commercial bank

What It Is

A commercial bank is a financial institution that offers checking accounts, demand deposits, business and personal loans, savings vehicles and a variety of other related financial services.

How It Works

Commercial banks are owned by shareholders and are run for a profit, which is largely obtained by lending at rates higher than they pay their depositors. Commercial banking is different from investment banking, which primarily raises money for businesses, facilitates mergers or acquisitions, and works for institutional investors.

A commercial bank must have a charter to operate, which will be issued by the federal government or by the state in which it plans to do business. States regulate and inspect state chartered banks, and the federal government regulates and inspects federally chartered banks.

In order to apply for a charter, the bank's "organizing group of founders" must provide a business plan, an overview of local zoning and business practice laws, and the names of directors and key executives. Each state has its own minimum capital requirements to issue a charter.

The organizing group is required to invest a minimum amount of its own money into the bank, making them primary shareholders. The remaining required funds will be raised by selling shares in the bank.

When a commercial bank receives a charter, it is a demonstration that the agency responsible for protecting the public from unsafe banking practices has done its job. Chartering requirements vary by the agency supplying the charter.

In some cases, a state-chartered bank is not required to be a member of the Federal Reserve System -- which allows them to borrow short-term funds from the Federal Reserve to meet reserve requirements.

If a bank requests a federal charter, however, it must become a member of the Federal Reserve System. All commercial banks must apply for deposit insurance with the FDIC, which protects depositors for up to $250,000 of losses if the bank fails.

Why It Matters

Commercial banks offer critical services that lubricate and facilitate economic activity throughout our entire financial system.

There are many alternatives to using commercial banks. Credit unions, savings and loans, and brokerage firms offer many of the services that commercial banks offer. Not all of these alternatives, however, have ATMs, accept certain checks, charge the same fees or offer competitive loans.

Source: Investing Answers