What Is a Commercial Bank?
The term “commercial bank” refers to a financial institution that accepts deposits, offers checking account services, makes various loans and offers essential 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, business, and personal loans. Customer deposits provide banks with the capital to make these loans.
KEY TAKEAWAYS
- Commercial banks offer essential banking services, including deposit accounts and loans, to consumers and small to midsize businesses.
- Commercial banks make money from various fees and earn interest income from loans.
- Commercial banks have traditionally been located in physical locations, but a growing number now operate exclusively online.
- Commercial banks are essential to the economy because they create market capital, credit, and liquidity.
How Commercial Banks Work
Commercial banks provide essential banking services and products to the general public, individual consumers, and small to midsize businesses. These services include checking and savings accounts; loans and mortgages; essential investment services such as CDs; and other services such as safe deposit boxes.
Banks make money from service charges. These fees vary based on the products, ranging from account fees (monthly maintenance charges, minimum balance fees, overdraft fees, and non-sufficient funds [NSF] charges), safe deposit box fees, and late fees. Many loan products also contain fees in addition to interest charges.
Banks also earn money from interest by lending money to other clients. The funds they lend come from customer deposits. However, the interest rate banks pay on the money they borrow is less than the rate charged on the money they lend. For example, a bank may offer savings account customers an annual interest rate of 0.25% while charging mortgage clients 4.75% in interest annually.
Commercial banks have traditionally been located in buildings where customers use teller window services and automated teller machines (ATMs) to do their everyday banking. With the rise in internet technology, most banks now allow their customers to do most of the same services online that they could do in person, including transfers, deposits, and bill payments.
Important:
- A growing number of commercial banks operate exclusively online, where all transactions with the commercial bank must be made electronically. Because these banks don’t have any brick-and-mortar locations, they can offer a broader range of products and services at a lower cost—or none at all—to their customers.
Significance of Commercial Banks
Commercial banks are an important part of the economy. They provide consumers with essential services and help create capital and liquidity in the market.
Commercial banks ensure liquidity by depositing the funds their customers deposit into their accounts and lending them to others. Commercial banks play a role in the creation of credit, which leads to increased production, employment, and consumer spending, thereby boosting the economy.
Commercial banks are heavily regulated by a central bank in their country or region. For instance, central banks impose reserve requirements on commercial banks. Banks must hold a certain percentage of their consumer deposits at the central bank as a cushion if there’s a rush to withdraw funds from the general public.
Special Considerations
Customers find commercial bank investments, such as savings accounts and CDs, attractive because they are insured by the Federal Deposit Insurance Corp. (FDIC), and money can be quickly withdrawn. Customers can withdraw cash upon demand, and the balances are fully insured up to $250,000. Therefore, banks do not have to pay much for this money.1
Many banks pay no interest (or at least very little) on checking account balances and offer interest rates for savings accounts well below U.S. Treasury bond (T-bond) rates.
Consumer lending makes up the bulk of North American bank lending; residential mortgages make up the largest share. Mortgages are used to buy properties, and the homes are often the security that collateralizes the loan. Mortgages are typically written for 30-year repayment periods, and interest rates may be fixed, adjustable, or variable. Although more exotic mortgage products were offered during the U.S. housing bubble of the 2000s, many riskier products, including pick-a-payment mortgages and negative amortization loans, are much less common now.
Automobile lending is another significant category of secured lending for many banks. Auto loans are typically for shorter terms and higher rates than mortgage lending. Banks face extensive competition in auto lending from other financial institutions, like captive auto financing operations run by automobile manufacturers and dealers.
Bank Credit Cards
Credit cards are another significant type of financing. Credit cards are, in essence, personal lines of credit that can be drawn down at any time. Private card issuers offer them through commercial banks.
Visa and Mastercard run proprietary networks through which money is moved between the shopper’s and merchant’s banks after a transaction. Not all banks engage in credit card lending, as the default rates are traditionally much higher than in mortgage lending or other types of secured lending.
That said, credit card lending delivers lucrative fees for banks—interchange fees charged to merchants for accepting the card and entering into the transaction, late-payment fees, currency exchange, over-limit, and other fees for the card user, as well as elevated rates on the balances that credit card users carry from one month to the next.
Commercial Banks vs. Investment Banks
Both commercial and investment banks provide essential services and play critical economic roles. For much of the 20th century, these two branches of the banking industry were generally kept separate in the United States, thanks to the Glass-Steagall Act of 1933, passed during the Great Depression.2 It was essentially repealed by the Gramm-Leach-Bliley Act of 1999, allowing for the creation of financial holding companies with commercial and investment bank subsidiaries.3
Fast Fact:
While it tore down the commercial and investment bank wall, the Gramm-Leach-Bliley Act did maintain some safeguards: It forbids a bank and a nonbank subsidiary of the same holding company from marketing the products or services of the other entity—to prevent banks from promoting securities underwritten by other subsidiaries to their customers—and placed size limitations on subsidiaries.3
While commercial banks traditionally provide services to individuals and businesses, investment banking offers banking services to large companies and institutional investors. They act as financial intermediaries, providing their clients with underwriting services, merger and acquisition (M&A) strategies, corporate reorganization services, and other brokerage services for institutional and high-net-worth individuals (HNWIs).
While commercial banking clients include individual consumers and small businesses, investment banking clients include governments, hedge funds, other financial institutions, pension funds, and large companies.
Examples of Commercial Banks
Some of the world’s largest financial institutions are commercial banks or have commercial banking operations—many of which can be found in the U.S. For instance, Chase Bank is the retail banking unit of JPMorgan Chase. Headquartered in New York City, Chase Bank reported more than $3.3 trillion in assets as of September 2022.4 Bank of America is the second-largest U.S. bank, with more than $2.4 trillion in assets and 67 million customers, including both retail clients and small and midsize businesses.54
Is my bank a commercial bank?
Possibly! Commercial banks are what most people think of when they hear the term “bank.” Commercial banks are for-profit institutions that accept deposits, make loans, safeguard assets, and work with many different types of clients, including the general public and businesses. However, if your account is with a community bank or credit union, it probably would not be a commercial bank.
What role do commercial banks play in the economy?
Commercial banks are crucial to the fractional reserve banking system currently found in most developed countries. This allows banks to extend new loans of up to (typically) 90% of their deposits, theoretically growing the economy by freeing capital for lending.
Is my money safe at a commercial bank?
For the most part, yes. Commercial banks are heavily regulated, and most deposit accounts are covered up to $250,000 by the Federal Deposit Insurance Corp. (FDIC).6 Moreover, commercial banking and investment banking funds cannot be comingled by law.6
The Bottom Line
Commercial banks are critical to the U.S. economy by providing vital capital to businesses and individuals through credit and loans. They offer a secure place where people save money, earn interest, and make payments through checks, debit cards, and credit cards.
Commercial banks are typically in brick-and-mortar locations in cities and towns, many with extensive branch networks. However, a growing number have no physical location; instead, they are accessible online and through mobile applications.
- Federal Deposit Insurance Corp. “Understanding Deposit Insurance.”
- Federal Reserve History. “Banking Act of 1933 (Glass-Steagall).”
- GovInfo. “Public Law 106-102: Gramm-Leach-Bliley Act,” 113 Stat. 1349 (Page 13 of PDF).
- Federal Reserve System. “Statistical Release: Large Commercial Banks.”
- Bank of America, Newsroom. “Company Overview.”
- GovInfo. “Public Law 106-102: Gramm-Leach-Bliley Act,” 113 Stat. 1399 (Page 62 of PDF).
