Commercial banks and thrifts offer various services to their customers. These services fall into three major categories: deposits, loans, and cash management services.
There are four major types of deposits: demand deposits, savings deposits, hybrid checking/savings deposits, and time deposits. What distinguishes one type from another are the conditions under which the deposited funds may be withdrawn.
A demand deposit is a deposit that can be withdrawn on demand at any time and in any amount up to the full amount of the deposit. The most common example of a demand deposit is a checking account. Money orders and traveller’s checks are also technically demanded deposits. Checking accounts are also considered transaction accounts in that payments can be made to third parties—that is, to someone other than the depositor or the bank itself—via check, telephone, or other authorized transfer instruction. Checking accounts are popular because as demand deposits they provide perfect liquidity (immediate access to cash) and as transaction accounts, they can be transferred to a third party as payment for goods or services. As such, they function like money.
Savings accounts pay interest to the depositor but have no specific maturity date on which the funds need to be withdrawn or reinvested. Any amount can be withdrawn from a savings account up to the amount deposited. Under normal circumstances, customers can withdraw their money from a savings account simply by presenting their “passbook” or by using their automated teller machine (ATM) card. Savings accounts are highly liquid. They are different from demand deposits, however, because depositors cannot write checks against regular savings accounts. Savings accounts cannot be used directly as money to purchase goods or services.
The hybrid savings and checking account allows customers to earn interest on the account and write checks against the account. These are called either negotiable order of withdrawal (NOW) accounts, or money market deposit accounts, which are savings accounts that allow a maximum of three third-party transfers each month.
Time deposits are deposits on which the depositor and the bank have agreed that the money will not be withdrawn without substantial penalty to the depositor before a specific date. These are frequently called certificates of deposits (CDs). Because of a substantial early withdrawal penalty, time deposits are not as liquid as demand or savings deposits nor can depositors write checks against them. Time deposits also typically require a minimum deposit amount.
Banks and thrifts make three types of loans: commercial and industrial loans, consumer loans, and mortgage loans. Commercial and industrial loans are loans to businesses or industrial firms. These are primarily short-term working capital loans (loans to finance the purchase of material or labour) or transaction or longer-term loans (loans to purchase machines and equipment). Most commercial banks offer a variable rate on these loans, which means that the interest rate can change over the course of the loan. Whether a bank will make a loan or not depends on the credit and loan history of the borrower, the borrower’s ability to make scheduled loan payments, the amount of capital the borrower has invested in the business, the condition of the economy, and the value of the collateral the borrower pledges to give the bank if the loan payments are not made.
Consumer loans are loans for consumers to purchase goods or services. There are two types of consumer loans: closed-end credit and open-end credit.
Closed-end credit loans are loans for a fixed amount of money, for a fixed period of time (usually not more than five years), and for a fixed purpose (for example, to buy a car). Most closed-end loans are called instalment loans because they must be repaid in equal monthly instalments. The item purchased by the consumer serves as collateral for the loan. For example, if the consumer fails to make payments on an automobile, the bank can recoup the cost of its loan by taking ownership of the car.
Open-end credit loans are loans for variable amounts of money up to a set limit. Unlike closed-end loans, open-end credit does not require a borrower to specify the purpose of the loan and the lender cannot foreclose on the loan. Credit cards are an example of open-end credit. Most open-end loans carry fixed interest rates–that is, the rate does not vary over the term of the loan. Open-end loans require no collateral, but interest rates or other penalties or fees may be charged—for example, if credit card charges are not paid in full, interest is charged, or if payment is late, a fee is charged to the borrower. Open-end credit interest rates usually exceed closed-end rates because open-end loans are not backed by collateral.
Mortgage loans or real estate loans are loans used to purchase land or buildings such as houses or factories. These are typically long-term loans and the interest rate charged can be either a variable or a fixed rate for the term of the loan, which often ranges from 15 to 30 years. The land and buildings purchased to serve as the collateral for the loan.
C Cash Management and Other Services
Although deposits and loans are the basic banking services provided by banks and thrifts, these institutions provide a wide variety of other services to customers. For consumers, these include check cashing, foreign currency exchange, safety deposit boxes in which consumers can store valuables, electronic wire transfer through which consumers can transfer money and securities from one financial institution to another, and credit life insurance which automatically pays off loans in the event of the borrower’s death or disability.
In recent years, banks have made their services increasingly convenient through electronic banking. Electronic banking uses computers to carry out transfers of money. For example, automated teller machines (ATMs) enable bank customers to withdraw money from their checking or savings accounts by inserting an ATM card and a private electronic code into an ATM. The ATMs enable bank customers to access their money 24 hours a day and seven days a week wherever ATMs are located, including in foreign countries. Banks also offer debit cards that directly withdraw funds from a customer’s account for the amount of a purchase, much like writing a check. Banks also use electronic transfers to deposit payroll checks directly into a customer’s account and to automatically pay a customer’s bills when they are due. Many banks also use the Internet to enable customers to pay bills, move money between accounts, and perform other banking functions.
For businesses, commercial banks also provide specialized cash management and credit enhancement services. Cash management services are designed to allow businesses to make efficient use of their cash. For example, under normal circumstances, a business would sell its product to a customer and send the customer a bill. The customer would then send a check to the business, and the business would then deposit the check in the bank. The time between the date the business receives the check and deposits the check in the bank could be several days or a week. To eliminate this delay and allow the business to earn interest on its money sooner, commercial banks offer services to businesses whereby customers send checks directly to the bank, not the business. This practice is referred to as “lock box” services because the payments are mailed to a secure post office box where they are picked up by bank couriers for immediate deposit.
Another important business service performed by banks is a credit enhancement. Commercial banks back up the performance of businesses by promising to pay the debts of the business if the business itself cannot pay. This service substitutes the credit of the bank for the credit of the business. This is valuable, for example, in international trade where the exporting firm is unfamiliar with the importing firm in another country and is, therefore, reluctant to ship goods without knowing for certain that the importer will pay for them. By substituting the credit of a foreign bank known to the exporter’s bank, the exporter knows payment will be made and will ship the goods. Credit enhancements are frequently called standby letters of credit or commercial letters of credit.