Commercial bank

Definition

A commercial bank is a financial institution that accepts deposits from the public, offers checking and savings accounts, and provides loans to individuals and businesses. These banks play a vital role in the economy by facilitating transactions and providing access to credit, thereby influencing the overall money supply and economic activity.

5 Must Know Facts For Your Next Test

1. Commercial banks are primarily profit-oriented institutions that earn revenue through interest on loans and fees for services provided.
2. They offer a variety of financial products including personal loans, mortgages, credit cards, and business loans.
3. Commercial banks play a key role in the money creation process through fractional reserve banking, allowing them to lend more than they hold in deposits.
4. They are subject to regulation and oversight by government agencies to ensure stability in the financial system and protect consumers.
5. The central bank influences commercial banks' operations through monetary policy tools such as adjusting interest rates and reserve requirements.

Review Questions

• How do commercial banks contribute to the money supply and overall economic activity?
  • Commercial banks contribute to the money supply through the process of fractional reserve banking, where they are able to lend out a portion of the deposits they receive. This lending creates new money in the economy, as borrowers spend their loans, which then gets deposited back into the banking system. This cycle of deposit and lending amplifies the money supply, stimulating economic activity as businesses invest and consumers spend.
• Discuss the relationship between commercial banks and the central bank in terms of monetary policy implementation.
  • Commercial banks are critical intermediaries in the implementation of monetary policy by the central bank. When the central bank adjusts interest rates or changes reserve requirements, it directly affects how much commercial banks can lend and at what cost. For example, lower interest rates make borrowing cheaper for consumers and businesses, leading to increased lending from commercial banks, which can spur economic growth.
• Evaluate how changes in regulations for commercial banks might impact their operations and the broader economy.
  • Changes in regulations for commercial banks can significantly impact their operations and the broader economy. Stricter regulations may limit how much they can lend, reducing their ability to create money and potentially slowing economic growth. Conversely, easing regulations could encourage more lending and investment but might also increase risks of financial instability if banks take on excessive risk. The balance of these regulations is crucial for maintaining a stable financial system while promoting economic growth.

Related terms

Deposits: Funds that individuals or businesses place into a bank account, which can be withdrawn or used for transactions.

Loans:

Money that is borrowed from a bank, which must be paid back with interest over a specified period.

Reserve Requirement:

The minimum amount of reserves that a commercial bank must hold against its deposit liabilities, set by the central bank.