Commercial Banking

The roots of modern banking date back to the sixth century B.C. The first banking operations existed in Mesopotamia, Ancient Greece and the Mediterranean region, where goldsmith bankers originated to facilitate trade by providing loans to merchants.

There are various actors in the economy: businesses, households, government, foreigners.

Depository institutions include commercial banks, savings banks and savings and loans associations as well as credit unions.

Non-depository institutions include insurance companies, pension funds, mutual funds, finance companies and investment banks.

Commercial banks are financial firms, which collect deposits from savers and channel those deposits to borrowers in the form of loans.

Commercial banks create money or credit against deposits through the money multiplier.

We can define money as anything that economic actors use as a payment mechanism in economic transactions or debt settlement.

Business lines in the commercial banking industry can be classified as Retail Banking and Corporate Banking.

Retail banking mainly covers individuals and includes financial services such as credit cards and consumer loans as well as mortgages.  It also covers very small enterprises, such as those of physicians or home services. 

Corporate banking transactions cover large businesses and include financial services like overnight loans, short term loans, revolving facilities, term loans, committed lines of credit or large commercial and industrial loans.

Excess reserves are reserves held by commercial banks above the reserves held to meet reserve requirements of the Central Bank.

An asset-backed security (ABS) is a financial security such as a bond or note, which is collateralized by a pool of assets such as loans, leases, credit card debt, royalties, or receivables.

Controllable liabilities include large denomination time deposits and short-term borrowings in the interbank money market.

The interbank money market is a market, in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate.

The most important source of funds and liability item for commercial banks is deposits.

The most important assets of a commercial bank can be categorized as follows:

• Loans
• Securities
• Cash Assets
• Fixed Assets

Loans include commercial loans, consumer loans and short-term loans extended in the interbank market or loans extended through repurchase agreements.

These credits are self-liquidating working capital loans, which can be withdrawn and repaid at different points of time within a certain limit.

Risk management in commercial banks involve the following processes:
• Identification of risks
• Measurement of risks
• Pricing of risks
• Control of risks

The most important types of risks, which commercial banks face, can be classified as follows:
• Interest rate risk, which arises from the different maturity structure of the banks’ assets and liabilities.
• Liquidity risk, which is the risk that a bank may not be able to meet its cash needs by selling assets or raising funds at a reasonable cost.
• Credit risk, which is the risk of changes in the economic value of the bank’s assets due to unexpected changes in the creditworthiness of counterparties.
• Operational risk, which includes the risk of damages caused by human and technological factors.