A lot of us operate one or more bank accounts. These accounts, which are opened in one or more commercial banks, serve as a safe for our money and other valuables. Aside from keeping our money safe, commercial banks offer loans, create credit, etc. Each type of commercial bank has various functions. And that begs the question, what are the types of commercial banks?
There are three main types of commercial banks: public sector banks, private sector banks, and foreign banks. Each type of bank operates differently.
Wouldn’t you like to know more about where you stash your hard-earned money? If you want to have an insight into how commercial banks operate, including their functions and types, you have come to the right place.
Types of Commercial Banks:
Many of us have accounts with one or more commercial banks. We stash our money there without having any insight into what a commercial bank is, its functions, or what differentiates them from other types of banks.
A commercial bank is a financial institution that takes deposits, provides checking account services, makes various loans, and provides basic financial products such as certificates of deposits (CDs) and savings accounts to individuals and small businesses. A commercial bank is where people conduct their banking. These banks profit by providing and earning interest from loans like mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to initiate these loans.
How Do Commercial Banks Work?
Commercial banks offer basic banking services and products to the public. Their customers range from individuals to small or medium-sized businesses. Commercial banks’ services include checking and savings accounts, loans and mortgages, basic investment services like CDs, and other services like safe deposit boxes.
Because a bank is a business, they need money to operate. And how do they make money to finance their operations?
Banks make money from service charges, including fees. These fees vary on the financial product, ranging from account fees (monthly maintenance charges, minimum balance fees, overdraft fees, non-sufficient funds (NSF) charges) and safe deposit box fees, including late fees. Many loan products also come with fees and interest charges.
Aside from charges and fees, banks also earn money from the interest they make by lending out money to other clients. The funds they lend come from customer deposits. But, the interest rate paid by the bank on the money they borrow is less than the rate charged on the money they lend. For example, a bank may offer savings account customers a yearly interest rate of 0.2% while charging mortgage clients 4.75% in interest yearly.
Importance of Commercial Banks:
Commercial banks are a significant part of the economy. Not only do they provide consumers with an essential service, but they also help create liquidity and capital in the market. Commercial banks ensure liquidity by taking their customers’ funds in their accounts and lending them out to others. These banks play a huge role in creating credit, which increases production, employment, and customer spending, thus boosting the economy.
Hence, commercial banks are well regulated by a central bank in their country or region. For example, central banks impose reserve requirements on commercial banks. This means banks are required to hold a particular percentage of their consumer deposits at the central bank as a cushion if there is a hurry to withdraw funds from the public.
Commercial banks are commonly divided into three types:
- Public sector banks:
Public sector banks are a type of financial institution state-owned by the corresponding government. The government holds a huge part of the share of such organizations.
- Private sector banks:
Private sector banks are commercial banks in which private businesses, including individuals, hold a significant share capital. These banks are registered as companies with limited liability.
- Foreign banks:
These are commercial banks housed in a foreign country but operate branches in different countries.
Major Functions of a Commercial Bank:
Accepting deposits:
The most important and traditional function of a commercial bank is accepting deposits from the general public. The deposit may be of three types: saving deposits, current deposits, and fixed deposits. In the case of the current account, people can withdraw deposits in bits or in full at any given time.
Interests aren’t often paid on them, as the bank cannot use these short-term deposits. Savings deposits are payable on demand, and checks can withdraw money.
Effects of Job Loss on Individuals
Providing loans:
The second important function of the commercial bank is to provide loans against suitable mortgages to the public. Loans can be granted in several forms, including cash credit, demand loans, short-term loans, overdrafts, bill discounts, etc. Under the cash credit system, the borrower is sanctioned a credit limit up to which he can borrow from the bank. The interest payable by the borrower is calculated on the amount of credit limit drawn. Demand loans granted by a bank are those loans that can be called back on demand by the bank whenever they deem fit.
Here, the interest is payable on the whole sum of demand loans granted. Short-term loans (such as car loans, housing loans, etc.) are given as personal loans against some security. The interest is payable on the whole sum of the loan granted. In the case of an overdraft facility, an account holder is allowed to withdraw a sum of money above the amount deposited with the bank.
Other functions of a bank are:
- Credit creation
- Transfer of funds
- Dealing with foreign exchange, etc.
