Similarities of a Commercial Bank & a Central Bank

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Although central banks and commercial banks serve different types of clientele, many of their functions are similar. Both of them make loans, take deposits and perform services. Commercial banks serve the local banking needs of the consumer and business entities where they reside. Furthermore, large commercial banks service smaller banks. On the other hand, central banks concentrate upon the needs of commercial banks, other financial institutions and government entities through monetary policy which is their main role.

Loans

  • Commercial banks make all types of loans to their customers based upon their credit background and collateral. The scope of loans includes consumer type auto and mortgage loans to business lines and trade financing. Central banks through the facility of the discount window make loans to their largest member banks for purposes of providing short term liquidity needs. These needs range from funding reserve requirements to borrowing money on an overnight basis to meet large payment transactions. Loan rates are influenced by central banks via monetary policy through the setting of key interest rates such as the discount and overnight federal funds rates. These rates flow through the commercial banking system and form the short term basis for higher or lower rates beginning with the prime rate that banks charge their most credit worthy customers. This forms a very close bond between the two different types of banks.

Deposits

  • Commercial banks offer their clients a very wide variety of deposit accounts that include checking, money market and time deposits accounts. Checking accounts may take the form of non interest bearing or interest bearing accounts depending upon the restricted nature of withdrawals. The interest bearing variety is known as NOW accounts or Money Market Demand Deposit Accounts (MMDA). Time deposits are interest bearing and their rates are influenced by the central bank's monetary policies. Commercial banks also offer correspondent deposit accounts to smaller banks. As concerns central banks, reserve requirement deposits payable to commercial banks are mandated and governed by the monetary policy of each particular country. In the U.S., reserve requirements are governed by Federal Reserve "Regulation D" which tightens or loosens money per monetary policy. During periods of inflation and strong business growth, the Federal Reserve Bank will increase reserve requirements which tends to increase interest rates. Central banks also offer commercial banks correspondent bank deposits in order to clear their checks and send wire transfers.

Services

  • Commercial banks offer their customer’s fee based services for all types of banking needs. For example, services are available for foreign exchange transactions, safe deposit and lock boxes, letters of credit, collections and wire transfers. On the other hand, central banks offer their client banks services for check collection and collateral safekeeping, to name a few. A very large part of central bank services are directed toward the governments that they represent. They are the depository and payment agent among other things for government programs such as social security, unemployment and disability payments. They also carry out monetary policy by purchasing and selling government bonds through free market operations. Whenever interest rates are too high, they inject money into the banking system by purchasing back government bonds from banks which places excess money into the economy and lowers interest rates.

References

  • Photo Credit bank image by Pefkos from Fotolia.com sign. loan sale image by L. Shat from Fotolia.com Checking credit card statement image by Elzbieta Sekowska from Fotolia.com cash money image by sergey kochetov from Fotolia.com
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