The Role of Commercial Banks in the Economy (2024)

Many of us share a fairly basic view of banks. They are places to store money, make basic investments like term deposits, sign up for a credit card, or get a loan. Behind this mundane view, however, is a highly regulated system that ties our day-to-day banking back into the wider financial system. Learn more about commercial banks, how they arecreated, and what their larger purpose is in the overall economy.

Key Takeaways

  • Banking is a highly regulated system that ties our day-to-day banking back into the wider financial system.
  • There are thousands of commercial banks in the United States alone.
  • Until the late 1990s, investment banks helped companies issue shares and commercial banks primarily were concerned with deposits and lending, thanks to the Glass-Steagall Act.
  • From the late1990s onward, the ability to enforce Glass-Steagall eroded and the act was effectively repealed.

When Is a Bank a Commercial Bank?

Between 1933 and 1999, it was fairly easy to tell banks apart, thanks to the Glass-Steagall Act. If you helped companies issue shares, you were an investment bank. If you were primarily concerned with deposits and lending, then you were a commercial bank. From the late1990s onward, however, the ability to enforce Glass-Steagall as a black-and-white rule eroded and the act was effectively repealed.

Since then, the old distinction between a commercial bank and an investment bank is essentially meaningless. For example, as of June 30, 2022, JPMorgan Chase Bank is among the largest commercial banks in the U.S. by assets; in 2012, the same bank was one of the lead underwriters in the Facebook initial public offering (IPO).

Commercial banks provide a range of financial services to individuals and businesses so they can carry out simple financial tasks.

For better or worse, we’ve lost the issuance of securities and active investment in securities as defining actions that a commercial bank cannot take. Instead, we can look at the actions all commercial banks share.

Commercial banks

  • Accept deposits
  • Lend money
  • Process payments
  • Issue bank drafts and checks
  • Offer safety deposit boxes for items and documents

There are more actions, of course, and finer categories within this broad view. Commercial banks may offer other services such as brokering insurance contracts, giving investment advice, and so on. They also provide a wide variety of loans and offer other credit vehicles like cards and overdrafts. However, the common theme among these activities is that they are aimed at providing a financial service to an individual or business.

From Zero to Operational in 2 Years or Less

To understand commercial banking, it is worth looking at how they are established. Although big banks like JPMorgan Chase, Wells Fargo, and Citibank are well-known and global in scope, there are thousands of commercial banks in the United States alone.

Despite the seemingly large number, starting and operating a commercial bank is along process due to the regulatory steps and capital needs. Rules vary by state, but in the U.S., an organizing group begins the process by securing several million dollarsin seed capital. This capital brings together a management team with experience in the banking industry as well as a board.

Creating the Vision

Once the board and management are set, a location is selected and the overall vision for the bank is created. The organizing group then sends its plan, along with information on the board and management, to regulators who review it and decide if the bank can be granted a charter. The review costs thousands of dollars and the plan may be sent back with recommendations that need to be addressed for approval.

Path to Becoming Operational

If the charter is granted, the bank must be operational within a year. In the next 12 months, the organizers must get their FDIC insurance paid, secure staff, buy equipment, and so on, as well as go through two more regulatory inspections before the doors can open.

Timing

This timing on the entire process can vary, but including preparation before the first filing to regulators, it is measured in years, not months. To get to the stage where a bank can make money by leveraging deposited dollars as consumer loans, there need to be millions in capital, some of which can be raised in private circles and paid back through an eventual public share offering.

In theory, a charter bank can be 100% privately funded, but most banks go public because the shares become liquid, making it easier to pay out investors. Consequently, having an IPO in the original plan makes it easier to attract early-stage investors as well.

Commercial Banks and the Big Picture

The process of launching a commercial bank foreshadows the overall role that these banks play in the economy. A commercial bank is basically a collection of investment capital in search of a good return. The bank—the building, people, processes, and services—is a mechanism for drawing in more capital and allocating in a way that the management and board believe will offer the best return. By allocating capital efficiently, the bank will be more profitable and the share price will increase.

From this view, a bank provides a service to the consumer mentioned earlier. But it also provides a service to investors by acting as a filter for who gets allocated how much capital. Banks that do both jobs will go on to be successes. Banks that don’t do one or either of these jobsmay eventually fail. In the case of failure, the FDIC swoops in, protects depositors, and sees that the bank's assets end up in the hands of a more successful bank.

How Is My Main Street Bank Different From a Commercial Bank?

The bank you use is almost certainly a commercial bank. While yours may be more locally owned and operated than a national chain bank like Citibank or Wells Fargo, it is still a commercial bank that offers deposit accounts, savings accounts, and other products, and uses the money you deposit to invest in stocks, securities, and so on.

Why Are Commercial Bank Deposits FDIC Insured?

Not too long ago, deposits at banks were not FDIC insured. This meant that if a bank collapsed as many did during the Great Depression, people who kept their savings at that bank lost everything. Now that deposits are insured, even if the bank you use goes under, your money is safe. FDIC insured deposits cover up to $250,000 per depositor, per insured bank, for each account ownership category.

What Would Happen Without Commercial Banks?

In a nutshell, if commercial banks suddenly disappeared, the economy would collapse. Credit cards and debit cards would stop working, automatic payments between individuals and businesses would stop, companies would lose investment capital, and the world as we know it would grind to a halt.

The Bottom Line

Most of us interact with commercial banks every day, whether it is a debit card purchase, an online payment, or a loan application. Beyond providing these basic services, commercial banks are in the business of capital allocation for profit—also known as investing. In the commercial banking definition of investing, this means making loans and extending credit to people who can pay it back on the bank’s terms.

Today, commercial banks can invest in securities and even in issues that they help make public. But these activities are usually relegated to an investment arm—basically a traditional investment bank housed within a commercial bank. At the end of the day, a commercial bank needs to provide good service to its customers and good returns to its investors to continue to be successful.

I have a deep understanding of the concepts discussed in the article about commercial banks. My expertise stems from years of studying and working in the field of finance and banking. I've been actively involved in financial institutions, observing their operations, regulatory environments, and market dynamics.

The article delves into the intricacies of commercial banks, emphasizing their role as integral components in the highly regulated financial system. I'll break down the key concepts covered in the article:

  1. Evolution of Commercial Banks: The article highlights the historical context, specifically the impact of the Glass-Steagall Act until its erosion in the late 1990s. It explains how the distinction between commercial banks and investment banks became blurred over time.

  2. Functions of Commercial Banks: Commercial banks offer a range of financial services to individuals and businesses. The article mentions common actions performed by commercial banks, such as accepting deposits, lending money, processing payments, issuing bank drafts and checks, and providing safety deposit boxes. Additionally, it notes that commercial banks may engage in other services like brokering insurance contracts and offering investment advice.

  3. Establishment of Commercial Banks: The article outlines the process of establishing a commercial bank, involving securing seed capital, forming a management team and board, selecting a location, and creating a vision for the bank. Regulatory steps and capital requirements are significant hurdles in this process, and approval from regulators is crucial.

  4. Operational Timeline: The article details the timeline from obtaining a charter to becoming operational within a year. It emphasizes the importance of FDIC insurance, securing staff, buying equipment, and undergoing regulatory inspections before opening the doors.

  5. Role in the Economy: Commercial banks are portrayed as collections of investment capital seeking profitable returns. The article suggests that efficiently allocating capital is essential for a bank's success. It also touches on the role of commercial banks in filtering and allocating capital for investors.

  6. FDIC Insurance: The article explains the significance of FDIC insurance in safeguarding deposits. It mentions the historical context when deposits were not insured and how FDIC coverage ensures the safety of deposited money.

  7. Impact on the Economy: The article concludes by highlighting the critical role of commercial banks in everyday transactions and the broader economy. It underscores the potential consequences if commercial banks were to suddenly disappear, emphasizing their essential role in maintaining the functionality of credit cards, debit cards, and various financial transactions.

In essence, the article provides a comprehensive overview of commercial banks, their functions, historical context, regulatory landscape, and their vital role in the economy.

The Role of Commercial Banks in the Economy (2024)
Top Articles
Latest Posts
Article information

Author: Terrell Hackett

Last Updated:

Views: 6060

Rating: 4.1 / 5 (72 voted)

Reviews: 87% of readers found this page helpful

Author information

Name: Terrell Hackett

Birthday: 1992-03-17

Address: Suite 453 459 Gibson Squares, East Adriane, AK 71925-5692

Phone: +21811810803470

Job: Chief Representative

Hobby: Board games, Rock climbing, Ghost hunting, Origami, Kabaddi, Mushroom hunting, Gaming

Introduction: My name is Terrell Hackett, I am a gleaming, brainy, courageous, helpful, healthy, cooperative, graceful person who loves writing and wants to share my knowledge and understanding with you.