Commercial Banks and Financial Institutions: Advantages, Limitations

The compilation of these Sources of Finance in Business Notes makes students exam preparation simpler and organised.

Commercial Banks and Financial Institutions

Banks are a very important part of our economy. They are the center of finance. People keep money in the banks because it is a safe and secure way to store the money. In the line with this, let’s learn further what are Commercial Banks and Financial Institutions.

Commercial Banks

Banks have immense monetary assets and subsequently are dominant players in all sectors of financial markets like credit, cash, securities, foreign exchange, and derivatives. Commercial banks have a critical part in the general financial position of the economy as they give assets to various purposes and additionally for various durations. A rate of premium is charged by banks for the loan.

Commercial banks give loans to organizations in either cash credits, overdrafts, term loans, purchase/discounting of bills, or issue of letters of credit. Banks help enterprises by providing loans to produce goods and contribute towards industrial growth and generate employment opportunities.

Technically, loans given by banks cannot be a permanent source of funds for the organizations as it has an interest rate and loan must be repaid within a specific period allotted. Before a loan is sanctioned by a bank, the borrowing party must provide some security. Banks also provide other services like merchant banking, corporate advisory services, portfolio management services, etc.

Merits of Commercial Banks
Every coin has two sides, similarly raising a loan from a bank has a sunny side as follows:

  • Banks are flexible sources of finance as the amount to be received is decided by the borrowing party and can be increased and decreased according to business needs. Loans can be repaid in advance when funds are not required.
  • Banks keep the borrower’s information confidential and secure.
  • Banks provide assistance in times of need to businesses by providing funds.

Limitations of Commercial Banks
Certain limitations occur while raising funds from commercial banks. The limitations of raising funds from commercial banks are as follows:

  • Banks are notorious for making a detailed investigation of the company’s background and affairs, financial structure, plan, etc., and also to ask for the security of assets and personal sureties. This makes the procedure of getting funds difficult.
  • Funds are generally available for short periods and renewal is uncertain and difficult.
  • Banks put forth difficult terms and conditions before providing a loan.

Financial Institutions

The economic development of any country depends on the growth of the business sector. The well-developed financial system helps the business to achieve growth by making funds available to them. For this, the government has established financial institutions all over the country to provide finance to businesses.

These institutions aim at promoting the industrial development of a country and are called ‘development banks’. The main role of a financial institution is to transfer financial resources from those who save it to those who are in need of financial resources for economic activity.

Central and state governments set up Financial Institutions. They provide both owned capital and loan capital for the long and medium-term and supplement the traditional financial agencies like commercial banks. Financial institutions give technical assistance and managerial services to organisations. These institutions give large funds for a longer duration.

Merits of Financial Institutions
The merits of raising funds from financial institutions are as follows:

  • Here, finance is available even during periods of depression, when no other source of finance is available in the market.
  • Besides providing funds, many of these institutions provide financial, managerial and technical advice and consultancy to business firms.
  • For long-term business funds requirements, financial institutions are preferable as they provide long-term finance, which is not provided by commercial banks.

Limitations of Financial Institutions
The limitations of raising funds from financial institutions are as follows:

  • Restriction on dividend payment imposed on the powers of the borrowing company by the financial institutions.
  • As these institutions come under government criteria, they follow rigid rules for granting loans. Too many formalities make the procedure time-consuming.
  • Financial institutions may have their nominees on the Board of Directors of the borrowing company thereby restricting the powers of the company.

Special Financial Institutions

1. Industrial Finance Corporation of India (IFCI):

Commercial Banks & Financial Institutions - IFCI

IFCI was set up as a statutory organization under the Industrial Finance Corporation Act 1948. Its main objectives were to provide help towards supporting the local advancement and urging new business visionaries to go into the urgent and needful sectors of the economy.

2. State Financial Corporations (SFC):
The State Financial Corporations Act, 1951 made the State Governments build up State Financial Corporations in their particular areas forgiving medium and short-term funds to businesses which are outside the extent of the IFCI.

3. Industrial Credit and Investment Corporation of India (ICICI):
This foundation was formed in 1955 as a public organization under the Companies Act. ICICI helps the creation, development, and modernization of industrial endeavours solely in the private sector.

4. Industrial Development Bank of India (IDBI):
In 1964, it was set up under the Industrial Development Bank of India Act, 1964 with a target to facilitate the working of other financial institutions including commercial banks.

5. Industrial Investment Bank of India Ltd:
It was set up as an essential institution for the restoration of sick units and was known as Industrial Reconstruction Corporation of India. It was reconstituted and renamed as the Industrial Reconstruction Bank of India in 1985 and again in 1997, its name was changed to Industrial Investment Bank of India.


The Life Insurance Company (LIC) is a commercial bank. True or False?
This statement is False. LIC is not a commercial bank it is a financial institution. The main function of LIC is to provide the public with insurance services. It was set up in 1956 by the Government of India to serve the public.