Terms Related to Banking: Definitions, Applications, Examples

Terms Related to Banking: The business of receiving, safeguarding, and lending money is called banking. In general, people who have some spare money do not keep it with them to avoid the risk of losing it by theft etc. They deposit this spare money in a bank. In the bank, the money is safe as well as it fetches interest on it. 

On the other hand, some people need money to start a business or to expand their business. So, they borrow money from the bank at a nominal interest on it. Thus, a bank is an institution that carries on the business of taking deposits and lending money.

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Functions of Banking

In addition to money-taking and money lending, the banks also perform various other functions. Almost every individual and every section of society deal with banks in one way or another. Let us discuss some essential functions of banking.

Receiving Money from Depositors

Different banks have different schemes to attract people who keep their money in the bank of their choice or the bank that gives them maximum return on their deposits.

Lending Money on Demand

Banks take deposits at a lower rate of interest and lend them at a higher rate, but they also perform certain other functions for the benefit of the needy. For example, they give a loan at concessional rates to small farmers, shopkeepers, educated unemployed persons to start a new business, disabled people, etc. 

Providing Other Useful Services to Society

Nowadays a maximum number of salaried people get their salaries through banks. Banks help in transferring money from one place to the other. In big cities, the school fees, different types of bills, Government loan instalments, income tax, etc., are paid through banks. Banks provide lockers for the safe custody of valuables. They provide traveller’s cheques, foreign currency, etc., to benefit tourists and travellers. ATM cards, credit cards, and debit cards that the banks provide are very beneficial to users.

Types of Accounts

There are three types of accounts. These are savings bank account, current account and term deposit account.

Savings Bank Account

It is one type of deposit account. Anyone can open a savings bank account with a minimum balance of \(₹\,500\). The minimum balance varies from bank to bank. A passbook is issued to a customer. It contains all the particulars of the transactions and the balance. However, the minimum age to open and operate an account differs from bank to bank and post office. A savings bank account carries a certain amount of interest compounded half-yearly. The rate of interest varies from bank to bank.

The monthly minimum balances from January to the end of June are added. The total amount is called the ‘Product’ in banks. Interest is calculated on the product and added to the opening balance on July \({1^{{\rm{st}}}}\).

\({\rm{Interest}}\, = \,\frac{{{\rm{Product}} \times \,{\rm{Rate}}\,{\rm{of}}\,{\rm{Interest}}}}{{12 \times 100}}\)

Current Account

This account is very convenient for business people, government offices, companies and various other institutes which need to make frequent and large amounts of monetary transactions. Bank does not give any interest in these accounts, but the operations of these accounts are very flexible. There are no restrictions on amounts deposited or withdrawn.

Term Deposit Account

There are two types of deposit accounts: fixed deposit accounts and recurring deposit accounts.

Fixed Deposit Accounts

Customers can avail the facility of depositing a fixed amount for a definite period. As the period is fixed, banks give a higher rate of interest on these accounts. Banks pay lesser interest than agreed upon if money is withdrawn from these accounts before the fixed period. As this discourages premature withdrawal, banks rely more on these funds. The rate of interest payable varies with the period for which the money is deposited in these accounts, and it varies from bank to bank.

Recurring Deposits Account

In the R. D. scheme, a depositor chooses a specified amount and deposits that amount every month for a fixed period, chosen by them when opening this account. This period may vary from three months to 10 years. At the expiry of this period, the depositor is paid a lumpsum amount. The maturity value of an R. D. account includes the amount deposited by the account holder together with interest compounded quarterly at a fixed rate. The rate is fixed by the Reserve Bank of India and is revised from time to time.

Let a sum of \(₹\,P\) be deposited every month in a bank for n months. If the rate of interest is \(r\% \) per year, the interest on the whole deposit is calculated by using the formula:

\(I = P \times \frac{{n(n + 1)}}{{2 \times 12}} \times \frac{r}{{100}}\)

Since the total sum deposited in \(n\) months \( = \,P \times n\)

Maturity value of the recurring deposit \(=\) Total sum deposited \(+\) Interest on it

\(P \times n + P \times \frac{{n\left( {n + 1} \right)}}{{2 \times 12}} \times \frac{r}{{100}}\)

Important Terms Related to Banking

Let’s understand some important terms related to banking.

Demand Draft

Money can be deposited through demand drafts. A person who wants to send money to another person can purchase a bank draft.

A bank draft is an order issued by a bank to its specified branch or another bank to pay the amount to the party in whose name the draft was issued.

Cheques

Money deposited in different types of accounts can be withdrawn by using withdrawal slips or cheques.

Bearer Cheque

A bearer cheque can be encashed by anyone who possesses the cheque, though the person’s name is not written on the cheque.

Crossed Cheque

If two parallel lines are drawn at the top left-hand corner of a cheque, it is called a crossed cheque—the words A/C payee may or may not be written between the two parallel lines. The payee has to deposit the crossed cheque in their account. The collecting bank collects the money from the drawer’s bank, credited to the payee.

Bouncing Cheques

If an account holder issues a cheque for an amount exceeding the balance in his account, the bank refuses to make payment. The check is said to be a dishonoured one. This is known as bouncing the cheque.

Interest

We deal with two types of interest when we borrow money from banks or keep money in the banks. Different banks may have different interest rates. Generally, there are two types of interest: simple interest and compound interest.

Simple Interest

If interest is calculated uniformly on the original principal throughout the loan period, it is called simple interest.

If \(P = \) Principal, \(R = \) Rate of interest per annum and \(T= \) time, then the simple interest formula is given by

\(S.I = \frac{{P \times T \times R}}{{100}}\)

Compound Interest

The compound interest may be compounded more than once a year. The period and rate of interest are converted accordingly.

The amount after \(T\)  years is calculated as

\(A = P{\left( {1 + \frac{R}{{100}}} \right)^T}\)

And the compound interest for this period can be calculated by the formula:

\(CI\, = \,A – P = P{\left( {1 + \frac{R}{{100}}} \right)^T} – P\)

Where, \(A = \) Amount at the end of a term

\(P = \) Initial principal

\(R = \) Annual interest rate per cent per annum

\(R = \) Number of years for which the interest is to be calculated

Solved Examples – Terms Related to Banking

Q.1. Madhu borrowed a certain sum at the rate of \(15\% \) per annum from a bank. If she paid at the end of two years \(2580\) as interest compounded annually, find the sum she borrowed.
Ans: Rate of interest \( = 15\% \) time \( = \,2\) years and Compound interest \({\rm{(C}}{\rm{.I) = 2580}}\)
\(CI\,{\rm{ = }}\,{\rm{P}}{\left( {{\rm{1 + }}\frac{R}{{100}}} \right)^2} – P\)
\( \Rightarrow ₹2580 = \,P{\left( {1 + \frac{{15}}{{100}}} \right)^2} – P\)
\( \Rightarrow ₹2580\, = \,P(0.3225)\)
\( \Rightarrow P\, = \,\frac{{₹2580}}{{0.3225}}\)
\( \Rightarrow P = ₹8000\)
Therefore, the sum borrowed by Madhu is \(₹8000\)

Q.2. At what interest rate per annum will \(₹10000\) amount to \(₹12100\) in two years if the interest is compounded annually by a bank?
Ans: Given, \(P\, = \,₹10000\) \(A\, = \,₹12100\) and \(T\, = \,\,2\) years.
Now, let \(R\) be the rate of interest.
\(A\, = \,P{\left( {1 + \frac{R}{{100}}} \right)^T}\)
\(₹12100\,\, = \,₹10000{\left( {1 + \frac{R}{{100}}} \right)^2}\)
\(\frac{{12100}}{{10000}} = \,{\left( {1 + \frac{R}{{100}}} \right)^2}\)
\(\frac{{121}}{{100}} = {\left( {1 + \frac{R}{{100}}} \right)^2}\)
\(\frac{{11}}{{10}} = 1 + \frac{R}{{100}}\)
\(\frac{{11}}{{10}} – 1 = \frac{R}{{100}}\)
\(\frac{{11 – 10}}{{10}} = \frac{R}{{100}}\)
\(\frac{1}{{10}} = \frac{R}{{100}}\)
\(R\, = \,10\)
Therefore, the rate of interest is \(10\% \) per annum.

Q.2. In how many years will \(₹750\) amount to \(₹900\) at \(4\% \) per annum?
Ans: Here, \(P = \,₹750\) \(A\,\, = \,₹900\), \(R\,\, = \,\,4\% \) per annum.
Let \(₹750\) amount to \(₹900\) at \(4\% \) per annum in \(T\) years.
Now, \({\rm{Interest}} = {\rm{Amount}}\, – {\rm{Principal}}\)
\( = \,₹900\, – \,₹750\, = ₹150\)
\(I = \frac{{P \times R \times T}}{{100}}\)
\( \Rightarrow 150 = \frac{{750 \times 4 \times T}}{{100}}\)
\( \Rightarrow T = \frac{{150 \times 100}}{{750 \times 4}}\, = \,5\) years
Thus, \(750\) amounts to \(₹900\) at \(4\% \)  per annum in \(5\)  years.

Q.4. Harsha deposits \(₹600\) per month in an R. D. account for \(2\) years a \(5\% \) per annum. Find the amount he receives at the time of maturity.
Ans: Here, principal \((P) = ₹600\)
\(N = 2 \times 12\) months and \(R\, = \,5\% \) per annum
Interest \( = \,P\, \times \frac{{n(n + 1)}}{2} \times \frac{1}{{12}} \times \frac{R}{{100}} = 750\)
Therefore, the total amount he receives at the time of maturity is
\( = (24 \times 600) + 750 = ₹15,150\)

Q.5.Ramesh took a loan amount of \(₹150000\) at \(5\% \) per annum for \(120\) days. Calculate the total interest.
Ans: \(P = ₹150000,\,R = 5\% \) per annum,\(T = 150\,\) \(\frac{{120}}{{365}}\,{\rm{year}}\, = \frac{{24}}{{73}}\,{\rm{year}}\)
\(I = \frac{{P \times R \times T}}{{100}}\)
\(I = ₹\left( {\frac{{150000 \times 5 \times \frac{{24}}{{73}}}}{{100}}} \right) = ₹\,2,46575\,\) (approximately)
Hence, the interest is \(₹2,46575\) approximately

Summary

Banking is the business of receiving, safeguarding, and lending money. In this article, we learnt about banking and its related terms such as type of account, cheques, draft, type of banking interests. We discussed the formula to calculate the amount at the R.D account and savings account for a certain time period. We learnt the usefulness of banking and at last, we solved some examples related to banking.

Frequently Asked Questions (FAQs): Terms Related to Banking

Q.1. What are the 4 banking service options?
Ans: The banking services are:
1. Receiving money from depositors
2. Lending money on demand
3. The facility of credit card, debit card
4. Discounting on bills of exchange

Q.2. What do you understand by savings account?
Ans: It is one type of deposit account. Anyone can open a savings bank account with a minimum balance of \(₹500\) The minimum balance varies from bank to bank. A passbook is issued to a customer. A savings bank account carries a certain amount of interest compounded half-yearly. The rate of interest varies from bank to bank.

Q.3. What is the current account?
Ans: This account is very convenient for business people, government offices, companies and various other institutes which need to make frequent and large amounts of monetary transactions.

Q.4.What is a recurring deposit account?
Ans:  It is one type of term deposit account where a depositor chooses a specified amount and deposits that amount every month for a fixed period, chosen by them when opening this account. This period may vary from three months to \(10\) years. At the expiry of this period, the depositor is paid a lumpsum amount.

Q.5. What is a fixed deposit account?
Ans: In this account, the customer can avail of the facility of depositing a fixed amount for a definite period. As the period is fixed, banks give a higher rate of interest on these accounts. Banks pay lesser interest than agreed upon if money is withdrawn from these accounts before the fixed period.

We hope this detailed article on terms related to banking helped you in your studies. If you have any doubts or queries regarding this topic, feel to ask us in the comment section. We will try to solve it at the earliest. Happy learning!