Commercial Banks are a type of financial institution that provide loans, accept deposits, and offer financial products and services like a savings accounts or a certificate of deposit to individuals and businesses.
A commercial bank primarily earns money by charging interest to customers and by providing loans. Such a bank may also give interest to its customers who have savings accounts or certificates of deposits but pays out less than it charges for loans.
Functions of Commercial Banks
The basic role of a commercial bank is to provide financial services to the businesses and individuals. Credit card interest, payments, small loans, deposits, checking, and basic securities trading all contribute significantly to the bottom line.
Commercial banks perform the following functions:
1. Agency Functions
Commercial banks may serve as agents by collecting and paying checks, dividends, and bills of exchange for their customers. They could also pay rent, insurance premiums, trade securities on behalf of their customers.
Banks can also act as trustees and executors of the estate on behalf of their customers for a nominal fee.
2. Taking Deposits
Initially, banks used to charge customers a fee to accept deposits, however as the banking system has evolved and become more profitable, banks pay a small interest to the depositors who keep money with them. Many of these accounts tend to charge an administrative fee if certain minimum deposit amounts are not met.
3. Advancing Loans
Banks earn most of their income from providing loans to businesses and individuals. After conducting a thorough review of the applicant, a bank will likely offer a short-term or medium-term loan. This is done to maintain long-term liquidity.
4. Credit Creation
After a loan has been approved, the bank will provide an account from which the customer can draw funds. By doing so, instead of giving actual cash, the bank is increasing the amount of money in circulation in the economy. This process results in the increase of credit.
5. Other functions
Banks may also provide other products such as safety deposit boxes for customers to safely store their valuables, or foreign currency exchange services.