The Role of Commercial Banks in the Economy Most people have a rather simplistic view of banks and banking. We view banks as places where we can get credit, take out a loan, and store our money. But there is a highly regulated system that connects our banks to the financial system at large. Commercial banks are part of this system. Your understanding of the role and activities of commercial banks will enhance your understanding of the economy and the banking industry as a whole. What makes a bank a commercial bank? The different types of banks used to be easy to distinguish, but changes in the laws have made the distinctions murkier. The distinctions between commercial and investment banks have been essentially erased. While the law originally only permitted investment banks to issue securities, now investment banking arms of commercial banks can perform these activities. These are the items that distinguish a commercial bank from others: 1. Accept deposits. Your paycheck is an example of a deposit these banks accept. 2. Lend money. Banks lend money for businesses, homes, cars, and for just about any other purpose you can imagine. 3. Process payments. Most banks refrain from keeping home mortgages on the books. They sell them in packages to other entities. However, the bank retains responsibility for collecting and processing the loan payments. This is an example of payment processing. 4. Issue checks and bank drafts. Banks aren't happy when you take money out, but that's part of the business. 5. Rent out safety deposit boxes. Safety deposit boxes can be a substantial income source for a bank branch. 6. Other services. There are other services that commercial banks provide, such as: * They commonly broker insurance contracts. * They've started to provide investment advice. * They issue credit card offers to their customers. How are Commercial Banks Established? By law, commercial banks have to be formed via a highly regulated process. There are actually thousands of commercial banks, just in the U.S. alone. Seed capital is raised by an organizing group, which then establishes a management team. The location is chosen and the overall plan is delivered to regulators who review all the information and (hopefully) grant a charter for the bank. In the event that the regulators have found something unacceptable, the plan will be sent back for modification. At this point, the bank has to be operational within a year. All the equipment and real estate must be secured, staff hired, and two more regulatory inspections must be passed. While commercial banks could be privately funded, in most cases there's a public offering of shares to raise the necessary funds to pay back the initial investors. The Big Picture At the end of the day, a commercial bank is a pile of investment capital looking for a good return. Everything you can see, including the people, services, and the building exist primarily to pull in more capital. Then they utilize that capital to get the highest return. Most of us use commercial banks every day with our debit card, online banking transactions, or when making loan payments. Behind what's easily seen, a commercial bank exists to invest capital for the highest profit. Commercial banks also have investment groups that invest in securities and help businesses issue shares. While investment banks and commercial banks used to be separate entities, most investment banks are now part of the larger commercial banks. Your local commercial bank is a significant part of the financial system and the economy. A better understanding of the banking system enables you to know more about your money and how it fits in with the bigger economic picture.