Commercial Banks and Investment Banks

Question 1

1. Difference Between a Commercial Bank and an Investment Bank

Answer 1

• Commercial Bank: financial institution which aims to make profits by selling banking services to its customers. (manages deposits, cheques and savings accounts)
• Investment banks: facilitate the trade of stocks, bonds and other forms of investment.

Question 2

2. Main Functions of a Commercial Bank

Answer 2

1. Accept deposits: Commercial banks accept deposits from the public, usually in the form of savings.
   - Those on low incomes might save a part of their income for security, whilst firms see saving as convenient.
   - Banks can meet the different needs of their depositors by providing different accounts….
   - Demand Deposits: which allow deposits to be made or withdrawn immediately. This is useful for firms who need to make immediate payments.
   - Fixed Deposits: store money for a long time. They have higher rates of interest, since banks can use these deposits knowing they will not be withdrawn.
2. Provide loans
   - Main source of income for commercial banks is interest, which banks earn through providing loans.
   - Banks create credit by using deposited funds as loans.
3. Overdraft: When a current account has no deposits, consumers can still borrow money from the bank in the form of an overdraft.
   - These are at a high interest rate and the amount that can be borrowed is limited.
4. Investment of Funds: funds could be invested into securities such as Government bonds and treasury bills.
   - These could be profitable for the bank.

Question 3

3. The Structure of a Commercial Bank’s Balance Sheet

Answer 3

•Balance sheets: show the value of a company’s assets, liabilities and owner’s equity during a period of time.

• A liability is something which must be paid. It is a claim on assets. (e.g. borrowing)
• An asset is something that can be sold for value. (e.g. bonds)
• The owner’s equity is what is left over when assets have been sold and liabilities have been paid.

Question 4

4. The Objectives of a Commercial Bank

Answer 4

• Liquidity: the liquidity of assets is how easy it is to turn assets into cash.

• Cash: most liquid asset, Loans / Bonds: least liquid assets
• Liabilities are payable on demand (to be profitable banks must have cash and liquid assets.)
• Profitability: Banks need to earn profits to pay their depositors interest, wages and general expenses.
• Security: Banks face uncertainties about how much cash they can get, and whether loans will be repaid or not…
• Banks therefore have to try and maintain the safety of their assets.
• Bank has to keep high proportions of their liabilities with itself and the central bank.

Question 5

5. Potential Conflicts Between These Objectives

Answer 5

• Prioritising liquidity means profits will be low

• Liquidity and safety are generally prioritised over profitability (considered to be additional to the bank’s survival.)
• Bank needs a balance between liquidity and profits

• Prioritising security means banks only hold their safest assets (more credit cannot be created)

• This means banks’ profits are lower and the bank might lose customers.
• The bank needs a balance between the risk level and their profits.

Question 6

Summary

Answer 6

1. Difference Between a Commercial Bank and an Investment Bank
2. Main Functions of a Commercial Banks
3. Structure of a Commercial Bank’s Balance Sheet
4. The Objectives of a Commercial Bank
5. Potential Conflicts Between These Objectives