What Is Business Banking?
Business banking is a specialized bank or financial institution division that deals only with businesses and corporate clients and offers products like business loans, assets management, and electronic transfer of funds specifically designed to meet their needs. These banking services allow corporates to be financially fulfilled for a healthy competition and growth.
Business banking loans do not serve the needs of individual customers. Instead, they directly cater to the needs of the companies/businesses. Though banks majorly focus on this area as these services and clients are their significant source of profit, interest rates, and fees are still higher for corporate clients than retail clients.
Table of contents
- Business Banking is a banking service that suits business corporations’ and organizations’ needs.
- The main services offered include business loans, asset management, electronic transfer, etc.
- Banks’ four main features to business organizations are Overdraft Facility, Credit facility, Bank Loan/Term Loan, and treasury and cash management.
- Business Banking has facilitated business organizations in the modern era to function better financially and in operations.
Business Banking Explained
Business banking, also known as corporate banking or commercial banking, helps corporate participants to obtain funds when required with the goal of providing them with the best corporate banking solutions using Innovative technologies to ensure the smooth functioning of businesses and create a loyal institutional client base for future growth.
From providing small business banking solutions to being available for the major businesses requiring financial assistance, a banking institution does it all. The major service seekers include corporations, partnerships, Limited Liability Companies (LLCs), and sole proprietorships, The most significant products that these financial institutions have in stock for their customers are everything from physical monetary assistance to electronic fund transfers.
Financial InstitutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. like Wells Fargo or Barclays bank sign agreements with corporations, which allow companies to use various facilities and services of a bank at fixed service costs. Facilities like short to long-term loans and services like a letter of creditLetter Of CreditA Letter of Credit (LC) is issued by a buyer’s bank to ensure timely, full payment to the seller. If the buyers default, the bank pays the sellers on their behalf. are provided, ensuring a business’s smooth functioning.
The types of business banking services available to corporate finance seekers have been listed below:
#1 – Overdraft Facility
When companies have more cash requirements than the available balance in companies’ current accounts, then companies generally avail overdraft facilities from banks for which banks charge interest rates. Overdrafts are often used as an alternative source of funding for unexpected expenditures. OverdraftOverdraftOverdraft is a banking facility that offers short-term credit to the account holders by allowing them to withdraw money from their savings or current account even if their account balance is or below zero. Its authorized limit differs from customer to customer. is a very common source of funding for small and medium enterprises.
- Overdraft facility is available as short-term financing and useful for companies with fluctuating finance requirements or a seasonal business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline..
- An overdraft facility can be used with or without pre-approval from a lender. Generally, a pre-approved facility carries a lower interest rate than without approval.
- Sometimes large overdraft facilities can be secured against company assets, which brings down the Interest rate as the risk to the lender will be lower.
- Interest paid is tax-deductible, and the balance of overdraft is not included in the company’s business financial calculation.
#2 – Bank Loan or Term Loan
When companies want to go for business expansion, like purchasing a new property, plant, or machinery, then companies generally prefer to go for a bank loan that has a fixed tenor with a fixed or variable rate of interest. The loan companies can expand their business through the bank without taking a big hit on an available cash reserve.
- Bank loans are the best funding source for medium and long-term business needs.
- The interest rate can be fixed or variable rate. The variable rate is based on LIBORLIBORLIBOR Rate (London Interbank Offer) is an estimated rate calculated by averaging out the current interest rate charged by prominent central banks in London as a benchmark rate for financial markets domestically and internationally, where it varies on a day-to-day basis inclined to specific market conditions. (London Interbank Offered Rate).
- The company’s revenue generation capability, future cash flow, loan amount, repayment schedules, and loan tenor will be decided.
- If the loan is secured against the company’s assets, interest rates will generally be lower, but in any case, the business fails to repay. The lender has the right to seize the assets and recover the loan amount.
- The default loan payment can increase the Interest rate for future loans and legal proceedings against the company.
#3 – Letter of Credit
A letter of credit or LC is generally used in international tradesInternational TradesInternational Trade refers to the trading or exchange of goods and or services across international borders. . Letter of the credit agreement states that, in any case, if the importer (or buyer) is not able to make the payment, then the issuer of LC, i.e., bank, will make full or remaining payment to the exporter (or seller) on behalf of the buyer.
Types of Letter of Credits
- Standby Letter of Credit: In this type of LC, the bank pays the amount only when the applicant of LCLCThe full form of LC is a Letter of credit. A letter of credit is a document issued by the buyer's bank, known as the issuing bank, that guarantees that the buyer will pay the correct amount to the seller on time, and that if the buyer fails to pay the amount to the seller, the bank is liable to pay the outstanding dues to the seller on behalf of the buyer. cannot make payment.
- Traveler’s Letter of Credit: This type of LC is useful for the traveler, in which issuing banks honor payment requests made at the foreign country banks.
- Revolving Letter of Credit: This type of LC allows any number of payments within a certain limit for a specific time period.
- Confirmed Letter of Credit: Two banks are involved (issuing bank and confirming bank); if the issuing bank or holder of LCs cannot make a payment, confirming the bank ensures payment to the seller.
- When a seller from another country cannot determine the reliability of an individual buyer, then letter credit from the buyer side plays an important role in completing the trade.
- Bank takes credit risk based on the buyer’s creditworthinessCreditworthinessCreditworthiness is a measure of judging the loan repayment history of borrowers to ascertain their worth as a debtor who should be extended a future credit or not. For instance, a defaulter’s creditworthiness is not very promising, so the lenders may avoid such a debtor out of the fear of losing their money. Creditworthiness applies to people, sovereign states, securities, and other entities whereby the creditors will analyze your creditworthiness before getting a new loan. and takes the service cost for issuing a letter of credit. Charges will be higher if credit riskCredit RiskCredit risk is the probability of a loss owing to the borrower's failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt's principal and an interest component, resulting in interrupted cash flow and increased cost of collection. is higher.
- Aspects such as distance, differing laws in each country, and difficulty in knowing the opposite party personally make a letter of credit even more important.
- A letter of credit helps in better payment terms and timely shipments of goods for both buyers and sellers.
#4 – Treasury and Cash Management Services
Banks provide Treasury management services to cooperate like a collection of payments. Disbursements, trading, and Investment in bonds, foreign exchangeForeign ExchangeForeign exchange, or Forex, is trading one currency for values equivalent to another currency.. Banks have a special department devoted to treasury management and provide these services at a fixed costFixed CostFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity..
- Effective Treasury management helps in the smooth functioning of business and gain lender and stakeholder confidence.
- The main purpose of Treasury management is to ensure a firm’s liquidity position is stable.
- Treasury management helps the company mitigate various operational and financial risksFinancial RisksFinancial risk refers to the risk of losing funds and assets with the possibility of not being able to pay off the debt taken from creditors, banks and financial institutions. A firm may face this due to incompetent business decisions and practices, eventually leading to bankruptcy..
Let us consider the following examples to have a better understanding of business banking services:
Example 1 (Overdraft Facility)
Suppose a small retail firm based out of New York has emergency cash requirements to pay off suppliers. The firm has the option to take a secured overdraft facility against its fixed deposit with a bank. Since an overdraft is secured against a fixed deposit, it will carry a lower Interest rate, and the firm can pay off overdraft principle and interest upon cash receivables.
Example 2 (Letter of Credit)
Suppose a furniture company Ladder Inc. based in the United States, wants to export $100,000 of furniture to a company ABC based in Kenya. Still, Ladder Inc. is concerned about Kenyan companies’ ability to pay them.
So, ABC gets a letter of credit from its bank, Bank of Kenya, indicating that it will make good on the $100,000 payment in 60 days or the bank can pay itself. Bank of Kenya then sends the letter of credit to Company Ladder Inc., which agrees to ship the furniture.
After the shipment goes out, Company Ladder Inc. then asks for its $100,000 by presenting a written draft (also called a bill of exchange) to the Bank of Kenya.
Example 3 (Treasury & Cash Management)
Suppose a company belonging to an export business has a standard requirement for foreign currencies. Then, the company can request the bank’s treasury service to get the best foreign exchange rate.
Business Banking Vs Personal Banking
Though the name business banking and personal banking reveal the services each of them offers, here is a list of differences between them mentioned briefly:
- While business banking is meant to serve the financial requirements of organizations, personal banking takes care of the personal finance requirements of individuals.
- In business banking, companies or businesses need to present and submit formal credentials, including their business license, tax return details, etc, to get their loans approved. On the other hand, personal banking takes into account the credit records of the individuals to assess their profile.
Frequently Asked Questions (FAQs)
Business Banking involves the banking services that facilitate business organizations and corporations and assist them in financial capabilities. Commercial Banking, on the other hand, is for individual savings accounts.
The main functions and operations of Business Bankers include analyzing loan and credit services, assisting business corporations in creating expansion plans, financing corporations, managing cash and cash equivalents, etc.
The numerous benefits of it include Financial Planning, Cash Management, Checking and Savings Accounts, Credit Building, Tax assistance, and others.
Smaller businesses, especially sole proprietors, typically employ “business” banking services. ‘Commercial’ or ‘corporate’ banking often refers to the products and services utilized by bigger businesses with a significant turnover.
This has been a guide to what is Business Banking. Here we explain its types of services, vs personal banking along with examples. You can learn more about financing from the following articles –