The term commercial bank refers to 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. A commercial bank is where most people do their banking.
Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.
Functions of Commercial Banks
The basic role of a commercial bank is to provide financial services to businesses and companies. Banks also ensure economic stability and the sustainable growth of a country’s economy. To learn more about the different roles available in a commercial bank, see CFI’s Careers in Commercial Banking course. A commercial bank performs the following functions:
Accepting deposits is one of the oldest functions of a commercial bank. When banks started, they charged a commission for keeping money on behalf of the public. With the changes in the banking industry over the years and the profitability of the business, banks now pay a small amount of interest to the depositors who keep money with them. However, depositors also incur administrative fees to maintain their accounts.
Banks accept three types of deposits. The first one is the savings deposit for small savers who are paid interest on their accounts. They can withdraw their money up to a limited amount by writing a cheque.
The second type of deposit is the current account for people in business who can withdraw their money at any time without notice. Banks do not typically pay interest on deposits held in current accounts. Instead, the account holders are charged a nominal fee for the services rendered.
The last type of deposit is the term or fixed deposit. Customers who have money that they do not need for the next six months or more can save in the fixed account. The rate of interest paid increases with the length of the fixed deposit. Customers can only withdraw the money at the end of the agreed period by writing to the bank.
Advancing Credit Facilities
Advancing loans is an essential function of banks since it accounts for the highest percentage of revenue earned annually. Banks mostly offer short-term and medium-term loans from a percentage of the cash deposits at a high interest rate.
They do not provide long-term financing due to the need to maintain the liquidity of assets. Before advancing loans to customers, banks consider the borrower’s financial status, business profitability, nature and size of the business, and ability to repay the loan without default.
While granting loans to customers, banks do not provide the loan in cash to the borrower. Instead, the bank creates a deposit account from which the borrower can draw funds. This allows the borrower to withdraw money by cheque according to his needs. By creating a demand deposit in the borrower’s account without printing additional money, the bank increases the amount of money in circulation.
Commercial banks serve as agents of their customers by helping them in collecting and paying cheques, dividends, interest warrants, and bills of exchange. Also, they pay insurance premiums, utility bills, rent, and other charges on behalf of their clients.
Banks also trade shares, securities, and debentures, and they provide advisory services for customers that want to buy or sell these investments. In property administration, commercial banks act as trustees and executors of the estate on behalf of their customers. Banks charge a nominal fee for the agency functions performed on behalf of their clients.
Apart from the above primary functions, banks also perform several other functions. They provide foreign exchange to clients in import and export businesses by buying and selling foreign currency. However, banks must get permission from the regulatory body, mainly the central bank, before dealing with foreign exchange.
A commercial bank also acts as a custodian of precious stones and other valuables. They provide customers with lockers where they can put their jewelry, precious metals, and crucial documents. Such items are more secure when stored at the bank than keeping them at home, where they may be stolen or damaged.