What Are the Functions of a Commercial Bank?

What Are the Functions of a Commercial Bank?

Commercial banks are responsible for adding customer deposits in a safe and liquid form and lending the proceeds to worthy commercial, industrial, governmental and nonprofit institutions. Commercial banks also provide market making activities in municipal, government and corporate bonds. Banks provide consulting and advisory services to customers as well as safekeeping and trust services.

The Lending Function

Commercial banks provide important services as financial intermediaries. Financial intermediaries collect funds from customers seeking safe, liquid and secure investment opportunities. These monies in turn are invested in higher yielding credit borrowers who must meet stringent credit checks. The movement from collector to lender provides an efficient method of moving cash to more efficient usage. The difference between a bank's cost of funds and the rate at which they lend is called the spread.

Loan Creation for Corporate and Individual Customers

Commercial and industrial loan creation is by far the most important function of the banking industry. Loans are given, with proper security, for growth, to aid in seasonal cash needs, for plant and equipment and for the financing of receivables. The bulk of a bank's profits comes from the spread minus the cost of bank operations and loan losses. Regulatory control of banks closely monitors lending patterns and loan loss provisions.

Trust Functions

Commercial banks provide investment advice for investors. Investors can be guided to mutual funds or direct investment by bank professionals. Banking specialists can invest in stocks, bonds, preferred stocks and futures. The bank can hold all investment securities as custodian as well as offer safety deposit boxes, provide letters of credit for investment opportunities, and act as trustee for wills and investment funds.

The Bank Portfolio

Banks segregate their loan portfolio by commercial lending, individual lending, and Treasury lending. Banks do not buy stock for their own account. Rarely will a bank own publicly traded corporate bonds, preferring instead to own private company debt. The portfolio is theoretically divided into two parts: portfolio for sale and portfolio for investment. Portfolio for sale will own Treasury bonds in expectation of trading the securities for short-term profits. Portfolio for investment will own securities for income and long-term capital gain.

The Trading Function

Commercial banks are allowed to act as market makers for municipal bond, United States Treasury bonds and corporate bonds. These operations are separate from portfolio operations that operate for the bank's trading position rather than for customers. Market making activities allow the banks to offer consulting, advisory and technical direction to issuers. It allows the banks to participate in underwriting securities and selling them to institutional and individual accounts.

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