Commercial banking refers to the products and services designed to meet the financial needs of corporations, medium and large businesses, and government clients. Examples of commercial banking products include deposit accounts, commercial lending offerings, merchant services, and investment products.
This contrasts with retail banking, which offers similar financial services to individual clients and the general public. In most cases, the same banking provider offers commercial and retail banking services.
If you need commercial banking products and services, Bank of America is an excellent option. You can earn cash back bonuses for opening a new business checking account, and it offers a wide range of small business resources and products. Visit Bank of America’s website for more information.
Key Takeaways
- Commercial banking is a set of bank products and services created to serve the financing needs of corporations, midsized and large businesses, and government clients. These include deposit accounts, commercial loans, merchant services, and investment products.
- Commercial banking functions include accepting deposits, lending funds, acting as an agent, and offering other financial and utility services.
- A commercial bank is a financial institution accepting deposits and providing a wide range of financial services and is vital in the economy. It caters to individual and business banking needs and is classified into three types, private, public, and foreign.
- Commercial banks earn money from the banking products and services they offer to all businesses, government entities, and individuals. Specifically, they make money from interest loan rates and banking fees.
- Commercial banks offer loans that contribute to business expansion, production, and job creation resulting in more capital and market liquidity. They also provide merchant services, global trade services, leasing, treasury management services, and corporate-oriented products and services.
Functions of Commercial Banking
Commercial banks have several essential functions that allow them to serve business and corporate customers with all their potential banking needs.
1. Accepting Deposits
The most common function of a commercial bank is accepting deposits. Often, these accounts pay interest to depositors but come with monthly fees, which can be waived by meeting certain balance or transaction requirements.
Commercial banks will accept deposits in three types of accounts:
- Checking Accounts: The most common bank account, these allow customers to withdraw money at any time without notice and often do not earn interest.
- Savings Accounts: These are smaller accounts that typically earn interest. There may be limits on when and how much can be withdrawn.
- Term or Fixed Deposits: Money in these accounts is held for a set period and cannot be withdrawn without a severe financial penalty until the term expires.
2. Lending Funds
Commercial banks will provide funding to companies, allowing them to expand, purchase equipment, meet day-to-day financial needs, and acquire additional property, among others. Companies will repay the bank’s funding with interest until the loan is satisfied.
There are several types of loans provided by commercial banks:
- Commercial term loan: A short-term lending product used by companies to purchase equipment, inventory, or for cash flow purposes. Loans are for a set period, usually less than 10 years, with full amortization at the end of the term.
- Commercial line of credit: A revolving line of funding provided to a company. The company can take draws against the line of credit, with interest paid only on the amount used. Draw periods can range from a few months to a few years. Companies will often have to present financials annually to renew the line of credit for future use.
- Commercial real estate loan (CRE): A mortgage loan used for the purchase, rehabilitation, or expansion of real estate. These types of loans include fix-and-flip loans, Small Business Administration (SBA)-backed loans, hard money loans, and conventional mortgage loans. These can be short-term loans that lead to permanent financing, a property sale, or can be permanent financing of up to 30 years. Our guide on the five types of CRE loans and how they work can tell you more about this type of loan.
- Cash credits: This product lets a company draw against a deposit account created by the commercial bank. The company borrows money without having a credit balance and only pays interest on the funds they’ve used. Cash credits are often secured with property, fixed assets, or stocks as collateral.
3. Acting as an Agent
Commercial banks can perform functions that assist customers with their business needs. Some of these functions include:
- Collecting bills
- Offering insurance
- Offering investment products
- Purchasing or redeeming securities
- Acting as executor, administrator, or trustee of a client’s estate
- Helping prepare income tax returns and claiming tax refunds
4. Offering Other Financial and Utility Services
Businesses often need other services from their commercial banks besides deposit, lending, and agent. Commercial banks can facilitate these business services, as well as:
- Overdraft fee protection
- Traveler’s checks
- Locker facilities
- Debit and credit cards
- Foreign currency exchange
- Funds transfers including wire services
- Discounting bills of exchange
Pros & Cons of Commercial Banking
| PROS | CONS |
|---|---|
| Helps your business by providing products and services specifically designed to meet the financial needs of businesses | Typically costly compared to retail banks |
| Typically assigns a representative who works directly with a client to find the best services and solutions based on a company’s unique needs | Different banks offer different products and services and charge different fees |
| Usually allows you to set up direct deposits for your employees | Barrier to entry can be high |
How Commercial Banks Work
How Commercial Banks Earn Money
Commercial banks charge monthly or annual fees for their products and services. They also earn money from product fees, overdraft fees, nonsufficient fund (NSF) charges, rental of safe deposit boxes, interest on loans, wire transfers, monthly maintenance fees, and out-of-network fees.
Another way commercial banks earn money is by providing loans. Banks use account deposits to provide funding to borrowers. They then earn money from the interest borrowers pay.
Generally, the loan interest rates are much higher than the deposit interest rates they give out to their customers. For instance, a bank may offer an annual percentage yield (APY) of 0.20% for a business checking account but can ask for 5.25% interest for a commercial real estate loan.
Where Commercial Banks Operate
Commercial banks used to be confined to physical locations, requiring customers to visit and perform their financial transactions in branches. Thanks to the advances in technology, banks can now offer their services online. With online banking, people can transfer funds, pay bills, view statements of accounts, and request new checks and debit cards using their computers, tablets, or smartphones.
Why Commercial Banks Are Important
Commercial banks promote economic growth by infusing capital and building market liquidity. They circulate money from different bank customers through loans to help businesses expand their operations, provide more job opportunities, and create new products and services for general consumption.
If you’re planning to open an account with a commercial bank, consider the providers in our list of the best small business checking accounts.
Types of Commercial Banks
There are three types of commercial banks, classified by how they are owned or where they are located: private, public, and foreign.
Click the tabs below to learn more about each type of bank.
- Private Banks
- Public Banks
- Foreign Banks
Private banks are commercial banks where most of the bank’s capital shares are owned by private individuals and businesses. These banks are generally registered as companies with limited liability, tend to service high-net-worth individuals, and offer an individualized approach to customer service and wealth management services. They often have retail and small business banking in addition to private banking.
Examples of private banks in the United States include:
- Bank of America
- J.P. Morgan Chase
- Citibank
Public banks are regionalized or nationalized, with the state or national government holding the majority of the stake in the bank. Private individuals and businesses do not own them. This is more common overseas and used to be more common in the US. For example, the US Postal Service (USPS) had banking services as recently as 1967.
Example of a public bank in the US:
- Bank of North Dakota
Foreign banks are established and operated from countries outside the US and often have operating branches stateside. To operate in the US, they must follow the rules and regulations for banking in this country. For multinational companies, choosing a foreign bank with branches worldwide can make banking while traveling for business much easier.
Examples of foreign banks in the US include:
- HSBC Bank
- Deutsche Bank
- RBC Bank
Commercial Banking vs Retail Banking
Retail banking and commercial banking are often handled by the same financial institutions. However, there are key differences in which customers they serve, what products and services they offer, and what requirements they request from applicants.
Commercial Banking | Retail Banking | |
|---|---|---|
Customers | Offers services to medium and large-sized businesses | Serves the general public |
Products & Services | Provides deposit accounts, lending products, debit cards, credit cards, certificates of deposit, business merchant services, investment products, retirement planning services, and almost all retail banking services | Has deposit accounts, lending products, debit or credit cards, and certificates of deposit |
Requirement for Account Opening | May require businesses to be established longer, have higher revenues, and structured as a limited liability company (LLC), S corporation (S-corp), or C corporation (C-corp) | Is less strict with the required length of the business operation, revenue earnings, and corporate structure of the business compared to commercial banks |
Small startups might find their initial banking products housed in a bank’s retail banking department when they first open a business bank account. As the business grows, adds employees, and potentially incorporates, those accounts may be moved to the commercial banking department.
When choosing a bank for your small business, you should consider whether the bank has both retail and commercial banking services. This would allow the same institution to continue serving your business as it grows. Before opening an account, check our guide on how to open a business bank account for a downloadable checklist of documents banks typically require.
Commercial Banking vs Investment Banking
If retail banking caters to the smallest businesses and commercial banking to mid- and large-sized businesses, investment banking serves the largest corporations. They provide services to large, publicly traded corporations.
They help these corporations by advising on investment strategies, stock issuance, and potential acquisitions and mergers. They also handle large amounts of money, typically deal with longer-term investments as opposed to day-to-day financial transactions and can assist with raising capital.
Commercial Banks | Investment Banks | |
|---|---|---|
Customers | Small, midsized, and large-sized companies | Investors, corporations, and government agencies |
Services Provided | Deposit accounts, lending products, and other business services | Buying and selling stocks, raising capital, mergers and acquisition, brokerage services |
How They Profit | Interest earned off of lending products | Fees charged |
Risk Level | Low | High |
Customer Base | High | Low |
Frequently Asked Questions (FAQs)
Commercial banking offers exclusive products and services that include investment products, payment processing, merchant services, and global trade services.
A commercial bank has four primary functions.
- Accepting deposits: These deposits can be accepted into current accounts, saving deposit accounts, and term or fixed deposit accounts.
- Lending funds: Commercial banks should offer a variety of lending products, including term loans, lines of credit, real estate loans, and cash credits.
- Acting as an agent: A commercial bank will act on behalf of the business for many transactions, including collecting bills, offering insurance, offering investment products, and helping with tax preparation.
- Offering other financial and utility services: Commercial banks offer services outside of deposit and lending services, including overdraft fee protection, traveler’s checks, locker facilities, debit and credit cards, and foreign currency exchange.
There are three major advantages of a commercial bank. They provide products designed specifically for the financial needs of a business, assign a customer service representative who works directly with the business to ensure their needs are met, and will enable you to set up deposit accounts for your employees.
Bottom Line
Commercial banks can provide your business with a wide range of services. Many offer commercial and retail banking services, allowing your business to grow into the services that a commercial bank offers. Before you start a business relationship with a bank, consider one that allows your business to grow and expand.
