Commercial banks are the largest group of financial institutions within a financial system and
therefore they are very important in facilitating the flow of funds between savers and borrowers.
The core business of banks is often described as the gathering of savings (deposits) in order to
provide loans for investment. The traditional image of banks as passive receivers of deposits
through which they fund their various loans and other investments has changed since deregulation.
For example, banks provide a wide range of off-balance-sheet transactions.
Banks now actively manage their sources of funds (liabilities). They offer a diversity of products
with different return, risk, liquidity and cash-flow attributes to attract new and diversified funding
sources. Sources of funds include current deposits, call or demand deposits, term deposits,
negotiable certificates of deposit, bills acceptance liabilities, debt liabilities, foreign currency
liabilities, loan capital and shareholder equity.
Commercial banks now apply a liability management approach to funding growth in their balance
sheets. Under this approach a bank will borrow in the domestic and international money markets
and capital markets to obtain sufficient funds to meet its forecast loan demand. This has resulted in
strong growth in the issue of securities such as negotiable certificates of deposit, debentures and
unsecured notes. Banks also issue subordinated debt (loan capital) and equity, including preference
shares, convertible notes and ordinary shares.
The use of funds is represented as assets on banks’ balance sheets. Bank lending is categorised as
personal and housing lending, commercial lending and lending to government. Personal finance is
provided to individuals and includes housing loans, investment property loans, fixed-term loans,
personal overdrafts and credit card finance. Banks invest in the business sector of the economy by
granting commercial loans. Commercial loan assets include overdraft facilities, discounted
commercial bills held, term loans and lease finance. While banks may lend some funds directly to
government, their main claim is through the purchase of government securities such as Treasury
notes and Treasury bonds.
Viewing banks only in terms of their assets and liabilities greatly underestimates their role in the
financial system. Banks have recorded strong growth in their off-balance-sheet business. The
notional value of off-balance-sheet business is nearly six times the value of the accumulated assets
of the banking sector.
Off-balance-sheet business is categorised as direct credit substitutes, trade- and performance-related
items, commitments, and foreign exchange, interest rate and other market-rate-related contracts.
Over 90 per cent of banks’ off-balance-sheet business is in market-rate-related contracts such as