What are commercial banks and why are they important?

Commercial banks are financial institutions that provide banking services and products to individuals and small to medium-sized businesses. They are institutions which accept deposits, offer checking and savings accounts, make loans, and provide other financial services including but not limited to certificate of deposit, safe deposit boxes, and basic investment services.¹

Commercial banks are important for the economy because they create capital, credit, and liquidity in the market. They use the deposits they receive from customers to lend money to borrowers, who use it for consumption or investment purposes. This process of credit creation stimulates economic activity and growth. They also facilitate payments and transactions between individuals and businesses, and provide financial advice and guidance to their clients².

How do commercial banks work and make money?

Commercial banks work by intermediating between savers and borrowers. They collect deposits from customers who have surplus funds and pay them interest. They then lend these funds to customers who need money and charge them interest. The difference between the interest rates on deposits and loans is the main source of income for commercial banks, referred as the net interest margin.

Commercial banks also make money from fees and charges for various services and products they offer. These include account fees, overdraft fees, loan origination fees, late payment fees, safe deposit box fees, and ATM fees. These institutions also make money or earn income from non-interest sources such as trading, underwriting and advisory services

What are the types and functions of commercial banks?

Commercial banks can be classified into different types based on their ownership, size, scope, and specialization. Some of the common types of commercial banks are:

• Private sector banks: Banks owned and operated by private individuals or corporations. The private sector pursue profit and compete with each other for customers and market shares. Example of private sector banks are Cal Bank, Ecobank of Ghana and Revolut of UK.
• Public sector banks: These are banks that are owned and controlled by the government or public authorities. They are usually established to serve the social and developmental objectives of the government. They may offer subsidized loans and preferential treatment to certain sectors or groups of customers. Examples of public sector banks are Bank of America, State Bank of India, and China Construction Bank and Ghana Commercial Bank³.
• Community development banks: These banks focus on providing financial services and products to low-income and underserved communities. They aim to promote economic development and social welfare in their target areas. They may offer microfinance, financial literacy, and community development programs. Examples of community development banks include arb apex bank and development bank Ghana.
• Cooperative banks: These are banks that are owned and managed by their members, who are usually customers or employees of the bank. They operate on the principle of mutual benefit and cooperation. They may offer lower interest rates, higher dividends, and more personalized services to their members. University of Ghana co-operative credit union and rabobank are examples of cooperative banks.
• Online banks: These are banks that operate exclusively through the internet and do not have any physical branches or locations. They offer convenience, speed, and lower costs to their customers. They may also offer more innovative and customized products and services. Examples: Ally Bank, ING Direct, and Simple⁴.

Roles of commercial bank

Commercial banks perform various functions that are essential for the financial system and the economy. Some of the main functions of commercial banks are:

• Deposits: Commercial banks accept deposits from customers and pay them interest. Deposits are the main source of funds for commercial banks. They also provide safety and security to the customers’ money. Deposits can be of different types, such as demand deposits, savings deposits, fixed deposits, and recurring deposits².
• Lending function: Commercial banks lend money to customers and charge them interest. Lending is the main use of funds for commercial banks. They also create credit and money in the economy by multiplying the deposits they receive. Lending can be of different forms, such as overdraft, cash credit, term loan, mortgage, and personal loan².
• Payment function: Commercial banks facilitate payments and transactions between customers and other parties. They provide various instruments and channels for making and receiving payments, such as checks, debit cards, credit cards, electronic funds transfer, and mobile banking. They also act as clearing houses and settlement agents for the payments they process².
• Investment function: Commercial banks provide investment services and products to customers who want to save and grow their money. They offer various options for investing, such as certificates of deposit, mutual funds, stocks, bonds, and derivatives. They also provide financial advice and guidance to their customers on how to invest their money wisely².

Agency function: Commercial banks act as agents and representatives of their customers for various purposes. They perform various services on behalf of their customers, such as collecting and paying bills, transferring funds, buying and selling securities, issuing drafts and letters of credit, and acting as trustees and executors.

How are commercial banks related to business building?

Business building is the process of creating and scaling new businesses that can generate revenue and growth for an organization. Business building can be done by entrepreneurs who start their own ventures, or by incumbents who launch new businesses within or outside their existing operations⁴.

Commercial banks are related to business building in several ways. They can support business building by providing financial resources, services, and solutions to entrepreneurs and incumbents who want to start or grow their new businesses. 

They can also engage in business building by creating and launching their own new businesses that can diversify their revenues, increase their organic growth, parry disruption, or rapidly meet the changing needs of their customers⁴.

Some of the ways that commercial banks can support business building are:

• Providing loans and credit facilities to entrepreneurs and incumbents who need funds to start or scale their new businesses. Commercial banks can offer various types of loans, such as startup loans, working capital loans, equipment loans, and project loans, depending on the nature and stage of the new business⁵.
• Providing deposit and payment services to entrepreneurs and incumbents who need to manage their cash flow and transactions for their new businesses. Commercial banks can offer various types of accounts, such as business checking accounts, savings accounts, and merchant accounts, as well as various payment instruments and channels, such as checks, cards, online banking, and mobile banking⁵.
• Providing investment and advisory services to entrepreneurs and incumbents who need to raise capital, access markets, or seek strategic partners for their new businesses. Commercial banks can offer various options for raising capital, such as equity, debt, or hybrid instruments, as well as various platforms and networks for accessing markets, such as stock exchanges, trading platforms, or crowdfunding platforms. They can also provide financial advice and guidance on various aspects of business building, such as business planning, valuation, risk management, and exit strategies⁵.

Ways commercial banks can engage in business building are:

• Creating and launching new products and services that can cater to the emerging or unmet needs of their existing or potential customers. Commercial banks can leverage their core competencies, customer insights, and market knowledge to develop and offer innovative and customized solutions that can create value and differentiation for their customers. Examples of new products and services that commercial banks can launch are digital wallets, robo-advisors, peer-to-peer lending, and blockchain-based solutions⁶.
• Creating and launching new business models that can disrupt or transform the existing or adjacent markets. Commercial banks can leverage their capabilities, resources, and partnerships to develop and offer new ways of delivering and capturing value that can challenge or change the status quo. Examples of new business models that commercial banks can launch are platform-based models, subscription-based models, freemium-based models, and network-based models⁶.
• Creating and launching new business units or ventures that can operate independently or in collaboration with their existing or external operations. Commercial banks can leverage their organizational structure, culture, and governance to develop and support new entities that can pursue new opportunities or address new challenges. Examples of new business units or ventures that commercial banks can launch are spin-offs, incubators, accelerators, and corporate venture capital⁶.

Conclusion

Commercial banks are vital players in the financial system and the economy. They provide various banking services and products to individuals and small to medium-sized businesses. They also support and engage in business building by providing financial resources, services, solutions, and innovations to entrepreneurs and incumbents who want to create and scale new businesses.

References

⁴: What is Business Building? Definition, Benefits, and Challenges ⁶: How Commercial Banks Can Build New Businesses ⁷: Commercial bank branches (per 100,000 adults) | Data ⁵: How Commercial Banks Can Support Small Business Growth ¹: Commercial banks in the U.S. – statistics & facts | Statista ²: FDIC: Industry Analysis ³: Types of Commercial Banks – Overview, Functions, Examples