The Banking System: Commercial Banking - What Banks Do
AAA
  1. The Banking System: Introduction
  2. The Banking System: Commercial Banking - What Banks Do
  3. The Banking System: Commercial Banking - Economic Concepts in Banking
  4. The Banking System: Commercial Banking - How Banks Make Money
  5. The Banking System: Commercial Banking - Business Lending
  6. The Banking System: Commercial Banking - Operations
  7. The Banking System: Commercial Banking - How Banks Are Regulated
  8. The Banking System: Commercial Banking - Where Commercial Banks Are Vulnerable
  9. The Banking System: Commercial Banking - Bank Crises And Panics
  10. The Banking System: Commercial Banking - Key Ratios/Factors
  11. The Banking System: Federal Reserve System
  12. The Banking System: Non-Bank Financial Institutions
  13. The Banking System: Conclusion

The Banking System: Commercial Banking - What Banks Do

ByStephen D. Simpson, CFA

Accept Deposits / Make Loans
At the most basic level, what banks do is fairly simple. Banks accept deposits from customers, raise capital from investors or lenders, and then use that money to make loans, buy securities and provide other financial services to customers. These loans are then used by people and businesses to buy goods or expand business operations, which in turn leads to more deposited funds that make their way to banks.


If banks can lend money at a higher interest rate than they have to pay for funds and operating costs, they make money. An illustration of this very basic concept can be found in the old "3-6-3 Rule," a tongue-in-cheek "rule" that said a banker would pay out 3% for deposits, charge 6% for loans and hit the golf course by 3 p.m.

Provide Safety
Banks also provide security and convenience to their customers. Part of the original purpose of banks, and the goldsmiths that predated them, was to offer customers safe keeping for their money. Of course, this was back in a time when a person's wealth consisted of actual gold and silver coins, but to a large extent this function is still relevant. By keeping physical cash at home, or in a wallet, there are risks of loss due to theft and accidents, not to mention the loss of possible income from interest. With banks, consumers no longer need to keep large amounts of currency on hand; transactions can be handled with checks, debit cards or credit cards, instead.

While banks do not keep gold or silver bullion as currency on hand anymore, many, if not most, banks still maintain vaults and will rent out space to customers, in the form of safe deposit boxes. This allows customers to keep precious or irreplaceable items in a secure setting and gives the bank an opportunity to earn a little extra money, without risk to its capital.

Act as Payment Agents
Banks also serve often under-appreciated roles as payment agents within a country and between nations. Not only do banks issue debit cards that allow account holders to pay for goods with the swipe of a card, they can also arrange
wire transfers with other institutions. Banks essentially underwrite financial transactions by lending their reputation and credibility to the transaction; a check is basically just a promissory note between two people, but without a bank's name and information on that note, no merchant would accept it. As payment agents, banks make commercial transactions much more convenient; it is not necessary to carry around large amounts of physical currency when merchants will accept the checks, debit cards or credit cards that banks provide.

The Banking System: Commercial Banking - Economic Concepts in Banking

  1. The Banking System: Introduction
  2. The Banking System: Commercial Banking - What Banks Do
  3. The Banking System: Commercial Banking - Economic Concepts in Banking
  4. The Banking System: Commercial Banking - How Banks Make Money
  5. The Banking System: Commercial Banking - Business Lending
  6. The Banking System: Commercial Banking - Operations
  7. The Banking System: Commercial Banking - How Banks Are Regulated
  8. The Banking System: Commercial Banking - Where Commercial Banks Are Vulnerable
  9. The Banking System: Commercial Banking - Bank Crises And Panics
  10. The Banking System: Commercial Banking - Key Ratios/Factors
  11. The Banking System: Federal Reserve System
  12. The Banking System: Non-Bank Financial Institutions
  13. The Banking System: Conclusion
RELATED TERMS
  1. Cost Of Funds

    The interest rate paid by financial institutions for the funds ...
  2. Debit Card

    An electronic card issued by a bank which allows bank clients ...
  3. Average Revenue Per User (ARPU)

    A measure of how much income a business generates, given the ...
  4. Money Market Account

    An interest-bearing account that typically pays a higher interest ...
  5. Compound Interest

    Interest calculated on the initial principal and also on the ...
  6. Straight Credit

    A type of letter of credit. A straight credit can only be paid ...
RELATED FAQS
  1. How does investing in banks in emerging markets compare to developed countries?

    Investing in banks in emerging markets compared to developed countries has its advantages and disadvantages. On the plus ... Read Full Answer >>
  2. What proportion of the global economy is comprised of banks?

    Most of the world's financial wealth is contained within the banking sector. After all, other industries part with their ... Read Full Answer >>
  3. What other sectors are most similar to banking?

    The banking system is not technically a sector, but rather an industry within the financial services sector. Other similar ... Read Full Answer >>
  4. What impact does quantitative easing have on banks in the U.S.?

    Quantitative easing has widespread and unequal consequences on banks in the United States. The Federal Reserve has purchased ... Read Full Answer >>
  5. How does investment banking differ from commercial banking?

    Investment banking and commercial banking are two primary segments of the banking industry. Investment banks facilitate the ... Read Full Answer >>
  6. Why do commercial banks borrow from the Federal Reserve?

    Commercial banks borrow from the Federal Reserve primarily to meet reserve requirements when their cash on hand is low before ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!