This article is part of a larger series on Business Banking.
Commercial banking is a group of bank products and services designed to meet the financial needs of corporations, medium and large businesses, and government clients. These can 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 and, in most cases, the same banking provider offers commercial and retail banking services. Banks will provide products and services to small businesses out of one or both of those banking categories.
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.
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.
The functions of commercial banking are accepting deposits, lending funds, acting as an agent, and offering other financial and utility services.
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:
- Current accounts: The most common bank account, these allow customers to withdraw money at any time without notice and often don’t earn interest.
- Saving deposits: 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 There may be limits on when and how much can be withdrawn.
- Term or fixed deposits: Money in these accounts is held for a set period and cannot be withdrawn without a severe financial penalty until the term expires.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 use 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 (CRE) loan: 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 or a property sale or can be permanent financing of up to 30 years.
- Cash credits: Rather than loaning a company money, the commercial bank allows a company to draw against a deposit account created by the commercial bank. The company borrows money without having a credit balance, and interest is only paid on the used amount. It’s often secured with property, fixed assets, or stocks as collateral.
3. Acting as an Agent
Commercial banks can perform functions for their customers to assist 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
Commercial Banking Products & Services
Commercial banks provide various services that can benefit a business beyond just deposit accounts. They are structured the same way for companies as they would for individual customers.
In addition to deposit accounts, here are some of the other services offered by commercial banks:
- Industrial loans and other lending services: Loans are the primary source of profits for commercial banks. By providing loans to corporations, commercial banks earn income in the form of interest paid to them by their borrowers.
- Merchant services: Most commercial banks offer merchant services that include credit card processing, mobile payment solutions, gift cards, and electronic check services.
- Global trade services: These services may include foreign exchange, foreign trade financing, letters of credit, global payments, export financing, and bank guarantees, among others.
- Leasing: Many companies use leasing as a financing method for acquiring real estate, automobiles, factory equipment, and other major fixed assets.
- Treasury management services: Commercial banks offer funds collection, disbursement, and fraud prevention.
- Corporate-oriented products and services: These include retirement products, employee stock ownership plans, payroll services, advisory services, and insurance products designed for corporations and institutions.
Pros & Cons of Commercial Banking
|Helps your business by providing products and services specifically designed to meet the financial needs of businesses||Typically costly compared to traditional 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||May not be ideal for new businesses|
Types of Commercial Banks
There are three types of commercial banks, classified by how they’re owned or where they’re located. Any kind of bank can work for your bank as long as you’re eligible to get an account.
Click the tabs below to learn more about each type of bank.
Retail Banking vs Commercial Banking
Retail banking and commercial banking are often handled by the same financial institutions. Retail banking provides financial services to the general public, while commercial banking offers those services to medium to large-sized businesses and corporations.
Almost all banking services in a retail bank would also be available in a commercial bank, including deposit accounts and lending products. Commercial banks would additionally offer business merchant services, investment products, and retirement planning services.
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.
While the general steps for opening a business bank account at a retail or commercial bank will be similar, the specific documentation may differ. The commercial bank may require your business to be established longer, have higher revenues, and be structured as a limited liability company (LLC), S corporation (S-corp), or C corporation (C-corp).
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.
Commercial Banking vs Investment Banking
If retail banking caters to the smallest businesses and commercial banking to the mid-sized and larger businesses, the largest corporations are served by investment banks. 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.
Here’s a table with some of the differences between the two types of banks.
Small, midsized, and large-sized companies
Investors, corporations, and government agencies
Deposit accounts, lending products, and other business services
Buying and selling stocks, raising capital, mergers and acquisition, and brokerage services
How They Profit
Interest earned off of lending products
Frequently Asked Questions (FAQs)
What is an example of commercial banking?
While commercial banking can include services that would also fall under retail banking, such as deposit accounts and lending products, other services would be exclusive to it, including offering investment products, payment processing, merchant services, and global trade services.
What are the primary functions of a commercial bank?
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.
What are the advantages of a commercial bank?
There are three major advantages of a commercial bank. They provide products specifically designed for the financial needs of a business, assign a customer service representative that works directly with the business to ensure their needs are met, and enable you to set up deposit accounts for your employees.
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 by opening a small business checking account, consider a bank that will allow your business to grow and expand.