Courses
Courses for Kids
Free study material
Offline Centres
More
Store Icon
Store

Commercial Banks and Financial Institutions: Role and Importance

Reviewed by:
ffImage
hightlight icon
highlight icon
highlight icon
share icon
copy icon
SearchIcon

Banking Financial Institutions

In today's financial services the financial institutions are created to provide a wide variety of deposits, lending and deposit procedures are required to be carried out to facilitate the individuals, businesses or the both. Financial Institutions focus on providing the services and accounts for the general public, while others serve specific consumers with specialised offerings.

Financial institutions are developed to appropriate the needs of the society and thus it is important to understand the difference between the types of institutions which will be more appropriate to serve their individual needs.

There are different types of financial institutions from non-banking ones to banking ones and they are as follows: 

  • Central banks: These are responsible for overseeing as well as managing all the other banks. No individual consumer has direct contact with a central bank because other big institutions tend to work with the Federal Reserve Bank for providing the general public with various products and services. 

  • Retail and commercial banks: These tend to offer products and services like savings accounts, checking accounts, personal loans, mortgage loans, credit cards, etc. 

  • Credit unions: A credit union is owned by their members and they tend to operate for their personal benefit. 

  • Internet banks: These are further classified as digital banks and neo banks, wherein the former is online-only platforms and the latter are strictly digital native banks, holding no affiliation with any other bank but themselves. 

  • Investment banks and companies: These are known to help individuals and businesses to raise their capital through the issuance of securities. 

  • Savings and loan associations: Individuals take the help of savings and loan associations for mortgage lending, personal loans, and deposit accounts. And these financial institutions don’t lend more than 20% when it comes to businesses. 

  • Brokerage firms: This helps both businesses as well as individuals to buy and sell securities if there are any available investors. 

  • Insurance companies: An insurance company is one that helps out an individual to transfer the risk of loss. 

  • Mortgage companies: Most mortgage companies are focused on serving the individual consumer market. However, there are a chosen few whose lending options are specialised in commercial real estate only.


The Difference Between a Bank and a Financial Institution 


Commercial Bank

Banks, more precisely termed as retail or the commercial banks, fall under the category known as the banking financial institutions. A bank is actually a financial intermediary, they act as a middleman between the suppliers of funds or the depositors and the borrowers. The major task of the bank is to accept the deposits and use the funds which will later on to offer loans to the customers. Yet another duty of a bank is to act as a payment agent, that is done by offering a payment. A bank makes money by investing the deposits in the financial securities and assets, but they mostly make money by lending the funds further to its customers. The primary reasons that the public deposits the money in banks are for convenience, safety and to gain interest income.


Financial Institutions

While financial institutions include all the categories of banks – banks, investment banks, insurance companies, investment funds and other categories of money sector corporates. Except for banks, all are known as non-banking financial institutions who provide financial services to the public but that differs from those of a bank. 

The main difference between other financial institutions and banks is that other financial institutions cannot accept deposits into savings and demand deposit accounts, while the same is the core business for banks.


Advantages of a Commercial Bank

The Advantages of Commercial Banks are as follows:

 

1. Location

The commercial banks are large companies thus, these companies are to be found all over the town, state or country. Some of these commercial banks have businesses in other foreign countries as well and hence their location facilitates the people. Commercial banks are literally located anywhere even inside of malls or retail stores, the ability to access money and account information can be done from almost any location.

2. Discounts

Commercial banks also serve the customers with low prices. Like wholesale companies, the commercial banks buy in bulk and sell to the public at a discount. These discounts may offer free checking, no fees while opening savings or checking accounts. They also provide the customers with low interest rates on real estate loans.

3. Product Offerings

Commercial banks offer more products and service offerings. Commercial banks offer every banking service which a small banking company would offer also CDs, investment accounts, commercial real estate loans, even mortgage plans and the option to have a debit card, credit card or both.

4. Online Banking

With the increasing growth of technology, commercial banks also offer their services online. Customers can keep track of their checking and savings accounts, transfer money to either of their accounts, also pay bills or apply for a loan over the internet itself. 

5. Electronic Banking

By using the 24-hour ATMs, customers can withdraw or deposit money and also can access their account information or transfer their funds.


Limitations of Financial Services 

The limitations with these financial institutions are as follows:

  • Restriction on dividend payment which is imposed on the powers of the borrowing capacity of financial institutions.

  • These institutions come under the government criteria hence, they follow rigid rules for granting these loans. 

  • Too many formalities are attached which is indeed time consuming. 

  • Financial institutions have their nominees on the Board of Directors of the borrowing company thereby restricting the powers of the company to borrow funds.

FAQs on Commercial Banks and Financial Institutions: Role and Importance

1. What is a financial institution? Discuss the various types of financial institutions?

A financial institution is developed to cater to the needs of society as a whole. Most financial institutions tend to focus on providing both services as well as accounts to the general public whereas others are set on providing specialised offers to a specific set of consumers. The different types of financial institutions include: 

  • Commercial and retail banks

  • Central banks

  • Internet banks

  • Credit unions

  • Investment banks and companies

  • Brokerage firms

  • Savings and loan association

  • Mortgage companies

  • Insurance companies 

2. What is a Commercial Bank?

Commercial Banks refers to that financial institution who accepts deposits, does checking account services, makes various loans arrangements and offers other financial product and savings accounts to individuals and other small businesses. 

A commercial bank is a place where most people do their banking activities. Commercial banks make money by providing and earning interest from the loans they provide such as mortgages, auto loans, business loans etc.

3. What is a Savings Account and Checking Account?

A savings account is a deposit account which carries an interest, this is held at a bank or other financial institution. These accounts may pay a modest interest rate but their safety and reliability make them an attraction.


A checking account is also a deposit account which is held at a financial institution that allows withdrawals and deposits. They are also called demand accounts or transactional accounts.

4. What are CDs?

A certificate of deposit abbreviated as CD is a product that is offered by banks and credit unions which provides an interest rate premium in exchange for the customer agreeing to leave a lump-sum deposit, till it matures for a predetermined period of time.

5. What are the advantages/benefits that commercial banks tend to provide?

There are a number of advantages associated with commercial banks and they are as follows: 

  • You can find commercial banks almost anywhere in a particular town, state, or country as these are large operating companies. This is why it becomes very easy to access money and account information from any location one wishes to. 

  • These tend to offer a plethora of products and services like commercial real-estate loans, CDs, mortgage plans, investment accounts, etc. 

  • Commercial banks also offer their abundant services through online modes. 

  • Electronic banking is yet another facility provided by these banks; 24-hour ATM services make withdrawing or depositing money a hassle-free process. 

6. Are there any limitations to commercial banking? If so, what are its drawbacks?

Some of the drawbacks associated with commercial banks are as follows: 

  • Commercial banks tend to be more expensive than traditional bank accounts. 

  • These have a stringent set of guidelines when it comes to the opening lines of credits, thereby rendering them as not the best options for businesses. 

  • Even in the case of granting a loan, commercial banks might set up certain tough conditions for the whole process. 

  • The entire process of securing funds from a commercial bank is quite a time-consuming affair.

7. Define a CD. How does it work?

A CD, or also commonly known as a certificate of deposit, is a simple yet popular savings tool that banks and credit unions tend to offer. An individual who decides to purchase this certificate is supposed to leave a specific amount of money for a specific length of time. And in exchange, the bank pays the individual a predetermined rate of interest along with guaranteeing them the repayment of the same at the end of the time period. This is a great and helpful tool as it ensures security as well as higher returns.

8. What are the drawbacks of financial institutions? 

Although financial institutions are known to serve the general public by catering to their needs and interests, there are certain limitations to these institutions too. They are as follows:

  • As financial institutions fall under the criteria of the government, their rules for granting loans are often quite rigid and difficult to fulfil. 

  • Certain restrictions on the dividend payments are imposed on the borrowing capacity of these institutions. 

  • There is also a systematic risk associated with financial institutions at times, i.e, the risk of asset value change that is associated with certain systematic factors.