What Is Commercial Banking?

Definition and Overview of Banking for Businesses

Access to Funds

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Commercial banks focus on products and services that are specifically designed for businesses, such as loans, credit cards, deposit accounts, and lines of credit.

Commercial banks can help small businesses through a corporate-banking arm as well as large enterprises through an investment-banking arm. They might also work with individual consumers, serving additionally as a retail bank.

Understanding what commercial banking offers can help you choose the right bank, products, and services for your business needs.

If your retail bank also acts as a commercial bank, you can hold business deposits at the same bank for added convenience. But if you run a small business, even as a sole proprietor, it’s a good idea to open separate accounts for your business and personal needs.

Basics of Commercial Banking

Since these banks are typically stock corporations, their aim to make a profit for their shareholders. The way they typically do this is through what is known as financial intermediation, whereby savers who are willing to hold their deposits with the bank are matched with borrowers who need loans.

To facilitate the movement of money between savers and borrowers, commercial banks receive customer deposits, place them in different types of accounts, extend loans with interest on those deposits to businesses and individuals, and pay interest to borrowers on the deposits.

Although the interest paid to borrowers represents a liability for commercial banks, these banks typically loan funds at higher interest rates than the rates they pay to borrowers, which allows them to turn over a profit.

Commercial Banking Services

Although these banks specialize in extending short-term credit to businesses, they provide a number of diverse offerings:

  • Deposit accounts: Businesses, like individuals, need checking and savings accounts. Checking accounts help firms make payments to suppliers and employees, while savings accounts can hold cash reserves and earn interest. 
  • Loans: Businesses need money to operate and grow. But if they're just starting out, or their assets are tied up in inventory or expensive equipment, they may require additional funds for big purchases. Commercial banks fill this role, extending loans to help businesses purchase supplies, real estate, and vehicles that are necessary for operations.
  • Lines of credit: This is similar to a small business credit card and provides short-term funding for various business expenses. A line of credit from a commercial bank can help provide an infusion of cash while waiting for receivables to come in—when a business needs to pay its employees but is still waiting for customer payments for recently shipped orders, for example.
  • Letters of credit: This is a document that a business that can secure from a bank to vouch for its ability to pay for goods or services. Trading with customers and suppliers overseas is complicated and can be risky. When businesses don’t know who they’re dealing with, or the other person is in a different country with different laws, a letter of credit can increase the likelihood of a successful transaction.
  • Lockbox services: If businesses need to efficiently handle payments in large volumes, lockboxes can help. Customers mail payments to a post office box set up by a bank at nearby locations, and the bank moves the funds into the business’ account. By accepting payments this way, firms can receive and deposits checks more quickly.
  • Payment and transaction processing: Just like individuals, businesses may need to accept payments from customers in a variety of ways. Customers like to pay with credit cards, electronic checks, and even paper checks. Banks help make this happen and can also help businesses manage their risks of fraudulent payments and chargebacks.
  • Foreign exchange: When businesses operate overseas by accepting money or spending it, they might need to handle local currencies. Commercial banks help them convert money and manage the risk of changing currency prices.
  • Investment banking: Many commercial banks have an investment-banking arm that helps businesses carry out less frequent, major financial transactions. For example, if a business wants to “go public,” sell a large amount of debt, or use other methods to fund an expansion, this function of a commercial bank can help.

New business owners typically must personally guarantee, or agree to be responsible for, business loans unless the firm owns assets that it can pledge as collateral.

Benefits of a Commercial Bank Account

Even if you have a small, home-based business, opening a business account offers several advantages:

  • It separates your business and personal finances. Having a different account for commercial banking can help with day-to-day bookkeeping, limit your personal liability in the event of a legal claim against your business, and prove useful when it's time to file your tax return. You'll know exactly which activities were personal and which were related to your business.
  • It lends credibility to your company. Customers, for example, might be more comfortable making payments to a business than to you, personally, for a product or service.
  • It helps your firm foot the bill for large expenses. A loan, line of credit, or credit card from a commercial bank can provide your business with capital that you may not be able to fund on your own.
  • It can help build business credit. Opening a line of credit, for example, can help build your business credit profile and secure better lending terms in the future.

Business accounts might not have the same consumer protection as most personal accounts. If thieves drain your account, federal law might not require banks to reimburse you.

The Bottom Line

Commercial banking provides businesses with similar offerings that are available to consumers, plus additional services that uniquely cater to businesses. But even if you don’t label your activities as “business,” you might need to work with a commercial bank.

For example, if you want to purchase real estate to use as a rental, traditional lenders might not be able to fund your loan. Commercial loans may help you buy office space or other properties that don’t fit the mold of an owner-occupied property. This makes commercial banks a one-stop shop of sorts for the varied financial needs of businesses small and large.

Article Sources

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