What is a commercial bank?
A commercial bank is a for-profit financial institution that accepts deposits, offers loans and provides other financial services to its customers. Commercial banks help fulfill the medium- and short-term financial requirements of businesses. They do not provide long-term credit since they need to maintain the liquidity of their assets.
A commercial bank’s funds belong to the public, which can withdraw funds on short notice. Because of that, commercial banks extend credit for shorter terms with the backing of securities that are tangible and easily marketable.
Before it grants a loan to a business, a commercial bank assesses the business’ ability to repay by looking at factors such as the type of business it is, and its profitability and size.
Commercial banks fall into three main types: public sector banks, private sector banks and foreign banks.
- Public sector banks are banks that have been nationalized by a country’s government. The major stakeholder is the government. In most cases, these banks operate under the country’s central bank.
- Private banks are banks whose major share capital lies with individuals and private businesses. As such, they are limited liability companies.
- Foreign banks are banks with headquarters in a foreign country and branches in different parts of the world. Foreign banks play a great role in helping support the economic standing of that country, apart from serving the financial needs of its people.
One of the basic functions of a commercial bank is to accept deposits. Deposits fall into various categories depending on their terms and requirements. For instance, there are demand deposits, or current account deposits, usually repayable by the bank on demand. Businesses maintain these accounts for making transactions. These accounts do not accrue interest and are subject to service charges by the bank.
Fixed deposits, on the other hand, are deposited in a bank for a specific amount of time. These deposits accrue interest, but are not used for writing checks or making other regular withdrawal transactions.
Finally, savings deposits combine the features of a fixed deposit and a current account. Depositors can withdraw cash from these accounts, but banks may impose restrictions on the amount and number of withdrawals. Additionally, they accrue less interest than fixed deposits.
Commercial bank example
Commercial banks do not let deposits remain idle. They use their cash reserves to give loans. They offer different types of loans based on the needs and abilities of their customers to repay. One of these is a cash credit loan, which a bank gives to a borrower against his stocks, bonds or other assets. The bank sets a credit limit on the loan, and the borrower can make withdrawals within the credit limit. The bank charges interest on the amount withdrawn.