What Is a Commercial Bank? How Commercial Banks Work

What Is a Commercial Bank?

A commercial bank is a bank that provides financial services to individuals, businesses and other organisations. Its main purpose is to provide banking services while generating a profit.

What Does a Commercial Bank Do?

Commercial banks provide a wide range of everyday financial services, including:

• Taking deposits — such as money held in current and savings accounts.
• Providing loans — including mortgages, personal loans, business loans and overdrafts.
• Processing payments — including card payments, bank transfers, direct debits and mobile payments.
• Providing foreign exchange — allowing customers and businesses to exchange currencies.
• Providing additional financial services — such as investment, wealth management and financial advice, depending on the bank.

How Does a Commercial Bank Make Money?

One of the main ways a commercial bank makes money is by earning interest on the loans and other assets it holds.

For example, suppose you place £10,000 into a bank account. That deposit becomes a liability on the bank’s balance sheet because the bank owes the money to you.

Those deposits form part of the bank’s overall funding. When a bank makes a loan, it generally creates a corresponding deposit in the borrower’s account. So the bank isn’t simply taking your particular £10,000 and handing it to someone else. The money in your account remains your money, while the bank’s lending creates a new deposit for the borrower.

The bank earns interest from borrowers while paying interest, where applicable, to depositors. The difference between the income earned on the bank’s assets and the cost of its funding is an important source of bank revenue.

Commercial banks can also generate income from fees and charges, foreign exchange services and other financial products.

Commercial Banks and the Bank of England

This distinction is important when looking at the history of the Bank of England.

A commercial bank deals directly with customers and businesses. The Bank of England, by contrast, is the UK’s central bank.

A central bank has a very different role. The Bank of England is responsible for monetary policy, issues banknotes in England and Wales, works to maintain financial stability and provides banking services to the government and parts of the financial system.

However, when the Bank of England was founded in 1694, it was not a government-owned central bank in the modern sense. It was established as a private bank with shareholders and was closely connected to government finance from the beginning.

The Bank remained privately owned for centuries. It was eventually nationalised in 1946, when ownership was transferred to the British Government.

So, in simple terms:

• Commercial bank: provides banking services to individuals and businesses.
• Central bank: manages monetary policy and plays a central role in the wider financial system.
• Bank of England today: the UK’s central bank, owned by the British Government.

This helps explain why the Bank of England’s origins are unusual. It began as a privately owned bank that was created partly to help finance the Government, but eventually became the public central bank we know today.

The distinction between commercial banks and central banks is useful when looking at how the modern banking system developed and how institutions such as the Bank of England came to play their current role.