Commercial Bank

Commercial banks are financial institutions that accept deposits from the public and provide loans for both consumption and investment purposes. They form a core component of modern financial systems, offering services to individuals, businesses and, in some cases, larger corporate clients through their wholesale banking divisions. Although often confused with central banks, commercial banks operate on fundamentally different principles, particularly with regard to profitability, risk exposure and potential insolvency within a fiat currency system.

Historical Background

The term bank originates from the Italian word banco, referring to the benches or counters used by bankers in Renaissance Italy, especially in Florence, where early financial transactions were conducted on green-covered tables. However, forms of banking activity can be traced back to ancient civilisations, where merchants and temple authorities performed rudimentary deposit and lending functions.
In the United States, the label commercial bank came into wider use to distinguish deposit-taking and loan-issuing institutions from investment banks. Following the Great Depression, the Glass–Steagall Act separated commercial and investment banking to reduce systemic risk by limiting the areas in which each type of institution could operate. This separation was largely repealed in 1999 under the Gramm–Leach–Bliley Act, allowing financial conglomerates to combine activities across commercial and investment banking once more.

Role and Economic Significance

Commercial banks contribute to economic development by providing financial services that support consumption, investment and business expansion. Their activities help maintain monetary stability and stimulate economic growth.
One of the most important roles of commercial banks is credit creation. When a bank grants a loan, it does not typically hand over physical cash; instead, it creates a deposit in the borrower’s account. This process increases the overall money supply in the economy and enhances liquidity. Through the circulation of cheques and electronic transfers, loan proceeds become new deposits known as derivative deposits, thereby amplifying the initial funds held by the banking system.

Primary Functions

Commercial banks carry out several essential functions, mainly centred on deposit mobilisation and lending.

• Accepting deposits: Banks receive deposits in various forms, such as savings accounts, current accounts and fixed or term deposits. These accounts may allow immediate withdrawal or require a specified holding period.
• Providing loans and advances: Lending activities include overdraft facilities, cash credit, bill discounting and call money operations. Banks offer demand and term loans to individuals, businesses and organisations, usually secured against collateral. They may also act as trustees for customers’ wills or estates.
• Credit creation: By utilising deposited funds to sanction loans and by enabling payment transfers, banks generate derivative deposits that expand available credit in the economy.

Regulatory Environment

Because of their central role in financial stability, commercial banks are subject to extensive regulation. In most jurisdictions, the central bank is responsible for supervisory oversight. Regulatory requirements typically include:

• maintaining minimum reserve balances;
• meeting specified capital adequacy standards;
• adhering to liquidity norms;
• implementing robust risk-management systems.

Such measures aim to protect depositors, prevent insolvency and preserve confidence in the financial system.

Core Products and Services

Commercial banks provide a variety of primary financial services, including:

• Deposit accounts: Savings, current and fixed-term accounts.
• Lending services: Secured and unsecured loans, overdrafts and other financing arrangements.
• Payment systems: Transaction accounts, issuance of bank drafts and cheques, electronic funds transfers, telegraphic transfers, EFTPOS processing and online or mobile banking platforms.

These services form the backbone of day-to-day financial operations for households and businesses.

Other Functions

Beyond their principal role, commercial banks undertake a range of secondary functions that support financial convenience and efficiency. These are commonly categorised as agency functions and utility functions.
Agency functions include:

• collecting and clearing cheques, dividends and interest warrants;
• making payments such as rent or insurance premiums on behalf of clients;
• conducting foreign exchange transactions;
• purchasing and selling securities for customers;
• acting as trustees, executors, attorneys or correspondents;
• receiving tax payments and returns.

Utility functions include:

• providing safe deposit lockers;
• offering electronic funds transfer facilities;
• issuing travellers’ cheques;
• acting as referees for clients’ financial standing;
• facilitating payment of utility bills such as water, gas and telephone charges;
• issuing credit and debit cards.

These activities enhance the convenience of banking services and extend the support that banks provide to their clients.

Types of Commercial Banking Activities

Commercial banking is commonly divided into retail and wholesale operations. Retail banking serves individuals and small businesses, focusing on personal accounts, mortgages and small-scale credit. Wholesale banking, by contrast, caters to medium and large businesses, offering corporate loans, treasury services, cash-management solutions and trade finance.
Commercial banks may operate within either the private or public sector, depending on national ownership structures and policy frameworks. Public sector banks often play a more pronounced role in implementing government economic priorities, whereas private sector banks may concentrate on competitive pricing, innovation and customer service.

Distinction from Central Banks

Although commercial banks and central banks both operate within the financial system, their functions differ markedly. Central banks do not typically aim to maximise profit and do not face the same risk of insolvency under a fiat currency regime, as they have the authority to issue currency and regulate the money supply. Their primary responsibilities include implementing monetary policy, supervising financial institutions and ensuring overall financial stability. Conversely, commercial banks operate with profit motives, intermediate between savers and borrowers and are subject to financial risks that may threaten their solvency.