Ivan Kitov • 6 Mar 2023 • 5 min read
Banking is a broad term that encompasses various financial intermediaries, including retail banks, commercial banks, investment banks, and even central banks. What characterizes commercial banking, in particular, is its overwhelming focus on corporate finance. Commercial banks offer loans, deposits, and other financial products to businesses and institutions. In addition, they play a fundamental part in supplying world economies with credit. As a result, navigating the often-hazardous field of credit analysis is a top priority for commercial bankers. Because of the scale at which these financial entities operate, they have enormous influence over the global economy, as became clear during the 2008 crisis. Commercial banks present ambitious individuals with multiple exciting career opportunities that all have one thing in common — the rigorous preparation in financial analysis needed to add value to the bank’s multifaceted ventures.
Table of contents:
- Commercial Banking vs. Investment Banking vs. Retail Banking
- Importance and Hazards of Commercial Banks
- Commercial Banking Products and Services
- Careers in Commercial Banking: Credit Analyst
Commercial Banking vs. Investment Banking vs. Retail Banking
One way to think about the spectrum of banking services is to consider types of bank clients and their needs. For example, we can categorize clients into two brackets, individuals and businesses. Similarly, we regard their needs as either simple or complex.
Retail banks offer products and services to individual consumers like us. In contrast, commercial banks work to serve businesses and institutions. These entities include small, medium, and large enterprises. In any case, both types of banks offer deposit and credit-related products.
Investment banks belong to a third class. They help clients raise capital through capital markets, advisory services, and other investment banking strategies. Although, like commercial banks, investment banks also serve large corporations and institutions. The needs of clients who seek out investment banking services are often a lot more complex than those of retail and commercial bank clients.
The Importance and Hazards of Commercial Banks
Commercial banks and financial institutions, in general, play a crucial yet often underappreciated role in the economy — they create credit. Without credit, production and consumer spending begins to slow down, resulting in a negative economic domino effect. Here’s an example to make this concept more concrete.
Generating Credit
Consider a business that earns $10. Without credit, the business is able to spend a maximum of $10. Keep in mind, though, that this spending is also what other players in the economy can earn from it at this stage.
With the introduction of credit, the business could be entitled to spend ten times more or $100. In essence, a bank vouches for the business’ creditworthiness and deems it worthy of an additional $90.
This additional $90 in spending translates to more earnings for other businesses too — remember that one business’s spending is another’s earnings. Eventually, these mechanics translate into more spending in the economy that accelerates growth.
The Pitfalls of Credit
That being said, credit can have detrimental effects too, particularly when banks are incentivized to offer credit to unstable and dubious players. In fact, subprime mortgages were one of the main drivers that led to the Global Financial Crisis of 2008.
Nevertheless, banks promote growth and ensure liquidity. Yes, improper incentives may have caused recessions in the past. But we can’t even imagine what the world without credit would be. All the technological advancements that shape our lives today are a result of the boost to the economy that credit provides.
Moreover, commercial banks are now obliged to adhere to credit risk mitigation strategies defined by governing bodies and central banks. These measures include a range of capital adequacy regulations and the Basel II accord.
Commercial Banking Products and Services
Like retail banks, commercial banks offer loans, deposits, and other credit products. However, on top of these, they can also act as corporate treasuries and offer payroll and capital management services.
Most of these products and services entail some form of credit. Hence, commercial bankers constantly need to assess the creditworthiness of potential clients to lower the bank’s credit risk.
Deposits
Commercial banks offer many types of deposit products. But in general, we can classify them as savings accounts, checking accounts, and time deposits or money-market accounts.
Deposits are probably the first banking service any of us encounters. That isn’t surprising, considering this basic bank offering has many uses:
- People need a store of money for safekeeping.
- Drawing money against a checking account is convenient when transacting with others.
- High-interest accounts somewhat ease the burdens of inflation.
Commercial banks offer deposits to large and small businesses for mostly the same reasons.
Commercial Loans and Other Credit Products
Businesses require capital to fund operations, and they usually turn to commercial banks to supply this need. Analysts separate capital requirements into short-term needs, or those that are paid within a year, and long-term needs that span longer periods of time. In accounting terms, we call short-term requirements working capital and long-term requirements capital expenditures. There is a special branch of corporate finance that deals with capital expenditures known as capital budgeting. It consists of a set of techniques for evaluating investments and allocating capital.
Careers in Commercial Banking: Credit Analyst
Commercial banks typically have large operations with many departments. So, careers can range from the back-office work of credit adjudicators and fulfillment officers to client-facing roles such as relationship managers and credit analysts.
As a credit analyst, you are expected to be familiar with the approaches to calculating and modeling credit risk prescribed by the Basel II accord. More importantly, when considering the opportunity for financing an organization, you must be aware of the industry it operates in and its financial position. Hence, you will also need to be familiar with the elements in a thorough industry analysis. While examining creditworthiness, credit analysts consider the 5 C’s of credit: character, capacity, capital, collateral, and condition.
- Character: Has the business paid its past borrowings? Is it in their character to pay back loans?
- Capacity: How is the business’ solvency ratio? Do they have the capacity to pay?
- Capital: How is the business’ liquidity ratio? Do they have the money to pay you back?
- Collateral: What is the quality of the collateral? Can the bank readily sell it in a secondary market? Is it a non-performing asset?
- Condition: Is the economy or industry on the decline? Or are we at the early stages? Does the loan make economic sense for the business?
What’s Next?
Astute credit analysts will take a holistic approach to the 5 C’s of credit. Nevertheless, these commercial bankers will need an understanding of financial analysis. Consequently, the abilities to interpret the four major financial statements and perform ratio analysis are baseline requirements. Sign onto our Complete Financial Analyst Course 2022 and start gaining the skills you need to succeed in the competitive world of commercial banking.
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