How Commercial Banking Works

How Commercial Banking Works

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Financial intermediation is the primary economic activity of a commercial bank. In other words, it uses deposits from the general public to fund the granting of credits in order to make a profit. The interest rate these banks charge for the financing they provide allows them to make money. As a result, they not only pay back the money they borrowed but also earn extra money. Savings accounts and current accounts are typically opened and maintained by commercial banks. Customers deposit money into these products in order to secure their funds and earn a little return. A country's economy depends heavily on commercial banks. They help generate market capital and liquidity while providing consumers with necessary banking services.

Commercial banks contribute to the development of credit, which boosts consumer spending, manufacturing, and employment. The RBI in India, the nation's central bank, imposes stringent regulations on these banks. For instance, central banks impose reserve requirements on commercial banks, which implies that in the event of a sudden rush to withdraw money from the general public, the commercial banks would be required to retain a specific percentage of their consumer deposits at the central bank. These organisations support healthy markets and, if their power is effectively wielded, they can encourage growth that will enable more people to access basic services and consumer products. Commercial banks offer a variety of diversified services in addition to their expertise in providing short-term credit to firms, including:

Deposit Accounts - Like individuals, businesses too require checking and savings accounts. Savings accounts can be used to store cash reserves and earn interest, whilst checking accounts assist businesses in making payments to suppliers and employees.

Loans - Companies need money to run and expand, but if they're just starting out or have assets connected to pricey inventory or equipment, they may need additional money for large acquisitions. Commercial banks play this role by providing loans to firms so they may buy the materials, property, and vehicles required for operations.

Credit Lines - Similar to a small business credit card, a line of credit offers short-term finance for a variety of business costs. When a company wants to pay its employees but is still waiting for customers to pay for recently shipped orders, for instance, a line of credit from a commercial bank can help offer an infusion of cash while waiting for receivables to come in.

Letters of Credit - A company can obtain this document from a bank as proof of its capacity to pay for goods and services. 4 Trading with clients and suppliers abroad is challenging and often dangerous. A letter of credit can improve the chances of a successful transaction when firms don't know the other party or the party is in a foreign nation with distinct laws.

Locker Facilities - Lockboxes can be useful if firms need to efficiently manage huge volumes of payments. Customers send checks to post offices that a bank has established up nearby, and the bank transfers the money into the company's account. Businesses can receive and deposit checks more rapidly if they accept payments in this manner.

Processing of Transactions and Payments - Businesses may need to receive payments from clients in a variety of ways, just like people do. Credit cards, electronic checks, and even paper checks are popular payment methods among customers. Banks contribute to this and can assist businesses in reducing the risk of chargebacks and fraudulent payments.

Foreign Exchange - Businesses that operate abroad and take or spend money may have to deal with local currencies. Commercial banks assist them in currency conversion and risk management.

Financial Trading - Investment banking is a division of many commercial banks that assists companies with infrequent but significant financial transactions. This function of a Commercial Bank, for instance, can be helpful if a corporation wants to "go public," sell a significant amount of debt, or employ other techniques to fund an expansion.