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Commercial banks are the largest, oldest, and probably most important financial institution in the U.S. and in most other countries as well. First of all, banks receive money for safe-keeping, and make loans to borrowers. Banking therefore is the business of receiving, protecting, and lending money. The primary role of banks is to intermediate between savers and borrowers. Banks pool the savings of households and make them available to businesses that want to invest.
Commercial banks perform a variety of financial services. These services include a wide range of checking and savings deposit accounts, consumer loans, credit cards, home mortgage loans, and business loans. Many banks rent safe deposit boxes to customers who want to store jewelry, legal documents, artwork, and other valuables.
Bank assets fall into three main categories: loans, securities, and cash assets. Because lending is the bread-and-butter business of commercial banks, loans compose the predominant category of assets held by commercial banks.
Those loans that commercial banks make to businesses are commercial and industrial loans (C&I).Businesses use funding from C&I loans to meet day-to-day cash needs or to finance purchases and equipment. C&I loans may be secured or unsecured. Secured loans are those backed by something of value, known as collateral, which may be seized by the lender if the borrower fails to repay the loan. The most common type of secured loan is mortgage, in which a piece of property like a building is used as collateral.
An unsecured loan requires no collateral. One example of unsecured loan is a working capital line of credit, which is an agreed-on maximum amount of money the bank is willing to lend the business during a specific period of time, usually one year. Once a line of credit has been established, the business may obtain unsecured loans for any amount up to that limit. Companies often arrange a revolving line of credit to be sure of obtaining credit when needed.
Commercial banks also extend credit to individuals. These loans are consumer loans. Banks usually issue consumer loans for purchase of automobiles or boats in the form of installment credit. The individual borrower agrees to repay the principle and interest in equal periodic payments. Real estate loans are ones that banks make to finance purchases of real property (such as buildings) by businesses and individuals.
When business people borrow money from a bank, they agree to pay a certain number of dollars (yens, rubles, etc.) a year in interest for every hundred dollars they borrow. The sum borrowed is called the principal, and the percentage paid is called the rate. If they pay five dollars for every hundred dollars they borrow, they are paying interest at a rate of 5 per cent. The upper limit of the interest rate is fixed by the amount borrowers can afford to pay and still make a profit with their borrowed money. The prime interest rate (prime) is the lowest interest rate charged by banks for short-term loans to their most creditworthy customers (preferred borrowers).
Banks are also heavily involved in foreign exchange trading. Nearly all banks trade currencies. Individuals, businesses, and governments may buy and sell currencies in a foreign exchange department of any commercial bank.