Learning Objectives:

  • Define a commercial bank and its core functions.

  • Distinguish commercial banking from other forms of banking.

  • Understand the importance of commercial banks in the economy.

1.1 Defining Commercial Banking

A commercial bank is a for-profit financial institution that accepts deposits from individuals and businesses, makes loans, and offers a range of financial services . Commercial banks are the most common type of bank and the primary intermediary between savers who deposit money and borrowers who need capital . They are the “traditional ‘High Street’ banks” that most people interact with in their daily lives .

A commercial bank is defined as taking deposits payable on demand and originating loans to private and corporate customers . This dual function of deposit-taking and lending is the defining characteristic of commercial banking, distinguishing it from other financial institutions that may not perform both functions.

1.2 Core Functions of Commercial Banks

Commercial banks perform several essential functions :

  • Accepting Deposits: Banks take in funds from individuals and businesses through checking accounts, savings accounts, money market accounts, and certificates of deposit. In the United States, these deposits are insured by the Federal Deposit Insurance Corporation up to $250,000 per depositor, per institution, per account category .

  • Making Loans: Banks deploy deposited funds by lending to consumers, businesses, and governments. Mortgage loans, auto loans, personal loans, and commercial loans are all common products .

  • Payment Processing: Commercial banks facilitate the movement of money through checks, wire transfers, ACH payments, and debit card networks .

  • Credit Products: Banks issue credit cards and lines of credit that allow customers to borrow on a revolving basis .

  • Treasury and Investment Services: Larger commercial banks offer foreign exchange, treasury management, and investment products to business clients .

The University of Edinburgh course provides a comprehensive framework for understanding these functions, requiring students to “have a knowledge and understanding of the roles and functions of different types of banks” .

1.3 The Commercial Bank Business Model

Commercial banks generate revenue through two primary streams :

  • Net Interest Income: The spread between the interest earned on loans and the interest paid on deposits, typically 2-4% net interest margin. This is sensitive to interest rate environments .

  • Non-Interest Income: Fees for services such as cash management, payment processing, foreign exchange, loan origination fees, and advisory services .

As noted by Nasdaq, in traditional banks, net interest income makes up a clear majority of their total net revenue, while non-interest income includes fees from wealth management businesses, safe deposit box rentals, overdraft fees, and monthly checking account fees .

1.4 Commercial Banks in the Economy

Commercial banks play an essential role in the financial system by acting as intermediaries between people and organizations with excess funds and those that need financing . The chapter “Commercial Banking: Changing Interactions between Banks, Markets, Industry, and State” in the Oxford Handbook of Banking and Financial History highlights that banks’ role in the financing of industry and economic growth, including their assigned responsibility, has shaped the development of commercial banks since the onset of industrialization .

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