Banks generally fall into two categories: commercial and investment. Although they're both called banks, they make money in very different ways. While investment banks underwrite securities and help their clients play the stock market, commercial banks collect deposits and lend money to consumers and businesses.
Basic Activities of Commercial Banking
If you have a checking or savings account at a bank in your town, you're already familiar with commercial banking. Commercial banks accept deposits from businesses and individuals and use those deposits to extend credit to other customers in the form of loans and credit cards. Most of a commercial bank's revenue comes from interest paid on loans and credit card debt. The banks you see on the streets of most cities, like Bank of America and Wells Fargo, are almost always commercial banks. The big Wall Street banks like Goldman Sachs or Merrill Lynch are investment banks.
Risks of Commercial Banking
For most customers, commercial banking is virtually risk free. Before the Great Depression, it was possible for banks to gamble with their customers' money by making risky loans. If the borrowers didn't pay the money back, the bank could go bankrupt and its depositors could lose their money. During the Great Depression, however, Congress created the Federal Deposit Insurance Corporation. The FDIC now ensures commercial bank deposits up to $250,000. Even if your bank gets robbed or the CEO steals all the deposits and flees the country, the government will return your deposit to you. Any money in the bank past the $250,000 limit, however, is still technically at risk.
Advantages of Commercial Banking
Commercial banks offer two big benefits to their customers: safety and convenience. Thanks to FDIC, commercial banking offers everyday people a safe way to store their money. If you keep your life savings under a pillow, you'll be broke if your house burns down or is robbed. If you keep that money in a bank, you'll be able to get it no matter what. Additionally, commercial banks offer convenience for their customers. Automated teller machines and local branch offices allow customers to access their cash from anywhere in the nation and much of the world.
Repeal of Glass-Steagall
For a long time, U.S. law drew a sharp line between commercial banks and investment banks. Commercial banks weren't allowed to play the stock market or trade bonds like the big investment banks did, and investment banks weren't in the business of home loans or consumer credit. That changed with the repeal of the Glass-Steagall Act in 1999. Since the repeal, commercial and investment banks are distinguished more by traditional functions than law.
- Federal Deposit Insurance Corporation. “Deposit Insurance FAQs.” Accessed May 22, 2020.
- Board of Governors of the Federal Reserve System. “What is the purpose of the Federal Reserve System?” Accessed May 22, 2020.
- U.S. Securities and Exchange Commission. “What We Do.” Accessed May 22, 2020.
- Federal Reserve History. “Banking Act of 1933 (Glass-Steagall).” Accessed May 22, 2020.
- Federal Reserve History. “Financial Services Modernization Act of 1999, commonly called Gramm-Leach-Bliley.” Accessed May 22, 2020.
Nick Robinson is a writer, instructor and graduate student. Before deciding to pursue an advanced degree, he worked as a teacher and administrator at three different colleges and universities, and as an education coach for Inside Track. Most of Robinson's writing centers on education and travel.