Bank Funds: Sources, Functions, Use of Bank Funds

Bank Funds: Sources, Functions, Use of Bank Funds

The bank is a financial intermediary that accepts surplus savings as deposits and extends funds to those who can approach the bank with bankable projects. Bank officials must know about the sources of deposits. The number of funds can be increased or decreased depending on the professional skill of the bank executives.

For example, stable deposits are preferable to sensitive and vulnerable deposits. On the other hand, short-term investments can be recovered on time to enable the bank to recycle the same to earn more profit than long-term investments.

Among short-term loans, money at call and short notice can play a positive role in maintaining both profitability and liquidity. On the other hand, a bank should be periodically monitored and evaluated to determine whether operating at an optimum pace toward its target.

Sources and Uses of Bank Funds

Banks get profit by investing their collected funds. Depositors provide a major part of bank funds. As such, banks must invest reasonable efforts to attract the money of depositors. Banks can also collect funds from different other sources.

On the other hand, providing loans is the largest head to use the funds of the commercial bank. Hopefully, it will be helpful to understand the flow of funds from the graph as under.

The above figure shows the use of funds by indicating the change in the inflow and outflow of bank funds from the previous year to the current year. It means increases in the number of deposits occurred due to the increase in the deposit source.

On the other hand, the amount decrease in the deposit in the current year than the previous year indicates a decrease in the deposit source.

In this way, an increase or decrease in the loan amount in the current period compared to the previous one indicates the volume of loans. Assets that are not currently in use can be sold to collect funds. On the other hand, bank fund decreases when assets are bought either new or as a replacement.

Managing the flow of funds is the basic concern of banks’ fund management. Bankers maintain their desired level of liquidity by taking short-term and long-term plans. So, the bank’s management always keeps a closer look at the inflow and outflow of funds.

The bank must consider that excess unused funds harm the bank while, in the same way, oxer use of bank funds causes liquidity problems. Thus, bankers need to make decisions keeping all these factors in mind.

3 Functions as Collector of Bank Funds

Bank collects funds from three main sources: deposits, borrowed funds, and capital. The variations in the sources of funds depend on the following three factors:

  • Duration to hold the fund at the bank’s disposal.
  • Relative advantage
  • Cost of the fund.

As the nature of the business, continuous cash inflow and outflow occur in the bank funds. By increasing deposits from more collections or opening new accounts, banks canalize the amount as an investment to other sectors for profit.

As the deposits are withdrawable at any time, banks need to hold sufficient cash in the vault to meet the demand as and when required.

Otherwise, it has to collect money by selling near-cash assets or borrowing from other sources, even at a higher interest rate.

All such transactions result in an increase and decrease of funds that are to be managed to maximize the profit earnings of the banks. To do this, management needs to take flexibility in the daily cash planning on a short-term and long-term basis, depending on the situation.

Cash inflow and outflow of Banks funds are regularly changed. Bank collects new deposits to increase deposits and judiciously invests mobilized deposits for earning.

Otherwise, if the deposit withdrawals are more than the arranged liquidity, fund shortage, and liquidity crisis may arise, jeopardizing public confidence. Funds are collected mainly from three sources;

  1. Capital,
  2. Deposit, and
  3. Borrowed funds.

1. Capital

Capital is the first source of bank funds. Bank also collects funds through the selling of long-term debentures. Generally, the bank collects owners’ funds through issuing shares. The more the shareholders purchase the shares, the more capital is collected.

Unclaimed dividends/undistributed profits also form a part of banks’ funds. The amount of undistributed profit depends largely on the dividend policy. The sale of unnecessary/ unusable assets increases the inflow of funds.

Large banks sometimes collect funds from the open markets using their goodwill. But, the case is different for small banks. Moreover, both the large and small banks fail to collect funds in countries with less developed money & capita) markets.

According to bank specialists, borrowing from other sources also acts as one of the bank funds. But the debt/ borrowings hold a second claim only after the depositors’ claims are met.

Many businesses collect funds by issuing debentures. Normally this type of debenture matures in 25 to 30 years. The bank specialist R. D Watson says that debt/ borrowings with more than seven years of maturity act as good as capital.

2. Deposit

Deposit is the largest source of bank funds. A medium-sized bank is assumed to collect 85%-95% of its funds through deposits. Deposit accounts can be classified into three categories-

  1. Current Deposit Account
  2. Savings Deposit Account
  3. Fixed Deposit Account

From the viewpoint of bank fund management, the highest cost is involved in fixed deposit accounts. But the banker gets more income from this account.

On the other hand, the cost of collecting the current deposit account is almost zero. Even though the amount is huge, it can be invested for a short span of time. The current account earns lower than the fixed account. A savings deposit account holds the features of the previously mentioned accounts.

Thus, the bank cams more than the current account from the savings account but less than the fixed deposit account.

3. Borrowed Fund

Banks collect funds from both short-term and long-term borrowings. Banks collect long-term funds from long-term borrowings by following contemporary rules and regulations.

Long-term funds thus act as capital. The instruments through which the bank collects short-term funds are selling securities with a repurchase agreement, borrowings from the central bank, and borrowings from sister banks.

This type of loan facility may have one or two days of maturity. Interest payable on these borrowings depends on such funds’ demand for and supply.

With a regular repayment record, banks may get lenders’ confidence and thus can collect short-term funds whenever needed, the costs of which become relatively less than funds from long-term sources.

Comparison of different sources of bank funds

SourcesDurationRelative AdvantageCost of Funds
CapitalUnlimitedUnlimited maturity.

Act as loss absorber.
Current DepositVery shortProvide immediate liquidity.

No interest expenses
Only account maintaining cost.
Savings DepositHigher than a current account but lower than a term deposit.Higher maturity.

Low liquidity risk
Interest is paid at a minimum level.
Term Deposit DepositLongest among all the deposit accounts.Long-term maturity.

Long-term investment facility.
Interest is paid at a relatively higher rate.
Borrowed FundRanging from 1 day to 20 yearsTax-deductible.

Provide deductible immediate and long-term liquidity.
Interest is paid at different rates based on maturity.

How Commercial Banks Use Bank Funds

Banks collect funds from deposits, debt, capital, and other sources. Most of the collected funds, when used able to earn profit.

Funds are used for two purposes; one is in loan, and another is an investment. While investing in the earning assets, banks should hold enough cash or near cash assets to meet different types of liquidity.

Though funds retained as liquid assets cam a little, banks hold them only to maintain day-to-day needs to uphold public confidence. The authority of bank business also holds a certain amount of funds as a statutory reserve which works as Mandatory.

Commercial banks use their fund in the following way-

1. Lending Function

Bank uses most of the funds mobilized as loans and advances. In developed countries, 50%-65%of commercial hank funds extend loans and advances, but the same ranges from 65%-75% in developing countries.

Loans are classified in two ways one for business- investment or working capital and another for a non-business loan for individuals, such as car loans, house loans, medical loans, etc.

2. Investment Functions

The investment function is the second head to use the banks’ funds. Bank invests in T-bill, which Govt issues. It is less risky than any other securities. It is easier to convert into cash than any oilier securities. For this reason, it is preferable.

It may be short-term, intermediate, or long-term. Banks also utilize funds as an investment in blue chips and first-class bonds, debentures, etc.

3. Cash Assets Functions

Cash assets indicate that a portion of the bank fund is used to maintain banks’ liquidity in different forms.

The assets in which funds are invested are –

  • Cash in Vault.
  • Items in the process of collection.
  • Balance with the central bank.
  • Balances with sister banks.

4. Other Functions

For a new bank, huge funds are used to purchase quality equipment, technology, furniture, building, office, etc., to create an impression that will attract many customers.

On the other hand, existing hank requires funds for replacement, modernization, or maintenance purpose. Moreover, banks may install high-technology investments to render smooth and quick service.