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Understanding Commercial Banking

What Is a Commercial Bank?

Most people do their banking at a commercial bank, a financial institution that accepts deposits, offers checking account services, makes various loans, and offers basic financial products like certificates of deposit (CDs) and savings accounts to individuals and small businesses.

Banks make money by providing loans such as mortgages, auto, business, and personal loans and earning interest from them. Customer deposits provide banks with the capital to make these loans.


How Commercial Banks Work

Commercial banks provide checking and savings accounts, loans and mortgages, basic investment services, and safe deposit boxes to individual consumers and small to mid-sized businesses.


Banks’ fees for their services vary depending on the product, with account fees (monthly maintenance charges, minimum balance fees, overdraft fees, non-sufficient funds (NSF) charges), safe deposit box fees, and late fees being the most common. Fees, in addition to interest charges, are also included in many loan products.

The fund’s banks lend to other clients come from customer deposits, and banks earn money from the interest on these loans. The interest rate paid by the bank on the money they borrow is less than the rate charged on the money they lend; for instance, a bank may offer savings account customers an annual interest rate of 0.25% while charging mortgage clients 4.75% in interest annually.

Most banks now allow their customers to do most of the same services online that they could do in person, including transfers, deposits, and bill payments.


Significance of Commercial Banks


Not only do commercial banks provide consumers with an essential service, but they also help create capital and liquidity in the market. This makes them an important part of the economy.

Commercial banks play an important role in the economy by ensuring liquidity and creating credit. When customers deposit money into their accounts, commercial banks lend that money out to others, which leads to an increase in production, employment, and consumer spending.

Commercial banks are heavily regulated by a central bank in their country or region. For example, central banks impose reserve requirements on commercial banks. Banks are required to hold a certain percentage of their consumer deposits at the central bank as a cushion if there’s a rush to withdraw funds by the general public. This protects the banks from going under if too many people try to take their money out at the same time.


Special Considerations


Customers find commercial bank investments, such as savings accounts and CDs, attractive because the Federal Deposit Insurance Corporation (FDIC) ensures them and money can be easily withdrawn. Customers have the option to withdraw money upon demand, and the balances are fully insured for up to $250,000. This money does not cost banks much.

Many banks offer interest rates for savings accounts that are well below U.S. Treasury bond (T-bond) rates and pay no interest at all on checking account balances (or at least pay very little).

Of North American bank lending, consumer lending makes up the bulk, and of this, residential mortgages make up by far the largest share. The homes themselves often collateralize the loans used to buy properties. Although a variety of more exotic mortgage products were offered during the U.S. housing bubble of the 2000s, many of the riskier products, including pick-a-payment mortgages and negative amortization loans, are much less common now. Mortgages are typically written for 30-year repayment periods, and interest rates may be fixed, adjustable, or variable.

Many banks consider automobile lending to be a significant category of secured lending, as it typically entails shorter terms and higher rates than mortgage lending. Other financial institutions, like captive auto financing operations run by automobile manufacturers and dealers, pose extensive competition for banks in auto lending.


Bank Credit Cards


Credit cards are a significant type of financing because they are essentially personal lines of credit that can be drawn down at any time. Commercial banks offer private card issuers through them.

Banks that don’t engage in credit card lending do so because the default rates are traditionally much higher than in mortgage lending or other types of secured lending.

However, even though credit card lending is lucrative for banks, it also charges fees to merchants for accepting the card and entering into the transaction, late-payment fees, currency exchange, over-the-limit, and other fees for the card user, as well as elevated rates on the balances that credit card users carry from one month to the next.


Commercial Banks vs. Investment Banks


Historically, commercial banks have catered to individuals and businesses, while investment banks have served large companies and institutional investors. As financial intermediaries, they provide underwriting services, merger, and acquisition (M&A) strategies, corporate reorganization services, and other brokerage services for institutional and high-net-worth individuals (HNWIs).

Other financial institutions, pension funds, large companies, hedge funds, and governments are investment banking clients, while individual consumers and small businesses are commercial banking clients.


Examples of Commercial Banks


Many of the world’s largest financial institutions are commercial banks, such as Chase Bank, which is the commercial banking unit of JPMorgan Chase and can be found in the United States. As of June 2021, Chase Bank, headquartered in New York City, reported about $3.2 trillion in assets.

Bank of America is the second-largest bank in the United States. It has more than $2.35 trillion in assets and 66 million customers, including both retail clients and small and mid-sized businesses.


Is My Bank a Commercial Bank?

Possibly! Most people think of commercial banks when they hear the term “bank.” If your account is with a community bank or credit union, it would probably not be a commercial bank. However, commercial banks are for-profit institutions that accept deposits, make loans, safeguard assets, and work with many different types of clients, including the general public and businesses.



What Role Do Commercial Banks Play in the Economy?

Banks play a crucial role in the fractional reserve banking system, which is currently used in most developed countries. This system allows banks to extend new loans of up to 90% of the deposits they have on hand. This theoretically frees capital for lending and grows the economy.



Is My Money Safe at a Commercial Bank?

Yes, for the most part. Most deposit accounts at commercial banks are FDIC-insured up to $250,000.

No commingling of commercial banking and investment banking funds is allowed by law.

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