Commercial Banks
- Article photo, courtesy of GLG
When you hear about banks, it’s most likely the commercial banks that come to mind. These institutions play a critical role in the global economy, offering a variety of essential financial services to individuals, corporations, and governments. But what exactly is a commercial bank, and how does it operate?
Defining Commercial Banks
A commercial bank is a financial institution that accepts deposits, offers checking account services, and makes various loans. Commercial banks are by far the largest type of depository institution, providing a range of services that we encounter in everyday life and business operations.
Commercial Banks in Numbers
As of mid-2007, there were 7,350 commercial banks in the United States. Interestingly, while less than 7% of these banks had total assets exceeding $1 billion, these large banks controlled over 85% of the total assets within the commercial banking sector. Some of the largest commercial banks in the U.S. by the end of 2005 included:
- Bank of America Corp. – $1,082.2 billion in assets
- J.P. Morgan Chase & Co. – $1,014.0 billion in assets
- Citigroup – $706.5 billion in assets
- Wachovia Corp. – $472.1 billion in assets
- Wells Fargo & Co. – $403.3 billion in assets
Services Offered by Commercial Banks
Commercial banks are versatile institutions that provide a broad range of services, typically categorized into three main groups:
Individual Banking
These services are tailored to consumers and include:
- Residential mortgage lending
- Credit card financing
- Student loans
- Personal investment services like brokerage and trust services
- Automobile and boat financing
Institutional Banking
These services cater to businesses and governments, such as:
- Commercial real estate financing
- Loans to corporations and government entities
- Leasing activities
Global Banking
In the international financial arena, commercial banks often compete with investment banks, offering services related to:
- Corporate financing and capital market products
- Underwriting securities and issuing letters of credit
- Financial advisory services on corporate restructuring and acquisitions
- Foreign exchange transactions
How Do Banks Fund Their Operations?
Commercial banks are highly leveraged institutions, meaning they fund their activities primarily through borrowed money, including customer deposits. The four main types of deposit accounts they offer include:
- Demand deposits (checking accounts): Withdrawable on demand with minimal interest.
- Savings deposits: Pay interest, often below market rates, without a fixed maturity.
- Time deposits (certificates of deposit or CDs): Have a fixed maturity and offer either fixed or floating interest rates.
- Money market demand accounts: Pay interest based on short-term interest rates.
In addition to deposits, banks also raise funds by borrowing in the money and bond markets, borrowing reserves in the federal funds market, and accessing the Federal Reserve’s discount window.
Bank Reserves and the Federal Funds Market
Banks are required to maintain a percentage of their deposits in noninterest-bearing accounts at one of the 12 Federal Reserve Banks, known as required reserves. If a bank has excess reserves, it can lend them to other banks in the federal funds market at the federal funds rate. Alternatively, if a bank falls short of its required reserves, it can borrow from the Federal Reserve at the discount rate through the discount window facility, although this requires collateral.
Regulation of Commercial Banks
Due to the significant role that commercial banks play in financial markets, they are subject to heavy regulation. At the federal level, they are overseen by entities like the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (FDIC). Additionally, commercial banks in the U.S. are insured by the Bank Insurance Fund (BIF), which is managed by the FDIC.
One of the biggest concerns for regulators is the capital structure of banks. Commercial banks typically have low equity capital, often less than 8% of total assets. This highly leveraged position makes them vulnerable to insolvency risks. To mitigate this risk, regulators have imposed risk-based capital requirements, which are guided by international standards set by the Basel Committee on Banking Supervision.
In summary, commercial banks are the backbone of the modern financial system. Whether you’re applying for a loan, opening a savings account, or managing business finances, commercial banks offer a suite of services to meet the needs of both individuals and institutions. Their role in facilitating financial transactions, offering loans, and supporting economic growth cannot be overstated.
