Commercial Bank – What is it?

What is a commercial bank? 

A commercial bank is a financial institution or a type of bank which usually accepts deposits from the public and provides loans to them for the purposes of consumption and investment to make a profit.

Commercial banks also refer to the bank, or the part of a large bank, that deals with different corporations or a large/middle-sized business to differentiate it from other retail banks and investment banks. These commercial banks include both private-sector banks and public-sector banks.

How do commercial banks work? 

The main function of commercial banks is to provide basic banking services and products to the general public that includes both individual consumers and small to mid-sized businesses. These banking services basically include checking and savings accounts, providing loans and mortgages, different basic investment services like CDs, as well as other services such as safe deposit boxes.

These banks make money from service charges and fees from the public. These fees generally vary from one bank to another based on the products, ranging from different account fees like monthly maintenance charges, minimum balance fees, overdraft fees, non-sufficient funds (NSF) charges, safe deposit box fees, and late fees. The loan products of these banks also contain fees in addition to interest charges.

These banks also make money from interest that they lend out money to other clients and customers. The funds that they lend to the clients come from customer deposits themselves. 

However, the interest rate that is paid by the bank on the money that they borrow is generally less than the rate which is charged on the money they lend. For the present situation, a commercial bank offers savings account customers an annual interest rate of 0.25% while charging interest rates for mortgage clients of 4.75% in interest annually.

Commercial banks have traditionally been located in different buildings where customers and clients come to use teller window services and automated teller machines (ATMs) to do routine banking activities. 

With the rapid increase in internet technology, most banks are now allowing their customers to do most of the same services through online procedures that they could do in person that includes transfers, deposits, and bill payments.

Types of Commercial Banks:

Basically, there are three different types of commercial banks.

Private bank

Private banks are a type of commercial bank in which private individuals and businesses generally own a majority of the share capital. All private banks can be recorded as companies with limited liability. 

For example, Housing Development Finance Corporation (HDFC) Bank, Axis bank, Industrial Credit and Investment Corporation of India (ICICI) Bank, Yes Bank, and more such banks.

Public bank

Basically, the public bank is a type of bank that is nationalized, and a significant stake is held by the government itself.  For example, Bank of Baroda, Dena Bank, State Bank of India (SBI), Corporation Bank, and Punjab National Bank.

Foreign bank 

Foreign banks are a type of bank that are established in foreign countries with different branches in other countries. Some major examples of foreign banks are American Express Bank, Standard & Chartered Bank, Citibank, Hong Kong and Shanghai Banking Corporation (HSBC), and more banks.

Functions of commercial bank

There are a number of Functions of a commercial bank. However, its major functions of it may be categorized as follows.

Accepting deposit

Deposit-gathering and accepting is a major function of every commercial bank as deposits are required to offer credit products and services to the customers at a lower cost than external financing. 

Gathering deposits from various sections is the key to generating an acceptable return on equity which is tied to the growth of the credit portfolio of a bank and interest income. 

If we look at the past, banks were generally trusted to hold cash and valuables for safekeeping. For that, depositors paid for the custodial services. 

With fractional banking, a bank can now lend a greater portion of its deposit to achieve greater margins and profitability. Cash and custodial fees are no longer the primary revenue source in today’s time.

Now a commercial bank is accepting deposits and pays interest for that to gather low-cost funds to grow its credit portfolio. 

Creation of credits

Regulators have set the minimum cash reserve a commercial bank must hold to support the liabilities of its deposits. Excess amount of deposits in banks may be utilized to create credit to lend via commercial loans and other credit products or also used to lend to other institutions at the overnight rate. 

So credit creation acts as a critical function of a commercial bank. Normally, the interest amount is the highest percentage of revenue at different commercial banks. So in their banks, Credit portfolio performance and health are the widely monitored performance measures.  

A lot of businesses are crediting products and services to the people and matching the operational and strategic needs of the customers. 

Treasury and payments 

Commercial banks offer invoicing, collection, and also merchant (point-of-sale) solutions to their customers to support current asset requirements for businesses and to increase economies of scope and scale, as well as the share of wallet.

Expenses can be paid via cheque, charge, and credit card, and also electronic payments are offerings that support current liability requirements.  

Companies specializing in the payment sector have outperformed other business bank models over the past five years and they are one of the attractive areas for high-tech due to the growth.

Agency and advisory

Commercial banks also offer various agencies and advisory functions to the customers because of their privileged position as financial intermediaries. Advisory services of various commercial banks are generally used to manage risks in business-to-business activities, support trade credit along with global entities that participate in import and export, or document the performance of cross-border services by the bank are some examples in this category.  

Institutions are generally highly regulated and integrated with global systems for example SWIFT which is a basic function that act as a barrier to entry for firms that don’t operate on the same scale.

These banks have separate advisory sections for your business and personal finances. So to have a different account for commercial banking in order to help yourself with the day-to-day bookkeeping.  It is suggested to limit your personal liability in the event of a legal claim against your business, and prove yourself useful when it’s time to file your tax return. 

At that time, you’ll get to know exactly which types of activities were personal and which were related to your business.

Benefits of having a commercial bank account

In today’s day, mostly everyone has a commercial account. But what are the benefits of it? 

Having a commercial bank account may lend credibility to your company. Customers are generally more comfortable making payments to a business than to you, specifically, for a product or service.

A bank account helps your firm to have a foot on the bill for large expenses. A loan, line of credit, or credit card that you can get from a commercial bank can provide your business with specific capital that you may not be able to fund on your own.

This can also help to build business credit and open a line of credit, for example, it can help build your business’s credit profile and secure better lending terms in the future. 

Examples of Commercial Banks

Certain examples of commercial banks in India are as follows:

    1. State Bank of India (SBI)

    2. Housing Development Finance Corporation (HDFC) Bank

    3. Industrial Credit and Investment Corporation of India (ICICI) Bank

    4. Dena Bank

    5. Corporation Bank

Difference between a commercial bank and an investment bank

Although commercial banks often misunderstand investment banking functions, it’s important to note that these two types of banking serve different purposes. 

The Investment bank generally serves as go-betweens for investors as well as businesses that help with raising capital, launching an initial public offering, conducting mergers and acquisitions, and more. These are separate from the traditional banking functions offered by commercial banks to a greater extent. 

Conclusion

Commercial banks are generally for the public and the system of commercial banking that is used in India is completely unique, and specific, and cannot be found anywhere else in the world. 

The most important resources for a commercial bank to have capital are the deposits that are made by customers themselves, the sale of certificates of deposit, and reserves which are generated from earnings that are kept on hand.

*image source from Google

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