Advantages and Disadvantages of Commercial Banks in Modern Economy

Alt: = "photo showing people walking pass front of Barcleys bank on London street"
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Commercial Banking

A commercial bank may be defined as a financial institution which deals in money and credit and which receives deposits from the public and from organizations, some of which are repayable on demand by cheque. It’s therefore referred to as deposit money bank.

Commercial banks are public or private limited companies owned by shareholders. They operate on a commercial basis; that is, they are out to maximize profits by trading in money. They differ from other banking financial institutions because they honour cheques drawn by their customers on their demand deposits.

Commercial banks play important roles in economic development of a country.

Roles of Commercial Banks in Economic Development

  • They give out loans and advances thereby providing short-term and medium-term capital for investors
  • They give financial, technical, and management advice to their customers in matters relating to investment.
  • Commercial Banks contribute directly to economic development by investing directly in the productive sectors of the economy.
  • Commercial banks facilitate business transactions by making the use of cheques and bank drafts possible.
  • They encourage investment by making it possible for private individuals and businesses to purchase government Treasury bills and development stocks. Such money can be channelled into productive ventures by the government.
  • Commercial banks facilitate international trades and travel by making foreign exchange transactions easier.
  • They act as referees as to the integrity and financial standing of their customers.
  • They encourage savings.

Advantages of Commercial Banks

1. Savings

Alt: = "overflowing bags of dollar"

The operation of commercial banks encourages savings. They provide facilities for saving. People could therefore save money. With help of fintech, people can save as little as 1$ from the comfort of their homes using their cellphones without having to walk down to the banks branches. This function of the banks helps individuals find the temptation of spending money extravagantly,  mobilize capital which can then be lent to investors. Although, money saved in banks are not regarded as investment, but then, it yields some interests to the savings fixed deposits and other forms of savings account holders. They therefore encourage capital accumulation which helps to scale up economic advancement. 

2. Safe Keeping of Public Wealth

Without commercial banks, people will be pilling up money in their homes. Before the advent of banks, people used to keep their moneys in containers, under their beds and pillows, bury beneath the soil, in grain stock etc. There were records of incidents of moneys being stolen, eaten up by rodents and termites. Keeping money at home in this modern time, will lead to high rate of theft and robbery.

3. Provision of Loans

Commercial banks give out loans and advances thereby providing short-term and medium-term capital for businesses. The loans and advances may be in the form of direct loans, overdrafts, or by the discounting of bills. With the amount borrowed, the investors could finance various projects in the areas of industry, agriculture, and commerce. This therefore helps in modern economy. Raising capital through bank loan is easier than raising capital at the capital market, which has along protocol, high qualification requirements and high cost of  raising capital.

4. Financial Prudence Advice

They give financial, technical, and management advice to their customers in matter relating to investment. They advise their business customers on how best they can carry out their business operations. They advise investors on the various ways of raising finance for investment purposes. The managers of businesses who are customers to a bank, can get management advice. Advice got.

5. Facilitation of Business Transactions and Payments

Commercial banks facilitate business transactions by making the use of cheques, bank drafts online transfer possible. Traders and individuals who handle plenty money therefore find it easier and safer to carry a large amount of money in the form cheques, bank drafts, ATM cards, online wallet from one place to another. The money lost by businessmen and investors is thereby reduced.

In this present modern economy which is basically digital economy, commercial banks makes the transactions possible by providing digital payments technological platforms available.

6. Facilitation of Global Trade

They facilitate international trade and travel by making foreign exchange transactions easier. They help in making overseas payments for their customers. They also assist in international trade by issuing letters of credit to importers and providing travellers' cheques to overseas travellers. With globalization, the modern economy is a border less economy, there is always need to settle international indebtedness. Commercial aid in remittance of cash, exchanging one currency for another; aids in export and import by transferring documents and payments; lend money to government, institutions and other world organizations. The reach of the banks is unlimited and it has helps in making the world a global village.

7. Reference

Banks act as referees as to the integrity and financial standing of their customers. Local investors who want to go into partnership with foreign investors could obtain references from bankers. Investment opportunities can therefore be created within an economy. This speeds up economic progress.

8. Conversion of Digital currency

There has been proliferation of digital assets, which are held electronically. Commercial banks still facilitate the transaction settlements of these cryptocurrencies. People who hold digital assets may wish to convert their digital currencies to fiat currencies, commercial banks facilitate the transfer and conversion.

Disadvantages of Commercial Banks

1. Leakages

There may be some leakages in the banks systems which may be caused by over blotted costs by the banks management, bank staff tampering with customers’ deposits, bad loans etc.

2. Risk of Robbery and Fraud

Piling up cash in publicly known places like banks can attract robbers. There has been prevalent cases  of robbers breaking in the banks and empty the vaults. The increase in internet banking in recent times has as well led to increase in cybercrime. Commercial banks customers are now exposed to criminal attacks in through stolen ATM cards, passwords, hacking of accounts, etc. There have been robberies where robbers have stolen millions of dollars through the internet, without physically entering the bank premises. With the rise in internet banking, fraudsters now device  more innovative ways to swindle and rob people off their money. Commercial banks are investing heavily on their internet and database infrastructure to wall off cyber acts. This adds to the operating costs of the banks which the customers have to bear.

3. Bankruptcy

Mismanagement of the depositors and shareholders funds by the banks management can lead to commercial banks going bankrupt. Global or regional economic recession and/ or depression where economic activities were negatively impacted can lead to customers doing more of withdrawal transactions than deposits, and also making the borrowers unable to meet up with their loan repayment obligations. Banks may not have enough cash to meet up with withdrawal demands. We recently witnessed the impact of Covid-19 pandemic on global economy. Some national governments where bailing out some financial institutions, taking up wage bills of banks staff so as to save their jobs and save the banks from going bankrupt.

4. Incumbrance Process of Getting Loans

The amount of collateral securities required by commercial banks before offering loans are usually high which the borrowers may not be able to provide. If people do not have the necessary collateral securities with which to borrow money from the banks, the banks will be reluctant to make loans available. This therefore tends to hamper the ability to create money.

5. Data safety issues

Data breaches as a result of poor security, cyber attacks, insider threats, which have become prevalent in recent times, especially at financial institutions with the introduction of Open Banking System.

The rise in implementation of open banking APIs has given rise to cybercrime as well. Open banking exposes more people to the risk of stolen passwords, hacked accounts, internet banking frauds, etc. There will be a more innovative way for fraudsters to swindle and divert people’s money. The people at the rural areas are more at risk

Ikechukwu Evegbu

Ikechukwu Evegbu is a graduate of Statistics with over 10 years experience as Data Analyst. Worked with Nigeria's Federal Ministry of Agriculture and Rural Development. A prolific business development content writer. He's the Editor, Business Compiler

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