Commercial Bank

Updated on March 19, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Commercial Bank?

Commercial Banks are profit-seeking financial institutions. They receive deposits from customers at a lower rate of interest and offer business loans at a higher interest rate. They serve individuals, small-scale businesses, and medium-sized businesses.

Commercial banks augment their profits by offering additional investment products and banking services—current account deposits, savings accounts, fixed deposits, cash credit, advances, overdraftsOverdraftsOverdraft 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.read more, locker facilities, and investments. Due to competition, they need to innovate continuously, adapting to automation, data analytics, digitization, artificial intelligence, faster transactions, and quicker responses to market changes.

Key Takeaways

  • Commercial banks are licensed financial institutions that provide banking solutions to their clients—individuals, small businesses, and medium-sized firms.
  • Commercial finance institutions serve both individuals and businesses. Retail banks on the other hand extend services only to individuals.
  • These institutions also execute various secondary functions for their client—overdraft facility, agency services, discounting bills of exchange, traveler’s check, investments, and locker facility.

How Do Commercial Banks Work?

Commercial Bank

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Commercial banks play a part in economic growthEconomic GrowthEconomic growth refers to an increase in the aggregated production and market value of economic commodities and services in an economy over a specific period.read more and liquidity by catering to a multitude of customers. Their clientele comprises individuals and small to mid-sized corporates. The customers obtain low rates of interest on bank deposits but the bank loans funds at a higher interest rate to earn a margin—also known as the spreadSpreadSpread is the price, interest rate, or yield differentials of stocks, bonds, futures contracts, options, and currency pairs of related quantities.read more. Recently, some of these banks introduced investment banking divisionsInvestment Banking DivisionsInvestment Banking Division is a segment of the investment bank offering advisory & corporate finance services. It executes mergers & acquisitions, deals with capital raising, & handles several kinds of advisory mandates. read more—Citibank and JPMorgan Chase. But banks like Ally operate only on commercial aspects of the business.

These banks mainly offer loan facilities and accept deposits. But in addition to that, they provide saving accounts, merchant services, commercial loans, global trade services, treasury services, lending services, current or checking accountsChecking AccountsA checking account is a bank account that allows multiple deposits and withdrawals. Additionally, it provides superior liquidity.read more, term deposits, consumer loans, mortgages, credit cards, debit cards, cash management Cash Management Cash Management refers to the appropriate collection, handling, & disbursement of cash for ensuring financial stability & avoiding insolvency risk. read moreservices, corporate loans, and online banking services.

In the contemporary digital era, most commercial banks function online—customers carry out electronic banking transactions without visiting their bank’s branch office. As a result, operating profit marginsOperating Profit MarginsOperating Profit Margin is the profitability ratio which is used to determine the percentage of the profit which the company generates from its operations before deducting the taxes and the interest and is calculated by dividing the operating profit of the company by its net sales.read more for “virtual” banks have increased. The Internet has brought down operating expenses (OpEx)Operating Expenses (OpEx)Operating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more—banks do not have to maintain physical branches—ancillary charges on rent, property taxes, and utilities have gone down.

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Video Explanation about Commercial Bank

 

Functions of Commercial Banks

Banks survive on loans. Commercial banks are no different. Given below are the various functions:

#1 – Primary Functions

  • Accepting current, demand, fixed, and savings account deposits from customers;
  • Providing cash credit, auto loans, mortgage loans, short-term loans, and advances;
  • Creating credit by expanding deposits.

#2 – Secondary Functions

Other miscellaneous services are enlisted below:

Role of Commercial Banks

The banking industry as a whole runs the economy Economy An economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read moreof a nation. The roles of a commercial bank are as follows:

Examples

According to a Federal Reserve Statistical Release report, JPMorgan Chase & Co is the largest commercial bank in the US. As of September 30, 2021, JPMorgan possesses consolidated assets worth $3,290,398 million. It is closely followed by Bank of Amer Corp and Wells Fargo & Co, with consolidated assets worth $2,400,819 million and $1,786,611 million, respectively.

JPMorgan Chase provides global financial solutions to its clients ranging from treasury payments, commercial real estate, international banking, credit, and financing. The bank also offers investment banking and asset managementAsset ManagementAsset management is a method of managing funds and investing in both traditional and specialized products in order to generate returns consistent with the investor's risk tolerance. read more facilities.

Types of Commercial Banks

They are further classified into the following categories:

  1. Private Sector Banks: The majority stake is owned by private shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more (individuals or corporates). They accept deposits and distribute loans to individual customers, small businesses, and medium-sized businesses.
  2. Public Sector Banks: For public banks, majority equity Equity Equity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet.read morelies in the hands of the government. Nationalized banks provide financial services to mass customers at affordable rates.
  3. Foreign Banks: As the name suggests, these financial institutions operate in foreign countries but have head offices in the parent country. The bank’s foreign branches take deposits, extend loans, engage in securities trading, and facilitate foreign exchange functions.

Commercial Banking vs. Retail Banking

Commercial and retail banks are both categorized as depository banks. Commercial finance institutions serve both individuals and businesses. Retail banks, on the other hand, extend services only to the general public. Commercial finance is a huge sector operating in small and medium scale industries, whereas retail bankingRetail BankingRetail banking or personal banking refers to the financial services offered by the financial institutions exclusively to the individual clients. The consumer banking provides personal loan, savings account, debit cards, credit cards, locker, etc.read more is the front for the common people.

In addition to primary functions, commercial institutions offer services like trade finance, corporate loans, cash management, treasury management facility, agency services, and overdraft facility. In comparison, retail banks offer services like mortgage loans, savings and checking accounts, line of creditLine Of CreditA line of credit is an agreement between a customer and a bank, allowing the customer a ceiling limit of borrowing. The borrower can access any amount within the credit limit and pays interest; this provides flexibility to run a business.read more, debit cards, and credit cards.

Frequently Asked Questions (FAQs)

How do commercial banks make money?

Commercial finance institutions offer various loans and advances—personal, mortgage, business, and auto loans. The banks earn interest on these credit services, and it is always less than the interest rate offered to the depositors. This margin between the interest rates acts as their source of income.

What are the different types of banks?

Financial institutions are classified as central banks, agricultural banks, cooperative banks, investment banks, savings banks, retail banks, rural banks, small finance, industrial banks, exchanges, and specialized banks.

What is the main purpose of commercial banks?

It is a licensed financial institution that provides various financial products and services—deposits, loans, credit, investments, locker facility, and overdraft facility. They provide banking facilities to individuals, small businesses, and medium-sized businesses. Banks make profits by charging interest on loans.

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This has been a guide to Commercial Bank and its Meaning. Here we explain the functions of a commercial bank along with examples, types, and roles. You can learn more about accounting from the following articles –

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