Commercial Banking

"Neither a borrower nor a lender be," advised Polonius to Laertes. Good thing commercial banks don't pay attention! Commercial banks differ from investment banks because, in general, they are "lenders" rather than "bankers." In other words, they loan money, rather than raise it. You can go to the local branch office of your bank and apply for a loan to start a business, but you can't ask them to find investors to fund it.

We'll take your money

A commercial bank may legally take deposits from consumers for checking and savings accounts. The federal government provides insurance guarantees on these deposits through the Federal Deposit Insurance Corporation (the FDIC) on amounts up to $100,000. To get FDIC guarantees, commercial banks must follow a myriad of regulations, including the limitation that they cannot sell stock. Investment banks cannot take deposits and therefore are not subject to banking laws.

The lending train

The typical commercial banking process is fairly straightforward. You deposit money into your bank, and the bank loans that money to consumers and companies in need of capital (cash). Consumers might borrow to buy a house, finance a car or pay for a wedding. Companies borrow to finance growth or to meet immediate cash needs. Companies that borrow from commercial banks can range in size from the dry cleaner on the corner to a multinational conglomerate.

Syndicates and the Fed

Commercial banks loan out large amounts of money to businesses (sometimes banding together with other banks for especially huge loans to issue what is called a "syndicated loan"), but traditionally could not raise money for clients by managing stock or bond offerings to the public. Commercial banks lend out money at interest rates that are largely determined by the Federal Reserve Board (the Fed). Along with lending money that they have on deposit from clients, commercial banks lend out money that they have received from the Fed. The Fed loans out money to commercial banks, which in turn lends it to its customers in a variety of forms, such as standard loans and mortgages.

Making money by moving money

Take a moment to consider how a bank makes its money. On most loans, commercial banks in the U.S. earn from 5 to 14 percent interest. Banks pay out much less on deposits, the money that it uses to make loans. Individuals earn about 1 percent (if anything) on a checking account and perhaps 2 to 3 percent on a savings account. Commercial banks thus make a tremendous amount of money by taking advantage of the difference between their cost of funds and their return on funds loaned.