What is Commercial Banking? How Commercial Banks Work?

What is Commercial Banking?

Commercial banking is a branch of banking dedicated to serving businesses, government entities, and institutions such as colleges and universities. Its primary role is to facilitate the financial needs of these organizations, helping them grow and thrive. Commercial banks generate revenue primarily by extending loans to businesses and earning interest and fees in return.

However, their services extend beyond lending and encompass various financial support functions, including deposit accounts, lines of credit, credit letters, payment processing, foreign exchange transactions, lockbox services, and professional services. These institutions play a pivotal role in providing crucial financial solutions to support the operations and growth of businesses and institutions.

How Commercial Banks Work?

Commercial banks provide basic banking services to individual consumers and small to midsize businesses. These services include checking and savings accounts, loans and mortgages, basic investment products like certificates of deposit (CDs), and safe deposit boxes. They make money primarily through service charges, fees, and interest income from loans.

Service charges and fees can include monthly maintenance charges, minimum balance fees, overdraft fees, non-sufficient funds (NSF) charges, safe deposit box fees, and late fees. Banks charge these fees for various products and services they offer.

Commercial banks also earn money through interest income from loans. They lend out money to customers, and the interest rate they charge on these loans is typically higher than the interest rate they pay to customers for their deposits.

Traditionally, commercial banks operated in physical locations where customers could visit to use teller window services and ATMs. However, with the advancement of internet technology, most banks now offer online services, allowing customers to perform various banking transactions such as transfers, deposits, and bill payments online.

How Does Commercial Banks Create Money?

Commercial banks create money primarily through the services they offer, including loans, credit card interest, and fees.

• Loans: Commercial banks lend money to individuals and businesses. When borrowers repay their loans, they not only repay the principal amount borrowed but also pay interest. The interest earned on loans represents a significant source of profit for commercial banks.
• Credit Card Interest: Commercial banks issue credit cards to consumers and charge interest on outstanding balances. When cardholders make purchases on credit and carry a balance, they are required to pay interest on that balance. This interest income contributes to the bank's revenue.
• Fees: Commercial banks charge various fees for different services, such as opening new lines of credit, maintaining accounts, processing payments, and providing professional services. These fees can vary widely and add to the bank's overall income.

Through these mechanisms, commercial banks generate revenue and profits, which in turn contribute to the creation of money within the financial system. When banks earn interest and fees from their customers, they have more funds to lend out to other customers, thereby expanding the money supply in the economy through the process of fractional reserve banking. This allows commercial banks to play a pivotal role in the creation and circulation of money within the broader financial system.

What Are the Examples of Commercial Banking?

Some examples of commercial banking institutions in the United States include,

• JPMorgan Chase: Chase Bank is the commercial banking unit of JPMorgan Chase, headquartered in New York City, with over $3.3 trillion in assets as of September 2022.
• Bank of America: Bank of America is the second-largest U.S. bank with more than $2.4 trillion in assets and serves 67 million customers, including retail clients and small and midsize businesses.

These are just a few examples of commercial banks in the U.S. There are many other commercial banks operating both nationally and regionally, providing a wide range of financial services to individuals and businesses.

If you have an account with a for-profit institution that accepts deposits, makes loans, and offers various financial services to the public and businesses, it is likely a commercial bank. However, community banks and credit unions typically do not fall under the category of commercial banks.

Commercial banks play a critical role in the economy by participating in the fractional reserve banking system, which allows them to extend loans using a portion of the deposits they hold. This process helps stimulate economic growth by making capital available for lending.

How to Get Into Commercial Banking?

To get into commercial banking, you should consider the following steps and requirements,

Education:

• Many employers prefer candidates with a bachelor's degree in a related field such as accounting or finance.
• To advance in your career, a master's degree in business administration (MBA) may be beneficial.

Certification:

• Depending on your specific role and the state you work in, you may need certifications or licenses. For example, working with securities, insurance, or loans may require specific certifications.
• Common certifications in commercial banking include Commercial Banking & Credit Analyst (CBCA) and Certified Public Accountant (CPA).

Skills:

• Develop strong mathematical skills for financial analysis.
• Cultivate soft skills like interpersonal and communication skills, which are crucial when dealing with clients and internal teams.
• Professional communication across various channels, including in-person, phone, email, and text, is essential.
• Demonstrate a sense of urgency in problem-solving, as commercial banking often involves addressing clients' needs promptly.

What Are the Career Opportunities in the Field of Commercial Banking?

• Teller: This entry-level position focuses on handling business client payments, managing deposit accounts, cashing checks, and facilitating withdrawals.
• Loan Officer: Loan officers assess business loan applications, organize loan contracts, and play a critical role in the lending process.
• Credit Analyst: Credit analysts evaluate a business's financial health and creditworthiness when they apply for loans or lines of credit.
• Business Development Manager: These professionals identify, develop, and bring in new business clients for the bank, helping it expand its customer base.
• Relationship Manager: Relationship managers are responsible for acquiring, retaining, and growing the bank's business clients by providing tailored financial solutions.
• Compliance Manager: Compliance managers ensure that the bank's policies and practices adhere to federal guidelines and regulatory requirements.
• Branch Manager: This is a senior position that oversees the operations, revenue generation, and goals of a bank branch.
• Commercial Banker: Commercial bankers work on various financial products and services tailored to businesses, including loans, lines of credit, and deposit accounts.
• Treasury Analyst: Treasury analysts manage a company's financial assets, cash flow, and investments, helping businesses optimize their financial strategies.
• Financial Advisor: Financial advisors in commercial banking provide expert financial guidance and investment advice to business clients.
• Risk Manager: Risk managers assess and mitigate financial risks associated with the bank's lending and investment activities.

These career opportunities in commercial banking offer a diverse range of roles, each contributing to the overall financial health and success of businesses and institutions. Depending on your skills, interests, and career goals, you can find a suitable path within the field of commercial banking.

What Are the Significance of Commercial Banks?

The significance of commercial banks lies in their crucial role in the economy, serving as essential financial intermediaries. Here are the key points highlighting their significance:

• Liquidity and Capital Creation: Commercial banks play a vital role in ensuring liquidity in the economy by accepting deposits from customers and then lending these funds to individuals, businesses, and institutions. This process creates capital and enables economic growth by facilitating investments, job creation, and consumer spending.
• Credit Creation: Commercial banks are central to the creation of credit. Through their lending activities, they provide businesses and individuals with access to the funds needed for various purposes, such as starting or expanding businesses, buying homes, and financing education. This availability of credit stimulates economic activity.
• Economic Growth: By providing financing and credit to borrowers, commercial banks contribute to economic growth and development. They help businesses expand, innovate, and create jobs, which, in turn, boosts overall economic activity.
• Financial Intermediation: Commercial banks act as intermediaries between those who have surplus funds (depositors) and those who need capital (borrowers). This intermediation process helps match the savings of individuals and businesses with the investment needs of the economy.
• Monetary Policy Implementation: Commercial banks play a vital role in the implementation of monetary policy. Central banks often set interest rates and reserve requirements for commercial banks to control money supply and stabilize the economy. Commercial banks' compliance with these policies helps maintain financial stability.
• Regulation and Stability: To ensure the stability of the financial system, commercial banks are subject to extensive regulation by central banks or relevant financial authorities. Regulations include reserve requirements, capital adequacy standards, and consumer protection measures.
• Deposit Insurance: Many countries provide deposit insurance, such as the Federal Deposit Insurance Corporation (FDIC) in the United States. This insurance guarantees deposits up to a certain limit, providing confidence to depositors and contributing to financial stability.
• Facilitation of Transactions: Commercial banks offer a wide range of financial services, including payment processing, which enables the smooth flow of money and transactions within the economy. This enhances the efficiency of trade and commerce.

What Are the Types of Commercial Banks?

Commercial banks are financial institutions primarily oriented towards serving businesses, offering a diverse range of services that encompass accepting deposits, extending loans to businesses, and delivering treasury management solutions, among other financial offerings. These banks can be categorized into three distinct types based on ownership structure and geographic location: private, public, and foreign.

• Private sector banks are owned by private shareholders, which may include individuals or corporate entities. They play a pivotal role in the financial landscape by receiving deposits from and granting loans to individual customers, small enterprises, and medium-sized businesses.
• Public sector banks, conversely, are government-owned entities entrusted with providing banking services not only to the general public but also to small and medium-sized businesses. These banks operate under the ownership and authority of the government, ensuring financial inclusivity.
• Lastly, foreign banks are headquartered outside the country in which they operate. They serve a broad clientele, catering to the banking needs of both individuals and businesses in their host countries.

What Are the Pros and Cons of Commercial Banking?

Pros of Commercial Banking:

• Commercial banking offers excellent entry-level positions, making it accessible for individuals starting their careers in finance.
• Compared to some other finance-related roles, commercial banking often involves more predictable and reasonable work hours, providing a better work-life balance.
• Many commercial banks offer attractive benefits packages, including health insurance, retirement plans, and other perks.
• Working in commercial banking allows professionals to gain a deep understanding of credit markets, interest rates, and economic dynamics, making them well-informed about financial trends and their impact on businesses.
• Commercial bankers have the chance to connect with business leaders in their local communities, fostering valuable professional relationships.

Cons of Commercial Banking:

• Commercial bankers may encounter stressful and high-pressure client relationships, especially when dealing with complex financial transactions or distressed businesses.
• Banks, especially large ones, can be complex and siloed institutions. Navigating internal processes and hierarchies can be challenging, requiring time and persistence.
• The financial industry is heavily regulated, and commercial bankers must adhere to strict regulatory requirements, which can add complexity to their roles.
• Building an external network of clients and business contacts can take time, which may affect early career progress.