You have probably been to your local bank and been met with the term commercial banking. With hundreds of financial service companies competing for business, it’s essential to understand the different banking services available. That way, you can choose the type of institution that best fits your particular needs. So, what is commercial banking anyways?
Commercial Banking Definition
Commercial banking, also called business banking or institutional banking, is a term used to describe banking products and services provided for businesses, institutions, and sometimes governments and is distinct from banking products offered to individuals.
The term ‘bank’ is vaguely understood to mean a commercial bank. It is where most people do their banking. However, if you have an account with a community bank or credit union, it is probably not a commercial bank.
Commercial banks offer products similar to those offered by retail banks to individuals, including checking and savings accounts. Commercial banks, however, also provide products and services that are tailored to meet the needs of corporations and institutions as well.
These banks also play a crucial role in the economy. As well as providing a necessary service to the consumer, they help create liquidity and capital in the market.
Currently, most developed countries use a fractional reserve banking system that depends on commercial banks. As a result, banks can extend new loans up to 90% of their deposits, theoretically fueling economic growth by releasing capital to lend.
Credit created by commercial banks increases production, employment, and consumer spending, thereby stimulating the economy.
Wonder how all this works?
How Commercial Banks Work
We have already discussed that commercial banks provide primary banking products and services to the general public, including consumers and small and medium-sized businesses. These services include a list of things we will get into later, but first, let’s cover how a commercial bank makes money?
Fees and service charges are how banks make money. There are different fees for various products, such as account fees (monthly maintenance, minimum balance, overdraft, nonsufficient funds), safe deposit box fees, and late fees. Loans also sometimes include fees as well as interest charges.
The interest that banks earn by lending out money to their customers is also part of how they make money. The funds they lend come from deposits made by their customers. Despite this, the bank pays a lower rate of interest on money it borrows than it charges on money it lends. An example would be a bank that offers savings account customers annual interest rates of 0.25% while charging mortgage clients yearly interest rates of 4.75%.
The majority of commercial banks are located in buildings where customers are able to use teller window services and automated teller machines (ATMs) to conduct routine banking activities. In addition, thanks to advancing internet technology, most banks now allow their customers to conduct most of the same activities online as they could in person.
Now, we’ll take a look at what this type of banking provides for customers!
Services and Products Provided by Commercial Banks
Many of the products offered by commercial banks are very similar to those used daily by the majority of people. Although these accounts are designed for corporate needs, they still have the same basic structure as checking and savings accounts.
Aside from these deposit products, commercial banks also provide a range of other products and services. The following are a few examples that some banks might offer:
- Payment solutions, gift cards, e-checks, mobile payment options, and credit card processing for merchants
- Services related to global trade including foreign currency exchange, loans, letters of credit, and global payments
- Fund collection and disbursement, as well as fraud prevention, are core treasury management services
- Financial services for businesses, including working capital, commercial real estate, and equipment financing
- Business and employee retirement products and services
- Shareholder plans for employees
- Corporate and institutional insurance products
- Services that provide special attention to certain types of businesses, such as lending for aircraft, investing in real estate, and others.
Examples of Commercial Banks
The banking sector is a cornerstone of U.S. business and finance.
Commercial banks or commercial banks with operations in the United States make up many of the largest financial institutions in the world. Chase Bank, for instance, is part of JPMorgan Chase’s commercial banking division. Located in New York City, Chase Bank had approximately $3.2 trillion assets at the end of June 2021. With a revenue of almost 130 billion dollars in 2020, it is the largest commercial bank in the United States.
With more than $2.35 trillion in assets and 66 million customers, Bank of America is the second-largest bank in the United States.
You can also check out the following data of commercial bank branches per 100 000 adults to better understand the importance of commercial banking.
Other Banking Types
Commercial banking is just one type of banking, although various others exist as well:
- Investment banking: Investment banks serve individuals, corporations, and governments. Among these services are debt and equity issuance underwriting, mergers and acquisitions assistance, and capital raising.
- Retail banking: Any banking service intended for the general public is considered retail banking. Those are checking and savings accounts, credit cards, auto loans, mortgages, CDs, and more.
- Private banking: The provision of banking and financial services to high-net-worth individuals similar to retail banking. Compared to traditional retail banks, private bankers provide financial and wealth management services on a much more personal level.
Investment Banking vs. Commercial Banking
Although investment banks and commercial banks both perform essential roles in the modern economy, they serve very different needs and have very different kinds of employees.
To understand their differences, let’s take a closer look!
In addition to accepting deposits and making loans, commercial banks safeguard assets and work with a wide range of clients, including the general public and businesses.
On the other hand, institutional investors and large corporations use the services of investment banks. Investment banks offer mergers and acquisitions (M & M&A), issuance of securities, and financing for large-scale business projects.
Investment banking, in general, is a more competitive career, pays more, and is viewed as being more glamorous than commercial banking. Many of the analysts at investment banks work at high levels of responsibility and are highly selective of their candidates, and demand their employees. In spite of this, each path can lead to a rewarding, high-earning, and long-lasting career.
Things To Consider
Investments in commercial banks, such as savings accounts and certificates of deposit (CDs), are attractive because they are insured by the Federal Deposit Insurance Corporation (FDIC), and money can be withdrawn easily. You can withdraw your money upon demand, and your balance is fully insured up to $250,000. As a result, banks don’t have to charge very much for your money.
The majority of banks pay no interest on checking account balances (or offer very little interest on saving accounts) and offer rates on savings accounts that are lower than rates on Treasury bonds (T-bonds).
Banks in North America primarily lend to consumers, and residential mortgages constitute the majority of this lending. When homes are purchased with mortgages, they are often used as collateral for the loan. An average mortgage has a repayment period of 30 years, and the interest rate may be fixed, adjustable, or variable.
Many of the more risky products, such as pick-a-payment mortgages and negative amortization loans, were available during the U.S. housing bubble of the 2000s, but don’t exist anymore.
The auto industry is another significant source of secured loans for many banks. Mortgage loan terms and rates are typically shorter on auto loans than they are on mortgage loans. Banks face significant competition from other financial institutions with auto loans, like captive auto finance operations run by manufacturers and dealers.
With all that being said, you can now get a better understanding of the term commercial banking, and we hope we got some unclear things out of the way. Commercial banking is a broad term that covers a variety of services and products, so it is important to get things clear.
Another thing to note is that, despite both being critical financial institutions in modern economies, commercial banks and investment banks perform very different functions and require different types of staff. So it’s important to differentiate the types of services they provide when it comes to choosing what’s best for you (or your career path).
Are you further interested in banking and finance? Check out this Banking 101 article, and find out everything you need to know!