another party account easy. The technology like MICR helps the banks to have innovative banking like anywhere banking, anytime banking, and virtual banking and so on.
  7.  Agency functions: The commercial banks act as agents for customers to buy and sell shares, securities on their behalf. It pays subscriptions to insurance premiums, mutual funds, rent, water taxes, electricity bills etc on behalf of its clients. It also acts as a trustee and executor of the property and will of its customers. 
  8. Miscellaneous functions: The miscellaneous functions performed by the commercial banks are: it provides safety locker facility, making and receiving payments on behalf of its depositors, issuing letters of credit and traveller’s cheques.


Assets structure will reflect the deployment of sources of funds of commercial banks. The main source of funds of commercial banks is deposits. The other sources of funds are borrowings from other banks, capital, reserves and surplus. The deposits of commercial banks are from savings deposits, current account deposits and term deposits. These deposits constitute 80 per cent of the total sources of funds. Out of the total deposits, term deposits constitute 50 per cent. Borrowings are around 5 per cent of the total liabilities of the commercial banks. These sources are deployed by the commercial banks mainly on its financial assets i.e, loans and advances which constitute 48.6 per cent of the total assets of the banks. The investments is another important component of the assets of commercial banks which is around 40 per cent of the total assets of the banks during the year 2005. This is because of pre-emptions like SLR and CRR requirements in the banking sector. The investments in commercial banks have increased also because of surplus liquidity in Indian banks during this period due to reduction of SLR and CRR to 25 and 4.5 respectively during that period and less demand for loans and advances from credit-worthy customers. This scenario is changing in India due to increasing demand in credit from industrial, agriculture sector and also the growth of FMCG market.

Profitability Performance of Commercial Banks:

 Profitability is one major criterion for evaluating the performance of banks. If profitability has to be planned and improved, detailed, systematic and objective analysis is necessary. It calls for studying the factors determining profitability, how they behave, how they are related to each other and how valid inter-bank comparisons are. To evaluate the profitability performance of the banks largely ratios are used as a tool for comparison. There is no unanimity in the selection of ratios. The ratios usually used are: 1. Net Profit / Net Worth 2. Spread / Working Funds 3. Burden / Working Funds 4. Interest Income / Total Earning Assets 5. Non-Interest Income / Total Earning Assets 6. Interest Expenses / Total Earning Assets 7. Non-Interest Expenditure (Operating Expenditure) / Total Earning Assets 8. Net Profit / Working funds 9. Net Non-Performing Assets / Net advances 10. Capital Adequacy Ratio 11. Savings Deposit / Total Deposits 12. Current Deposits / Total Deposits 13. Term Deposits / Total Deposits 46 Indian Financial System shifted their attention to increasing non-interest income.

How a Commercial Bank Works:

The amount of money earned by a commercial bank is determined by the spread between the interest it pays on deposits and the interest it earns on loans it issues, which is known as net interest income.

Customers find commercial bank investments, such as savings accounts and CDs, attractive because they are insured by the Federal Deposit Insurance Corp. (FDIC), and money can be easily withdrawn. However, these investments traditionally pay very low interest rates compared with mutual funds and other investment products. In some cases, commercial bank deposits pay no interest, such as checking account deposits.

Example of How a Commercial Bank Earns Money:

When a commercial bank lends money to a customer, it charges a rate of interest that is higher than what the bank pays its depositors. For example, suppose a customer purchases a five-year CD for $10,000 from a commercial bank at an annual interest rate of 2%.

On the same day, another customer receives a five-year auto loan for $10,000 from the same bank at an annual interest rate of 5%. Assuming simple interest, the bank pays the CD customer $1,000 over five years, while it collects $2,500 from the auto loan customer. The $1,500 difference is an example of spread—or net interest income—and it represents revenue for the bank.

In addition to the interest it earns on its loan book, a commercial bank can generate revenue by charging its customers fees for mortgages and other banking services. For instance, some banks elect to charge fees for checking accounts and other banking products. Also, many loan products contain fees in addition to interest charges.

An example is the origination fee on a mortgage loan, which is generally between 0.5% and 1% of the loan amount. If a customer receives a $200,000 mortgage loan, the bank has an opportunity to make $2,000 with a 1% origination fee on top of the interest it earns over the life of the loan.

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