Commercial banking refers to institutions that provide a variety of financial services – like deposit accounts, loans, and credit – to individuals and businesses. They are vital to the economy, facilitating the movement of funds, managing risks, and providing mechanisms for savings, investments, and daily financial transactions.¹
Commercial banks collect deposits from both individual consumers and small and medium enterprise (SMEs) businesses, which then become the capital they lend out. Commercial banks make money from interest earned from these loans and any account or service fees.¹
The role of commercial banks in economic growth
Commercial banks play an important role in economic growth because they:
- Fuel the market with capital, credit, and liquidity
- Gather savings from individuals and businesses and direct these funds into productive investments across various sectors
- Create credit, effectively increasing the money supply, influencing inflation, interest rates, and overall economic activity
Commercial banking vs. investment banking
For most of the 20th century, commercial banking and investment banking operated separately as a result of the Glass-Steagall Act of 1933. That is, until the Gramm-Leach-Bliley Act of 1999, which allowed for the establishment of financial holding companies that could own both commercial and investment bank branches.²
While commercial banks provide services such as savings and checking accounts, loans, and credit, investment banks serve a different purpose. They focus on providing services such as underwriting, facilitating mergers and acquisitions, and acting as intermediaries between security issuers and investors.³
Investment banks help companies raise capital through stock or bond issuance and provide advisory services for complex financial transactions. Unlike commercial banks, investment banks do not take deposits from the public.³
Everyday interactions with commercial banks
People interact with commercial banks all the time. From opening a checking or savings account to securing a mortgage or personal loan, commercial banks are key to managing personal finances.
Businesses rely on commercial banks for operational accounts, financing expansions, managing cash flow, and facilitating trade through financial tools like letters of credit.
A family seeking a mortgage to purchase a home, for example, might go to a commercial bank to get a loan. The bank evaluates the family’s financial health and the home’s value to determine loan eligibility and terms. Once approved, the bank funds the purchase, with the home serving as collateral. The family repays the loan with interest over an agreed period.
The significance of regulation in commercial banking
Commercial banks operate under strict regulations to ensure the stability of the financial system, protect depositors, and maintain public trust. Regulatory bodies such as the Federal Reserve and the Office of the Comptroller of the Currency oversee banks to ensure they comply with legal and financial standards. These regulations are crucial in maintaining the health of the banking sector, often seen as an indicator of the overall economic condition.⁴
Is your money safe in commercial banks? In the U.S., commercial banks are generally considered safe places to keep your money.
They are regulated by federal agencies such as the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). The FDIC insures deposits up to $250,000 per depositor per insured bank, providing a layer of security for your money.⁵ So, consumers and businesses can have peace of mind knowing that their money is safe in the event of a bank failure, which is already quite rare.
Banks must adhere to stringent regulatory standards to ensure their solvency and operational stability. These measures help protect your deposits and maintain trust in the banking system.
Commercial banking: an economic cornerstone
Commercial banking is a cornerstone of the financial system, offering essential services that enable daily transactions, savings, and investment activities for individuals and businesses.
Banks play a crucial role in economic development by mobilizing savings and allocating capital efficiently. Understanding the functions and significance of commercial banking is important for anyone looking to navigate personal finance successfully.