Distinguishing between commercial and cooperative banking
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Broadly speaking, there are three main retail bank types. They are commercial banks, credit unions, and certain investment funds that offer retail banking services. All three retail bank types work toward providing similar banking services. These include checking accounts, savings accounts, mortgages, debit cards, credit cards, and personal loans.
One of the retail bank types is commercial banks, which offer a wide range of consumer banking services. Typical services include certificates of deposit (CDs), savings and checking accounts, credit and debit cards, etc. Commercial banks are for-profit institutions that generate income through interest rate spreads and transaction fees.
The interest rate spread is the difference in interest rates that banks charge on loans and the rates they pay on deposit accounts. The spread fluctuates greatly across various economic cycles. In prosperous economic times, the spread is generally wider. The widened spread allows these institutions to generate more income.
Conversely, during times of economic recession, banks may need to incentivize consumer spending by lowering interest rates on loans. This compresses their profit margins.
Offering higher interest rates on savings accounts may incentivize consumers to hold more money in these accounts. The practice, in turn, may reduce consumer participation in the capital markets.
Transaction fees make up a substantial amount of revenue for commercial banks. Such fees include usually recurring charges on credit cards and fees for transfers or other financial services. Since commercial banks essentially monopolize the market, they are able to charge premium prices without seeing excessive erosion in demand.
Credit Unions and Cooperatives
Another of the retail bank types are credit unions (or similar cooperative institutions). They offer services similar to commercial banks, but usually on a smaller scale. Credit unions are not-for-profit institutions, where the depositors are its shareholders. As a result, credit unions face smaller pressures to generate profits.
This means that they typically charge lower interest rates on loans and offer higher rates on deposit accounts. Transaction fees are also relatively low because credit unions do not perceive them as revenue drivers. They are viewed more frequently as services that can be offered at cost.
Nonetheless, there are some disadvantages to credit unions. Due to being much smaller institutions, credit unions lack a big brick-and-mortar presence. This is likely to dissuade consumers that prefer banking services being delivered in-person.
Credit unions also employ less advanced technology than banks, making their online banking services less secure. Credit unions also have fewer employees and are open for shorter hours than commercial banks.
Functions of Retail Banks
From an economic standpoint, all three types of retail banks exist to:
1. Provide more liquidity by influencing the money supply in an economy
This is usually done by adjusting interest rates and periodically reviewing creditworthiness protocols.
2. Reduce the probability of default on loans by pooling together the risks of lending money
The institutions are also in better positions to cope with defaults due to federally-mandated reserve ratios. The ratio ensures that banks always have a minimum amount of cash on hand that is a percentage of total consumer deposits.
3. Lower the cost of borrowing by offering competitive interest rates
Economies that follow a Keynesian monetary policy increase profits during economic booms by increasing interest rates on loans and building cash reserves. Then, during a recession, banks are expected to lower interest rates in order to spur consumer spending and stimulate economic growth.
Thank you for reading CFI’s explanation of retail bank types. CFI offers the Commercial Banking & Credit Analyst (CBCA®) certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following CFI resources:
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