What is Commercial Banking?
The banking industry is a highly specialized field. To the layman, it may appear like all banks perform the same function. However, this is not the case. There are a wide variety of departments within a bank that perform different functions. Commercial banking is one such department. In most banks, it functions like a different entity and is completely separated from its retail banking business.
In this article, we will have a closer look at what commercial banking is and how it is different as compared to retail banking.
What is Commercial Banking?
The traditional banking system revolves around the deposits and lending needs of an individual. Hence, it is called retail banking since it addresses the needs of an individual at a retail level. However, the deposits, as well as lending needs of corporations, are quite different from that of individuals. Also, in addition to deposits and lending, corporations also have other needs such as treasury management and transaction processing. This is where commercial banking comes into play. In essence, commercial banking is a system created by the banks to understand and better serve the needs of corporations. Commercial banking is also known as corporate banking in many parts of the world.
Difference Between Commercial Banking and Investment Banking
It also needs to be understood that commercial banking is not the same as investment banking. Investment banking caters to the fund-raising needs of any corporation. This means that investment banks help companies raise funds by tapping shares as well as debt markets across the world. They also help companies hedge their risks with the use of derivatives.
However, commercial banking is totally different. Commercial banking also deals with corporations. However, it is not related to fundraising. Instead, it is related to the everyday functioning of large corporations. Hence, it is related to facilities such as overdraft, short-term loans, deposits, and transaction processing.
Differences Between Retail and Commercial Banking
The commercial banking system is quite different from the retail banking system. There are some similarities between the two as well. For instance, both retail, as well as commercial banking, provide deposit and loan services. In both cases, the bank acts as an intermediary who assumes risks and makes money by charging more interest than they are paying. However, there are some vital differences between the two. Some of the important differences are as follows:
- The products and services offered by commercial banking are quite different from retail banking. Products such as commercial credit cards, overdraft loans, term loans, payroll processing, etc.
- The retail banking system is all about the number of customers. In retail banking, most banks try to increase the number of accounts that they have and derive a small profit from each account. This is not the case with commercial banking. Commercial banking, on the other hand, is more about profit margins.
Each commercial bank has a small number of customers. However, each customer provides a large volume of business to the bank. Hence, a well-managed commercial banking unit can generate more profit for the bank as compared to a retail banking unit
- Since retail banking services are provided to a large number of people, these services are highly standardized. They are like an off-the-shelf products wherein the customer has no control over the features. On the other hand, commercial banking services are highly customized. The corporations can themselves decide on the various features. Banks are very flexible while providing these services to corporations.
The Need for Commercial Banking
- Business organizations have grown into complex entities. There are many businesses that function in many countries of the world. As a result, their trade financing needs can be quite complex. They may require different types of financing in different currencies at different locations. It, therefore, makes sense for a company to consider a bank as a business partner instead of being a vendor. This is where commercial banking comes into play.
- As mentioned above, commercial banking services are not off-the-shelf services. Instead, in the case of commercial banking, a relationship manager is typically assigned to the corporation. This relationship manager studies the business of the corporation. He/she then creates tailor-made banking solutions which perfectly fit the need and budgets of the customer. The tailor-made solution is generally a combination of some off-the-shelf financial products combined with some custom-made solutions.
- From the banks point of view, commercial banking has been used in a strategic manner. Banks often try to provide their customers with the best deal when it comes to commercial banking. This puts them in a position where they have the maximum knowledge about the entitys raising operations as well. This information can then be used to sell investment banking and other advisory services to end clients. In essence, commercial banking has been used by many banks as a loss leader to build a strong relationship with a customer.
The bottom line is that commercial banking is a very complex and vast operation. The total market for commercial banking services within the United States is worth over a trillion dollars every year. Hence, it is imperative that banks pay more attention to the banking needs of their corporate partner since it can help banks improve their revenue and profitability rapidly.
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