The Functioning of Commercial Banks

A commercial bank is the banking institution that is commonly called “the bank,” as in, “I need to go to the bank and get some cash.” By simple definition, a commercial bank is a business that receives deposits from and provides loans to customers. The first side of the business, receiving deposits, provides the following functions:

-> Liquidity. Customers have ready access to their money. Customers give their money to the commercial bank in the form of a demand deposit, which is generally held in a checking or savings account. They are called demand deposits, because customers are not required to give prior notice for withdrawal of any amount, up to and including all of their money.

-> Convenience. It is simply easier for customers to visit any branch location or automated teller machine, use a debit card, or write a check to access their money than to go home and rip open their mattress to have money to pay the water bill.

-> Safe-keeping. Generally, commercial banks take numerous precautions to insure that customer’s deposited moneys are not only safe, but accurately kept. In the United States, commercial bank deposits are insured through the Federal Deposit Insurance Corporation up to a stated amount. Therefore, customers assume little to no risk in depositing their money with the commercial bank.

The primary function of the other side of the commercial banking business is customer financing. Based on the commercial bank’s confidence in a customer’s ability to repay a loan, the bank will give money to a customer for various needs. Historically, these loans have been short-term loans. Banking regulations require that commercial banks need only keep a certain percentage of demand deposit balances on hand for customer’s potential withdrawals. Thus, the banking institution has money that it can legally lend. Usually, the loan is given with interest charged. A borrower is given $10,000, but in the course of paying back the loan, the borrower returns $11,000.

Thus, the business of a commercial bank is to provide services enough to attract deposit making customers so that it has money available to make loans. The interest generated from loans provides a source of income for the commercial banking business. Because other financial institutions have begun offering commercial banking services, many commercial banks have also included functions generally associated with other financial institutions, like investment banking. However, these functions are still technically associated with these other institutions and are not considered commercial banking functions.