What is a commercial bank?
A commercial bank is a financial institution that accepts deposits from the public and uses those funds to provide loans and payment services to individuals and businesses. In plain terms: you can open deposit accounts, use ATMs, make transfers and payments, and the bank makes loans (mortgages, auto loans, business loans, credit lines) backed by the deposits it holds.
Key definitions (first-use jargon)
– Deposit: money a customer places with a bank (checking, savings, certificates of deposit).
– FDIC: Federal Deposit Insurance Corporation — the U.S. agency that insures certain bank deposits up to specified limits.
– Collateral: an asset pledged to secure a loan (e.g., a house for a mortgage).
– Secured lending: loans backed by collateral.
– Liquidity: the ease with which assets can be converted to cash without large loss of value.
– Reserve requirement: a rule from a central bank that asks commercial banks to keep a fraction of deposits as reserves.
Core functions and typical services
– Retail accounts: checking, savings, money market accounts, and CDs (time deposits).
– Payment services: debit cards, ACH transfers, bill pay, merchant services for businesses (processing electronic customer payments).
– Lending: residential mortgages, auto loans, business loans, personal loans, and credit-card lines.
– ATM and teller services (in-branch), plus online and mobile banking platforms. Some commercial banks operate only online and can offer lower fees because they lack branches.
How commercial banks make money
1. Interest margin: banks pay interest to depositors at a low rate and charge higher interest to borrowers. The difference is the net interest income.
2. Fees: account maintenance fees, overdraft and NSF (non-sufficient funds) charges, late loan payments, safe-deposit box rents, and merchant/processing fees.
3. Transaction-driven income: interchange fees charged to merchants for credit/debit card transactions and other processing charges.
How lending works (high-level)
– Customer deposits supply the funds banks use to originate loans.
– Loans can be secured (backed by collateral such as a house or car) or unsecured (credit cards, some personal loans).
– Mortgages typically have long terms (commonly 30 years in many markets) and can be fixed-rate or adjustable-rate. Auto loans are shorter-term and often carry higher rates than mortgages. Credit cards are revolving lines of credit with higher default rates and higher interest rates, but they also generate substantial fee income.
Safety for depositors
In the U.S., customer deposits at FDIC‑insured banks are protected up to $250,000 per depositor, per insured bank, for each account ownership category. This insurance covers cash in checking, savings, and certain other deposit products. That is one reason banks can access low-cost funding from depositors.
Commercial banks’ role in the economy
– Liquidity provider: they transform short-term deposits into longer-term loans, making cash available to borrowers.
– Credit creation: by lending, banks expand credit in the economy, which supports investment, consumption, and job creation.
– Regulated activity: central banks and other regulators supervise commercial banks and may impose reserve requirements or capital rules to limit risk.
Commercial banks versus investment banks (brief)
– Commercial banks focus on deposit-taking, payment services, and lending to households and firms.
– Investment banks engage in underwriting securities, advisory services for mergers and capital markets, and trading. Some institutions operate both sets of activities, but the two types serve distinct functions.
Short checklist: How to tell if your bank is a commercial bank (and what to check)
– Is it taking deposits (checking, savings, CDs)? If yes, it’s offering typical commercial-banking services.
– Does it offer retail lending (mortgages, auto loans, personal loans, credit cards)? That’s another sign.
– Is your deposit insured by FDIC (U.S.)? Look for the FDIC logo or check the institution’s disclosures.
– Compare: fees (monthly, overdraft), interest rates (savings vs loan rates), branch/ATM access vs online-only convenience, and available business services if you’re a company
How commercial banks make money
– Net interest income: The primary source of revenue for most commercial banks is the difference between interest earned on assets (loans, securities) and interest paid on liabilities (deposits, wholesale funding). That difference is often expressed as the net interest margin (NIM), which is:
NIM = (Interest income − Interest expense) / Average earning assets
Worked example:
– Bank A has $80 billion in interest-earning assets.
– It earns $3.6 billion in interest income and pays $0.8 billion in interest on deposits and borrowings.
– NIM = ($3.6B − $0.8B) / $80B = $2.8B / $80B = 3.5%
A higher NIM usually means more profit per dollar of assets, but it can reflect different business models or risk profiles.
– Noninterest income: Fees and service charges (checking-account fees, ATM fees, loan origination fees), wealth-management and advisory fees, trading gains, and income from investment securities. Noninterest income can stabilize revenue when interest margins compress, but it may be more volatile.
– Other lines: Principal investing, securitization of loans, merchant services, and Treasury operations. Large banks may also earn significant revenue from capital markets activities, while community banks rely more on lending and deposit services.
Key risks and regulatory metrics (what to watch)
– Credit risk: Borrowers may default. Measured by metrics like nonperforming loans (NPLs) and the ratio of loan-loss reserves to total loans.
– Liquidity risk: Inability to meet short-term obligations (deposit withdrawals). Monitored via liquidity coverage ratio (LCR) and available liquid assets.
– Interest-rate risk: Asset–liability mismatches can cause net interest income and economic value to fluctuate when rates change.
– Capital adequacy: Capital cushions absorb losses. A common metric is Common Equity Tier 1 (CET1) ratio:
CET1 = Common equity / Risk-weighted assets
Worked example:
– Common equity = $10 billion
– Risk-weighted assets = $100 billion
– CET1 = $10B / $100B = 10%
Regulators set minimum CET1 requirements (Basel III baseline is 4.5%, plus buffers such as a 2.5% conservation buffer, making a practical minimum ~7%), and many banks operate above regulatory minima. Higher CET1 generally implies greater loss-absorbing capacity.
– Market and operational risk: Trading losses, model failures, cyberattacks, and compliance issues can also hurt banks.
How regulators and safety nets mitigate risks
– Deposit insurance (U.S.): The Federal Deposit Insurance Corporation (FDIC) insures eligible deposits up to $250,000 per depositor, per insured bank, per ownership category. This reduces the chance of bank runs on insured deposits.
– Supervision and capital rules: National regulators (Federal Reserve, FDIC, OCC in the U.S.) and international standards (Basel Committee) require reporting, stress testing, capital, and liquidity standards.
– Lender-of-last-resort: Central banks can provide emergency liquidity to solvent but illiquid banks to avert system-wide crises.
Where to find a bank’s health indicators (step-by-step)
1. Check the bank’s quarterly and annual reports (10-Q, 10-K) via the investor relations page or SEC EDGAR for U.S.-listed banks.
2. Review regulatory filings: U.S. banks file Call Reports (FFIEC 031/041) with balance-sheet detail—available on the FFIEC or bank regulatory websites.
3. Look for key ratios: NIM, CET1, return on assets (ROA), nonperforming loans ratio, loan-loss reserve ratio, and LCR if disclosed.
4. For public commentary and stress-test results, consult Federal Reserve announcements (large banks) and FDIC Risk Profiles (for community banks).
5. Verify deposit insurance status using the FDIC’s BankFind tool.
Comparing bank types briefly
– Commercial bank vs. investment bank: Commercial banks take deposits and make loans. Investment banks focus on securities underwriting, advisory, and capital markets. Some firms combine functions under holding companies, but statutory separations and capital rules create different risk and regulatory profiles.
– Commercial bank vs. credit union: Credit unions are member-owned cooperatives with member-depositors and often tax-exempt status. They typically offer similar products but may have different fee structures and membership eligibility.
– Commercial bank vs. fintech/online bank: Online banks may offer higher deposit rates and lower fees but may lack physical branches. They may partner with traditional banks for insured deposits or custody.
Practical checklist for customers (quick)
– Is the institution FDIC-insured? (U.S.) Confirm via FDIC resources.
– Are the products you need offered (checking with low fees, ATM access, mobile app, business banking)?
– Compare interest rates: yield on savings vs. cost of loans; watch for promotional vs. ongoing rates.
– Read fee schedules: monthly fees, overdraft fees, ATM surcharges, wire fees.
– Review customer-service options: branch access, call center hours, dispute resolution.
– For larger exposures, check the bank’s CET1 ratio, nonperforming-loan trends, and recent earnings reports.
– Keep uninsured deposit concentration in mind: amounts above the FDIC limit are at risk in a failure.
Short closing note on economic role
Commercial banks intermediate funds from savers to borrowers, provide payment services, and help allocate capital across the economy. That intermediation creates leverage and liquidity benefits but also entails systemic links that regulators and safety nets seek to manage.
Educational disclaimer
This information is educational, not individualized investment advice. Check primary regulatory filings or speak with a licensed professional before making financial decisions.
Sources
– Investopedia — Commercial Bank: https://www.investopedia.com/terms/c/commercialbank.asp
– Federal Deposit Insurance Corporation
– Federal Deposit Insurance Corporation — https://www.fdic.gov
– Board of Governors of the Federal Reserve System — https://www.federalreserve.gov
– Office of the Comptroller of the Currency — https://www.occ.gov