Commercial banks perform the following functions in an economy;
- Receiving deposits. Commercial banks receive deposits from customers, and the customers receive some interest for keeping money with the bank. However, an administrative fee is charged to the depositors. Banks accept deposits in three categories: savings deposits, current account deposits, and fixed deposits. Savings deposits can be withdrawn up to a limited amount. Current account depositors can withdraw at any time; therefore, they do not receive any interest. Fixed deposits cannot be withdrawn before a certain time, and these receive more interest.
- Safeguarding money. Commercial banks safeguard money by insuring the Federal Deposit Insurance Corporation deposits. Therefore, the money is usually safe with the bank such that even if the bank were robbed, depositors' money would still be intact, and depositors would still access their money.
- Disbursing payments. Commercial banks conduct the disbursem*nt of payments from one party to another in their accounts. Banks make it possible for customers to make transactions when purchasing a commodity or paying someone.
- Providing credit services. Commercial banks provide credit services on a loan basis for short and medium terms. The loans they grant their borrowers are a fraction of the money that customers deposit in the bank. Banks do not extend long-term loans to borrowers due to the requirement of maintaining assets' liquidity.
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The various types of commercial banks vary based on their major shareholders, who can either be the government or individuals and companies on a private basis. Therefore, the banks fall into private, public, and foreign categories. Both public and private banks are classified into the category of scheduled banks. In contrast, foreign banks fall under the category of non-scheduled banks.
Private Banks
Private banks have more than 50% of their share capital in the hands of individuals and companies and not the government. Hence, they are private businesses. This characteristic renders them limited liability entities. However, they are listed in an exchange as they are publicly recognized even if they are private. The wealthy mostly use private banks as wealth management agents that provide financial management services to the individual or team.
Most private banks operate with a minimum balance of the depositor depending on the purpose of the deposit and the company itself. The balance also varies with other purposes like investments, assets, and retirement arrangements. Therefore, private banks offer more personal attention to their customers, and some may even have a personal certified financial planner.
Public Banks
When the government owns more than 50% of a bank's share capital, the bank is deemed a public bank. Public banks mostly democratize the economy by leveraging available funds to avail capital for credit services to public and private borrowers seeking to invest and engage in projects locally. Therefore, public banks are more focused on developing the community in which they are based and the local economy.
Foreign Banks
Foreign banks describe the banking institutions established in foreign countries to operate as branches to help in the financial establishment of that country besides the usual provision of financial services. Therefore, for instance, in the U.S, a foreign bank entails any institution headquartered outside the U.S but has its operations in the U.S.
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- An example of a commercial bank is the Bank of America, whose headquarters are in North Carolina, where the executive offices are held. It is a Delaware Corporation, hence giving it legal rights to operate in other states but with its registration in Delaware State. It is one of the largest public banking institutions in the world, which provides services to individuals, medium businesses, and established corporations. Like other major commercial banks, it provides services like managing assets, banking, investments, and financial risks.
- Another commercial bank example is Citigroup, founded in the late 1990s with its headquarters in New York. Citigroup is among the top five largest public banking institutions in the U.S. It is well known for its diversity in the provision of comprehensive financial services like corporate and investment banking and consumer banking. It provides these services nationally and beyond its geographical boundaries by dealing with NGOs, governments, and public entities.
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Commercial banks are necessary for an economy as they contribute to its growth. They mobilize savings to individuals with minimal income by establishing saving schemes where people and organizations can save their money, and the banks, in return, pay them an interest since the banks use this money to lend to borrowers at a higher interest. Therefore, this generally helps individuals not to run bankrupt, which could affect productivity negatively.
Commercial banks also help expand the market by forming the economy in a way that aids in the expansion of international trade and commerce. Eventually, this helps develop the economy through market expansion when trade heightens. Additionally, commercial banks finance private capital investments through raising capital goods stock and availing funds that can aid in innovative activities and business expansion. By financing private capital investments, commercial banks eliminate capital deficiency which translates to increased investments hence economic growth and development.
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A commercial bank infers a financial institution that receives deposits from customers, lends money to borrowers at an interest rate, and provides other financial services to customers. Commercial banks are usually monitored and governed by the Federal Reserve System, the U.S central bank, by ensuring that they adhere to a particular set of rules as per the system. Commercial banks have the primary functions of accepting customer deposits in the current account, savings, and fixed deposits, lending money as credit to borrowers who then pay with interest, and disbursing payments in the form of transactions and customer payments.
Commercial banks generate their money from the deposits that customers make, where they use a percentage of the amount to lend to borrowers. The interest at which the borrowers repay the short and medium-term loans is the means under which banks make money. Commercial banks do not grant long-term loans because they need to maintain their assets' liquidity. Commercial banks are important in an economy as they finance private capital investments and mobilize savings through savings schemes.
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Video Transcript
Defining Commercial Bank
A commercial bank is a financial institution that is authorized by law to receive money from businesses and individuals and lend money to them. Commercial banks are open to the public and serve individuals, institutions, and businesses. A commercial bank is almost certainly the type of bank you think of when you think about a bank because it is the type of bank that most people regularly use.
Banks are regulated by federal and state laws depending on how they are organized and the services they provide. Commercial banks are also monitored through the Federal Reserve System.
Functions
A commercial bank is authorized to serve the following functions:
- Receive deposits - take money in from individuals and businesses (called depositors)
- Disburse payments - make payments upon the direction of its depositors, such as honoring a check
- Collections - a bank will act as your agent to collect funds from another bank payable to you, such as when someone pays you by check drawn on an account from a different bank
- Invest funds in securities for a return
- Safeguard money - banks are considered a safe place to store your wealth
- Maintain and service savings and checking accounts of its depositors
- Maintain custodial accounts - accounts controlled by one person but for the benefit of another person, such as a trust account
- Lend money
Role in Economy
Commercial banks are probably the largest source of financing for private capital investment in the country. A capital investment is the purchase of an asset with the intention of you either generating income from the asset, the asset appreciating in value over time, or both. Common capital purchases made by businesses include things like plants and equipment. The quintessential capital purchase by individuals is the purchase of their homes.
Commercial banking is a vital part of economic growth because it permits investment through financing. If investment was only possible through money already saved by the investor, growth would be much slower because it takes a long time to accumulate sufficient funds to buy large fixed capital assets, like machinery and factories. Just think how long it would take for you to raise all the money necessary to pay for a house with cash.
How does a bank get the money to provide loans? The answer is simple: through depositors like you. Basically, when you deposit money into a bank account, the bank will take that money and use it to fund loans. Banks will make money off the loans through the interest it charges. Of course, it charges borrowers a higher rate of interest than the interest it pays you for use of the money.
Lesson Summary
Commercial banks are an important part of a modern economy. Such a bank is a financial institution that is authorized by law to receive money from businesses and individuals and lend money to them. Functions of a commercial bank include receiving deposits, disbursing payments, collections, safeguarding money, loaning money, and maintaining and servicing checking, savings, and custodial accounts. Commercial banks' most important role in an economy is probably lending money to investors for purchase of capital goods that help grow the economy.
Learning Outcomes
The facts presented in this lesson on commercial banks can prepare you to:
- State the characteristics of a commercial bank
- Specify the functions of a commercial bank
- Recognize the role of commercial banks in an economy
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