Commercial Bank - Explained
What is a Commercial Bank?
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Table of ContentsWhat is a Commercial Bank?How Does a Commercial Bank Work?
What is a Commercial Bank?
A commercial bank is a financial establishment that collects deposits and offer a basic range of financial services to its customers. These services include, check account services, business loans, personal loans, mortgage loans, among others. A commercial bank also offers financial products to its customers, this includes CDs (certificates of deposit). A commercial bank is a financial institution that offers loans to individuals and organizations, accepts deposits which are payable on demand and also collects and offers documents.
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How Does a Commercial Bank Work?
Commercial banks are private financial institutions that handle financial matters for individuals and organizations. These banks offer loans to individuals and organizations and interests are paid on the loans by the borrowers. A commercial bank can generate income from interests on personal loans, business loans, mortgage loans and auto loans. Aside from offering loans to individuals, commercial banks accepts deposits from customers and issue certificates of deposits (CDs). People deposit money into savings or checking accounts that they open with commercial banks. With these deposits, commercial banks offer loans to individuals and pay interest to the customers. Interest rates on loans offered and interest paid to customers are however different. There are certain ways through which commercial banks make money. The major source of income is the net interest income which refers to the amount left from the interest earned on loans and interest paid on deposits. Since these banks do not pay the exact interest rates collected on loans to customers with deposits, the remaining amount serve as revenue for the bank. Commercial banks are insured by the Federal Deposit Insurance Corp. (FDIC), and customers can withdraw their deposits easily without barriers. Usually, the interest that customers earn on deposits in commercial banks is smaller compared to the interest on investment products. It is also lower than the interest rates commercial banks charge on loans. A Commercial bank can create money through the money multiplier effect or the reserve ratio. When money multiplier effect is used, if means the bank allows multiple claims to assets on deposit in order to create money. This is the creation of credits that were non-existent when loans were made at a certain period. When a commercial bank uses the reserve ratio in creating money, it means it keeps a percentage of all deposits in liquid form (cash). The United States operates a 10% reserve ratio, that is, in $100 the bank receives in deposits, $10 must be reserved, while the $90 can be offered as credit loans. The money created from money multiplier effect is not different from the one created from reserve ratio. Commercial banks evolved as financial institutions with physical presence, that means customers can walk into the banks to make deposits, request loans and perform other transactions. However, in recent times, there is a record of commercial banks that operate online, this means all financial transactions are done electronically. Although, some commercial banks have investment banking segments, commercial banks are different from investment banks in mode of operation and the type of service they tender. The separation of these two distinct financial institutions was a provision of the Glass-, Steagall Act of 1932 during the age of the Great Depression.