Question

Discuss the limits on the types of products and services a commercial bank can offer

Answer 1

Commercial banking has traditionally been the backbone of banking. Banking was created to funnel idle resources in households to productive purposes in business. Over the long period of time that banking has been in existence, the nature of products provided to commercial customers has undergone a huge change. Several new types of products have been introduced in response to the changing demand in the marketplace and certain old products have become obsolete.

Industrial Loans

The primary business of commercial banks is to make loans to large industrial corporations. Corporations in any nation are interested in obtaining debt at favorable terms. The bank is in a position to fulfill this demand through the services that they offer.

Although with the evolution of the debt market, the idea of banks as the principal source of debt has become outdated as far as mega corporations are concerned. Mega corporations are in a position to raise funds directly from the markets. This proves cheaper since they do not have to pay an intermediary i.e. the banks.

Therefore in the past century or so, banks have seen their primary business declining. To combat this decline, they have created special teams which provide capital market services and assist clients in issuing their debt securities. Banks have centuries of experience regarding dealing in debt markets and hence are in a position to provide their expertise for a fee. Therefore debt market advisory has become one of the major products that banks sell to mega corporations.

Project Finance

Project finance is one type of loan for which mega corporations largely rely on banks till date. In case of project finance, the banker finances the project as an individual entity. The parent company that is sponsoring the project has a limited liability in case the loan goes bad. For instance, if bank funds DEF project that was initiated by ABC Corporation and the project goes bankrupt over time.

In this case, banks only have access to the assets owned by DEF project. ABC Corporation does not have to assume any liability for the losses the bank incurred while financing the project. The project is treated as a separate entity in its own right.

Syndicated Loans

Banks often times combine to make huge syndicated loans to corporations. This is because the debt requirements of a particular corporation, let’s say, General Electric may be so huge that any single bank may not be in a position to fulfill them without creating a significant risk on their books. Hence, in such cases, several banks have to form a syndicate to fulfill the loan requirement.

One bank may play a lead role in coordinating with other banks and making the funds available to the corporation. Hence, this bank would be called the “lead financier” and would be entitled to a special fee over and above the regular interest that is earned on the loan. Also, the corporation will service the loan i.e. pay the payments to this bank only. It is the lead arranger that will have to create a mechanism to redistribute the monthly payments to the other banks proportionately.

Leasing

With the advent of off balance sheet financing, a lot of companies have started using leasing as a financing method. This is because it provides control of the said asset without leveraging the balance sheet of the given corporation. Banks have become heavily involved in the business of such financial leases. Financial leases are being signed by companies for acquiring real estate, automobiles, factory equipment or such other major fixed assets. It needs to be noted that banks usually only fund financial leases and not pure play operational leases.

Foreign Trade Financing

A lot of the corporations in the world today are multi-nationals. Thus their business interests cross national borders. This means that foreign trade in rampant and has become the norm. Now, foreign trade has some special financing needs. Banks have traditionally specialized in such financing. In the modern world too, banks provide letters of credit, export financing, bank guarantees and other such services to corporations which help them conduct foreign trade in an efficient manner.

Bills of Exchange

Companies often use bills of exchange for accounts receivables and accounts payables purposes. For instance if company A agrees to pay company B at a later date, they could sign a bill of exchange for the same. Company A can then take this bill of exchange to the bank at get the bill discounted.

This means that the bank will take over the right to collect receivables from B. They will do so by purchasing the bill at a discount. This means that they will pay company A, a discounted amount for the bill. The difference between the face value of the bill and the discounted price for which the bank bought it is considered to be the interest earned by the bank.

Bills discounting is an important service provided by banks to many commercial corporations. This service helps them streamline their accounts receivable processes.

Commercial banking involves a division within a bank that focuses on business accounts and working with business owners. Some banks may refer to these services under the term "business banking" instead of commercial banking. The bank may offer services such as payroll processing, a way to pay your quarterly taxes, and financial planning services. The financial planning may also include the management of retirement accounts in addition to financial planning for the business. Many commercial banking divisions focus on lending money to help businesses stay afloat.

Advantages

Commercial banks can help a small business by making it easier to manage day-to-day financial tasks. An established commercial account with a bank will make it easier to borrow money when you grow your business. The Advantages of raising funds from a commercial bank are as follows:

(i) Banks provide timely assistance to business by providing funds as and when needed by it.

(ii) Secrecy of business can be maintained as the information supplied to the bank by the borrowers is kept confidential;

(iii) Formalities such as the ssue of prospectus and underwriting are not required for raising loans from a bank. This, therefore, is an easier source of funds;

(iv) Loan from a bank is a flexible source of finance as the loan amount can be increased according to business needs and can be repaid in advance when funds are not needed.

Disadvantages

Commercial bank accounts are often more expensive than traditional bank accounts. Banks may charge fees for night deposits, for processing a certain number of checks and for the payroll services. The major Disadvantages of commercial banks as a source of finance are as follows:

(i) Funds are generally available for short periods and its extension or renewal is uncertain and difficult;

(ii) Banks make detailed investigation of the company’s affairs, financial structure etc., and may also ask for security of assets and personal sureties. This makes the procedure of obtaining funds slightly difficult;

(iii) In some cases, difficult terms and conditions are imposed by banks, for the grant of loan. For example, restrictions may be imposed on the sale of mortgaged goods, thus making normal business working difficult.