Principles of Finance/Section 1/Chapter/Financial Markets and Institutions/Commercial Banks


A commercial bank (or business bank) is a type of financial institution and financial intermediary. It is a bank that lends money and provides transactional, savings, and money market accounts and that accepts time deposits.[1]

Origin of the wordEdit

The name bank derives from the Italian word banco "desk/bench", used during the Renaissance era by Florentine bankers, who used to make their transactions above a desk covered by a green tablecloth.[2] However, traces of banking activity can be found even in ancient times.

In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders would set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are derived. As a moneychanger, the merchant at the bancu did not so much invest money as merely convert the foreign currency into the only legal tender in Rome – that of the Imperial Mint.[3]

The role of commercial banksEdit

Commercial banks engage in the following activities:

  • processing of payments by way of telegraphic transfer, EFTPOS, internet banking, or other means
  • issuing bank drafts and bank cheques
  • accepting money on term deposit
  • lending money by overdraft, installment loan, or other means
  • providing documentary and standby letter of credit, guarantees, performance bonds, securities underwriting commitments and other forms of off balance sheet exposures
  • safekeeping of documents and other items in safe deposit boxes
  • sales, distribution or brokerage, with or without advice, of: insurance, unit trusts and similar financial products as a “financial supermarket”
  • cash management and treasury
  • merchant banking and private equity financing
  • traditionally, large commercial banks also underwrite bonds, and make markets in currency, interest rates, and credit-related securities, but today large commercial banks usually have an investment bank arm that is involved in the activities.

Types of loans granted by commercial banksEdit

Secured loanEdit

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral — in the event that the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain some or all of the amount originally lent to the borrower, for example, foreclosure of a home. From the creditor's perspective this is a category of debt in which a lender has been granted a portion of the bundle of rights to specified property. If the sale of the collateral does not raise enough money to pay off the debt, the creditor can often obtain a deficiency judgment against the borrower for the remaining amount. The opposite of secured debt/loan is unsecured debt, which is not connected to any specific piece of property and instead the creditor may only satisfy the debt against the borrower rather than the borrower's collateral and the borrower.


A mortgage loan is a very common type of debt instrument, used to purchase real estate. Under this arrangement, the money is used to purchase the property. Commercial banks, however, are given security - a lien on the title to the house - until the mortgage is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it.

In the past, commercial banks have not been greatly interested in real estate loans and have placed only a relatively small percentage of assets in mortgages. As their name implies, such financial institutions secured their earning primarily from commercial and consumer loans and left the major task of home financing to others. However, due to changes in banking laws and policies, commercial banks are increasingly active in home financing.

Changes in banking laws now allow commercial banks to make home mortgage loans on a more liberal basis than ever before. In acquiring mortgages on real estate, these institutions follow two main practices. First, some of the banks maintain active and well-organized departments whose primary function is to compete actively for real estate loans. In areas lacking specialized real estate financial institutions, these banks become the source for residential and farm mortgage loans. Second, the banks acquire mortgages by simply purchasing them from mortgage bankers or dealers.

In addition, dealer service companies, which were originally used to obtain car loans for permanent lenders such as commercial banks, wanted to broaden their activity beyond their local area. In recent years, however, such companies have concentrated on acquiring mobile home loans in volume for both commercial banks and savings and loan associations. Service companies obtain these loans from retail dealers, usually on a nonrecourse basis. Almost all bank/service company agreements contain a credit insurance policy that protects the lender if the consumer defaults.

Unsecured loanEdit

Unsecured loans are monetary loans that are not secured against the borrower's assets (i.e., no collateral is involved). There are small businesss unsecured loans such as credit cards and credit lines to large corporate credit lines. These may be available from financial institutions under many different guises or marketing packages:

  • bank overdrafts

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft, and the amount overdrawn is within the authorized overdraft limit, then interest is normally charged at the agreed rate. If the POSITIVE balance exceeds the agreed terms, then additional fees may be charged and higher interest rates may apply.

  • corporate bonds
  • credit card debt
  • credit facilities or lines of credit
  • personal loans

What makes a bank limited liability company

A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business.[1] The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used for instruments with a shorter maturity.) Sometimes, the term "corporate bonds" is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities and supranational organizations do not fit in either category.[clarification needed] Corporate bonds are often listed on major exchanges (bonds there are called "listed" bonds) and ECNs like Bonds.com and MarketAxess, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. However, despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized, dealer-based, over-the-counter markets. Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. Other bonds, known as convertible bonds, allow investors to convert the bond into equity. Corporate Credit spreads may alternatively be earned in exchange for default risk through the mechanism of Credit Default Swaps which give an unfunded synthetic exposure to similar risks on the same 'Reference Entities'. However, owing to quite volatile CDS 'basis' the spreads on CDS and the credit spreads on corporate bonds can be significantly different.

  • Assets and Liabilities of Commercial Banks in the United States
  • Glass-Steagall Act
  • Mortgage constant

ReferencesEdit

Further readingEdit

  • Brunner, Allan D.; Decressin, Jörg; Hardy, Daniel C. L.; Kudela, Beata (2004-06-21). Germany's Three-Pillar Banking System: Cross-Country Perspectives in Europe. International Monetary Fund. ISBN 1-58906-348-1. ISSN 0251-6365.  Abstract
  • Khambata, Dara (1996). The practice of multinational banking: macro-policy issues and key international concepts (2nd ed.). New York: Quorum Books. pp. 320. ISBN 978-0-89930-971-2. 
  • Commercial Banks directory and guidelines Commercial Banks
Last modified on 24 August 2012, at 15:09