Commercial Banks

Definition of Commercial Banks

Again:

A commercial bank is a type of financial institution that accepts

deposits, offers checking account services, makes business, personal,

and mortgage loans, and offers basic financial products like certificates

of deposit (CDs) and savings accounts to individuals and small

businesses. A commercial bank is where most people do their banking,

as opposed to an investment bank. 

The definition indicates to:

 Commercial banks accept all kinds of deposits, and therefore they

provide many opportunities for savings to invest their savings in short
investment opportunities.

 Commercial banks provide banking services to all customers of various

services, arranged, business establishments, government.

 Commercial banks grant different types of loans for many terms, short,
medium or long term, which provides various opportunities for
borrowers.
History of commercial banks:

1. English concept:
This is based on that banks have only invest in short-term
investment, this is because that banks responsible for keeping
depositors` money at all times.
2. German concept:
The main idea of this concept is that deposits have to be utilized for
investment purposes on short, mid, and long term.
This is for having real positive impact on the economic
development.
Commercial banks main objectives:

 The main objective that commercial banks seek to achieve is

profitability in light of the commitment to two main constraints:
liquidity and security, as follows:

1. Profitability:

 The main criterion for the success of managing a commercial

bank is to achieve the largest possible profit. In order for the
commercial bank to achieve profits, its revenues must exceed its
costs.
The commercial bank's revenues are
represented by the following items:
1. Credit interest on credit facilities.

2. Credit commissions for the services provided by the banks to

others.

3. Charges for services not related to the nature of the banking

business, such as charges for economic feasibility studies and
economic and financial consultations.
The commercial bank's revenues are
represented by the following items:

4. Foreign currency returns resulting from profits made from the

difference between the buying and selling price of foreign currency.

5. Other income, such as capital gains generated from the bank

selling one of its assets at a price higher than their book value,
returns on investment in securities.
The costs of the commercial bank are
represented in the following items:

1. Debit interest on deposits paid by the bank.

2. Debit commissions paid by the bank to other financial

institutions in return for providing their services.

3. General and administrative expenses.

4. Operations expenses.
Banks make profit when revenue is higher than costs
Commercial banks main objectives:

2. Liquidity:

In general, the liquidity of the asset means the ease of converting it into cash
at the maximum speed and with the least possible loss. For example, goods
are considered more liquid than real estate, and receivables are more liquid
than goods.

The concept of liquidity in banks refers to the bank's ability to fulfill its
obligations, which is represented in the ability to fulfill depositors' withdrawal
requests and respond to credit requests and any other financial requests.
Commercial banks main objectives:

 It should be noted that commercial banks cannot postpone the payment

of their dues, even for some time, like other business establishments.
Accordingly, commercial banks must maintain a liquidity that enables
them to fulfill their obligations at any moment so that the confidence
of depositors is not shaken, which leads them to withdraw their
deposits, which exposes the bank to the risk of bankruptcy, as
happened recently in the USA. Hence, liquidity is considered one of
the important constraints that the bank must take into account when
seeking the main goal of the bank, which is to achieve profitability.
Commercial banks main objectives:
3. Safety:

Commercial banks seek to provide as much security as possible for

depositors by avoiding entering or lending to high-risk projects, and
this is considered a restriction on management when it seeks to
achieve the main objective of the bank, which is to maximize the
profitability of the bank, as commercial banks cannot absorb losses
that exceed the capital owned, because any losses exceeding Owned
capital means devouring part of the depositors’ money, which may
result in bankruptcy of the bank.
Commercial banks main objectives:
3. Safety:

The bank can increase the degree of safety through diversification,

which is represented in the multiplicity of geographical areas served
by the bank, which leads to a variation of customers and their
activities, and then a variation in the sensitivity of those activities to
general economic conditions, which results in reducing the
possibility of sudden huge withdrawals that may expose the bank to
the risk of financial distress.
Matching profitability, liquidity and security:

These three main objectives are conflictive, this is because that

owners want the highest profits regardless of liquidity and security
level. While depositors prefer that a bank reserve the higher level of
liquidity as well as investing in low-risk investment, this has a
negative impact on profits.

Think about this carefully.

Matching profitability, liquidity and
security:

 For example:

Achieving a high degree of liquidity requires keeping stagnant funds that

do not generate any returns, while the bank must pay the returns due on
customer deposits. By the same logic, the commercial bank can come
close to achieving the goal of profitability by directing its money to
investments that generate a high return, but it is accompanied by a high
degree of risk, which may result in large capital losses, and therefore
safety will not be achieved.
The main activities of commercial banks:

 1. Acceptance of deposits

 Accepting deposits represents the first major activity of the

commercial bank through which the commercial bank can perform the
second function, which is lending. Deposits are the main source for the
bank to obtain funds, as deposits represent 90% of the total sources of
funds for the bank. Deposits can be divided in terms of maturity into
current deposits, term deposits, savings deposits, and frozen deposits.
The following is a brief explanation of each type of these deposits.
The main activities of commercial banks:

 2. Granting credit (loans):

 As deposits represent the sources of most of the bank's financial

needs, granting credit (lending) represents most of the bank's
operational activities. The senior management of the bank,
represented by the Board of Directors, determines the lending
policy. Commercial banks may grant secured or unsecured loans.
Characteristics that distinguish commercial
banks from other financial institutions:

 1. Commercial banks are considered the intermediary financial

institution that allows its creditors to keep their deposits in the
form of current deposits (on demand) that allow creditors to
withdraw from them by means of sukuk, and their ownership can
be transferred to a third party, and therefore banks are considered
part of the money supply, which is not available in other financial
institutions
‫األنشطة> األساسية للبنك التجارى‬

 2. Commercial banks play an important role in directly influencing

the money supply, of which current deposits constitute the greatest
part, and therefore any increase in current deposits leads to an
increase in the money supply. Although other intermediary financial
institutions accept deposits and grant loans, they do not have clear
effects on the money supply, because the money that these
institutions deal with is not created by these institutions, but
obtained from borrowing.
‫األنشطة> األساسية للبنك التجارى‬

 3- Commercial banks are considered more vulnerable to risk than

other financial institutions, and this is due to the fact that current
deposits are considered a major source of their funds, which are
characterized as deposits that are obligatory to be paid on demand
without prior notice, while other financial institutions do not
represent the majority of their funds in deposits that are
obligatory to be paid on demand, and as a result of commercial
banks being more conservative and keen to balance between
liquidity and profitability than other financial institutions so that
they can fulfill their obligations and maximize their net revenues.
The End