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Commercial banks provide financial services for small and large businesses, including checking and savings accounts, loans, lines of credit, letters of credit, underwriting, and payment processing. These services enable businesses to operate in domestic and international markets. What’s more, financing from commercial banks may help businesses grow, which could potentially help drive the domestic economy.

What Is Commercial Banking: A Definition

Commercial banking involves financial institutions that are dedicated to serving businesses. This differs from retail banking, which provides personal banking services to individuals, such as checking and savings accounts.

Typically, a commercial bank offers businesses everything from deposit accounts, loans, and lines of credit to merchant services, payment processing, international trade services, and more. In these ways, a commercial bank can be a vital partner in helping a business succeed and grow.

While commercial banks offer a suite of services for medium and large businesses, small and new business owners can also take advantage of their offerings. Sometimes, people starting an enterprise use their personal accounts for banking. However, it is typically better to seek out commercial banking and open separate accounts for business vs. personal finances. This simplifies record keeping and the payment of taxes, and it also helps keep these two realms separate in case of any legal action.

How Commercial Banking Works

Commercial banks serve small- to large-sized businesses. You may be familiar with their names, as many of them also have retail banking divisions. Three examples of commercial banks in the United States are JPMorgan Chase & Co., Bank of America Corp., and Wells Fargo & Co. All are regulated by the United States Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC).

One very important function of commercial banks: providing financing to businesses. Before a commercial bank extends a loan to a business, it assesses the creditworthiness of the borrower by looking at its assets, profitability, and size.

In addition, commercial banks provide an array of services, supporting businesses with transfers from one account to another, lines of credit, lockbox services, payment processing, and foreign exchange services. Here is a closer look at what a commercial bank may offer:

Deposit Accounts

Commercial bank deposit accounts function like retail bank checking and savings accounts. They enable businesses to pay suppliers and employees by holding cash and, in some cases, account holders may earn interest on the balance.

There are three main types of deposit accounts: demand, fixed, and savings.

•   Account holders can use demand deposits or current account deposits for business transactions. They typically do not earn interest and are subject to service charges.

•   The bank holds fixed deposits for a specific term. Deposits likely earn interest, and the account holder can make withdrawals.

•   Savings deposits function as both fixed deposit and current accounts. Depositors can withdraw cash from these accounts, but the amount may be limited. Savings accounts earn interest but probably less than a fixed deposit.

Loans

Businesses need capital to thrive. Whether hiring staff, renting office or manufacturing space, or buying materials and supplies, operating a business and growing it takes cash. Commercial banks extend business loans vs. personal loans and charge interest on the loans. That’s one of the key income streams for banks. The bank likely turns a profit on lending, and the business gets the funds it needs to launch its enterprise or to expand or buy real estate or new equipment.

Lines of Credit

Commercial banks usually provide businesses with lines of credit. A line of credit is short-term funding that can help a company manage its obligations while it waits for cash flow to improve. For example, a company may have to wait for receivables’ payment in order to meet this month’s payroll. A line of credit can help bridge that gap.

Letters of Credit

A business may need to request a letter of credit from a commercial bank to show creditworthiness and to secure goods or services from an overseas trading partner. A letter of credit can serve as a guarantee from the issuing bank of payment for the goods once the letter’s requirements are met. The requirements might include the shipping date and the address the goods should be shipped to. In this way, a commercial bank can smooth international trade and help its clients’ business grow.

Lockbox Services

Lockboxes facilitate faster payments for businesses. Bank customers can send payments to a post office box near the bank, and the bank deposits the payments or funds to the customer’s account. This helps expedite the receipt of deposits and subsequent payments from the client to its providers. It can be a helpful cash flow tool for commercial enterprises.

Payment and Transaction Processing

Commercial banks typically facilitate the payments that businesses receive from their customers through electronic checks, paper checks, and credit card payments. Commercial banks may also provide services such as chargeback management fraud protection. All of these services can help keep a business humming along.

Foreign Exchange

Cross-border payments are complex because of exchange rates and the fact that each country has a different legal system. Commercial banks can provide foreign exchange services so that a company can do business overseas with a minimum of time and effort. This can streamline operations for a business enterprise so they can focus their attention on other activities.

The Significance of Commercial Banks

Commercial banks play a vital role in the financial life of the U.S. They help support the country’s economy by providing capital and services to businesses. By providing loans, they likely allow businesses to increase production and potentially expand, which may, in turn, boost the economy, lower unemployment, and encourage consumer spending. In addition, commercial banks support cross-border trade and transactions (say, by issuing revolving letters of credit) so that businesses can operate in international markets.

Commercial Banking vs Investment Banking

When considering the definition of commercial banking, it can be helpful to compare and contrast it to other kinds of banking. For instance, investment banking is a subset of banking that is focused on creating capital for companies, governments, and other organizations.

While some financial institutions may combine commercial and investment banking, because of the Gramm-Leach-Bliley Act of 1999, the two kinds of banking serve different markets. Here’s more detail of what investment banks do:

•   Underwriting

•   Overseeing mergers and acquisitions and initial public offerings (IPOs)

•   Facilitating reorganizations

•   Aiding in the sale of securities

•   Brokering trades for institutions and private investors

Commercial Banks vs Retail Banks

Another important distinction is how commercial banks differ from retail ones. Some banks will offer both sets of services, but here’s what retail banks typically offer in terms of personal banking services:

•   Savings accounts and checking accounts (you can often open these bank accounts online)

•   Mortgages

•   Personal loans

•   Debit cards

•   Certificates of deposit (CDs)

There are also alternatives to traditional banking that can assist with personal finance transactions.

Examples of Commercial Banks

It can be helpful to have specific examples of commercial banks to better understand what they do and how they work. There are three types of commercial banks: public sector banks, private banks, and foreign banks.

•   A public sector bank is one where the government owns a major share. Public banks provide funding for projects that benefit the local public and community, which could include infrastructure projects or affordable housing. The Bank of North Dakota (BND) is the only active public bank in the United States.

•   Most of the banks in the United States are private banks run by individuals or limited partners. Examples are JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo.

•   A foreign bank is any bank headquartered in another country but doing business in the United States. Two examples are Barclays Bank PLC, headquartered in the United Kingdom, and the Royal Bank of Canada (RBC).

Benefits of a Commercial Bank Account

There are several reasons for a business to consider opening a commercial bank account.

•   Clients are likely to feel more confident making payments for services rendered to a business rather than an individual. Simply put, it’s more professional and may be perceived as more trustworthy.

•   Having separate bank accounts for business and personal transactions can simplify accounting and taxes (business expenses are more easily deducted).

•   If a business owner faces legal or financial challenges with their business activity, their personal liability could be limited and protected.

•   A business can apply for business loans from a commercial bank and finance expansion or costly equipment purchases with favorable lending terms.

•   Business accounts are FDIC-insured in the event the bank fails.

Is My Bank a Commercial Bank?

If your bank provides services to businesses, such as checking accounts, financing, lines of credit, and international trade services, it is likely a commercial bank. A retail bank, on the other hand, will provide services to individuals (joint vs. separate accounts, debit cards, personal loans, and more) and could be a department within a commercial bank.

The Takeaway

Commercial banking differs from retail banking in terms of the clientele it serves. Retail banks provide checking and savings accounts, loans, and other services to individuals to manage their day-to-day finances. Commercial banks help businesses launch, operate, and potentially grow with services like deposit accounts, loans, lines of credit, payment services, and more.

If you are hunting for personal banking services, explore what different retail banks have to offer, such as direct deposit, low or no account fees, and mobile banking, to find the best option for your financial needs.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

What is the difference between commercial banking and retail banking?

Retail and commercial banking serve different clients. Retail banking provides checking and savings accounts, financing, lines of credit, credit cards, and other services to individuals. Commercial banking usually provides checking and savings accounts, financing, underwriting, letters of credit, lines of credit, and other functions to businesses.

Is my money safe in a commercial bank?

Your money is essentially as safe in a commercial bank as it can be. It is generally protected from loss due to bank failure by federal insurance up to $250,000.

What role does a commercial bank play in the economy?

Commercial banks may support the economy by providing capital and services to organizations. These, in turn, could stimulate the economy by doing business, growing, and employing more workers. Commercial banks may also facilitate cross-border payments so that businesses can move into international markets.

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SOBK-Q224-1927483-V1

An income investing strategy focuses on generating income from your principal rather than growth, i.e. capital gains. Income investors typically seek out investments that provide a regular income stream, such as dividends from stocks, interest from bonds, or rental payments from a property.

Investors might be interested in income investing in order to create an additional income stream during their working years. Other investors may focus on generating monthly income during retirement. Income investors need to take into account several factors, including the tax implications of different types of income.

How Income Investing Works

Income investing can be a way to generate a passive income stream that supplements ordinary income as well as retirement income. Rather than creating a portfolio that’s solely focused on capital gains, i.e. growth, an income investing strategy is geared toward setting up one or more sources of steady income.

Again, dividend-paying stocks, interest-bearing bonds, and real estate proceeds are common types of income investments that may provide steady cash flow. While many people associate investment income with retirement, many investors seek to establish other income streams long before that.

That said, these two aims — growth and income — are not mutually exclusive. In fact, an income-generating portfolio must also have a growth component, in order to keep up with inflation.

Types of Income Investing Strategies

There are a range of income investing assets and strategies that investors can adopt, depending on their goals and preferences. For example, when creating an income-focused portfolio, it’s important to consider your risk tolerance, as different income investments may have different risk profiles.

1. Dividend Stocks

Dividend stocks are stocks that pay out regular dividends to shareholders. Not all companies pay dividends. Companies that do usually pay dividends quarterly, and they can provide a reliable source of income for investors.

Income investors are generally attracted to companies that pay out reliable dividends, like the companies in the S&P 500 Dividend Aristocrats index. Companies in this index have increased dividends every year for the last 25 consecutive years.

•   Dividend Yield

One metric that income investors should consider is the dividend yield. While dividends are a portion of a company’s earnings paid to investors, expressed as a dollar amount, dividend yield refers to a stock’s annual dividend payments divided by the stock’s current price, and expressed as a percentage.

Dividend yield is one way of assessing a company’s earning potential.

While a high dividend yield might be attractive to some investors, risks are also associated with high-yield investments. Investors who want regular and consistent income tend to avoid stocks that pay high yields in favor of dividend aristocrats that may pay lower yields.

Recommended: Living Off Dividend Income: Here’s What You Need to Know

2. Bonds

Bonds are a debt instrument that normally make periodic interest payments to investors. Also known as fixed-income investments, bonds are typically less risky than stocks and can provide a steady stream of income. The bond’s yield, or interest rate, determines the interest income payment.

There are various bonds that fixed-income investors can consider. For example, government bonds are debt securities issued by a government to support government spending and public sector projects. Government bonds — like U.S. Treasuries and municipal bonds — are generally less risky than other types of bonds and can provide tax-advantaged income and returns.

Investors can also lend money to businesses through corporate bonds, which are debt obligations of the corporation. In return for money to fund operations, companies make periodic interest payments to investors. Corporate bonds carry a relatively higher level of risk than government bonds but also provide higher yields.

However, not all bonds offer yield to investors interested in generating regular income. Some bonds, called zero-coupon bonds, don’t pay interest at all during the life of the bond.

The upside of choosing zero-coupon bonds is that by forgoing annual interest payments, it’s possible to purchase the bonds at a deep discount to par value. This means that when the bond matures, the issuer pays the investor more than the purchase price.

Recommended: How to Buy Bonds: A Guide for Beginners

3. Real Estate

Real estate may be a great source of income for investors. Rents paid by tenants act as a regular income payout. Real estate may also offer long-term price growth, in addition to some tax benefits.

There are several ways to invest in real estate, including buying rental properties and investing in real estate investment trusts (REITs).

Recommended: Pros & Cons of Investing in REITs

4. Savings Accounts

Savings accounts are a safe and easy way to earn interest on cash. Savings accounts and other cash-equivalent saving vehicles like high-yield savings accounts or certificates of deposits (CDs) are often considered very low risk. But they also typically offer lower interest rates than you might see with other investments. Because these interest rates are typically lower than the inflation rate, inflation can erode the value of the money in these savings accounts longer term.

In addition, when you purchase a CD it may have more stringent minimum deposit requirements, as well as keeping your money locked up for a specific period of time. Still, they can be a low-risk way to earn income.

5. Money Market Accounts

A money market account (MMA) is an FDIC-insured deposit account that typically pays higher interest rates than a traditional savings account. However, MMAs may be more restrictive than a savings account, often only allowing a certain number of withdrawals each month using checks or a debit card.

Also, money in a money market account can be invested by the bank in government securities, CDs, and commercial paper — which are all considered relatively low-risk investments. With a traditional savings account, money is not invested.

But unlike most investments, money market accounts at most banks are FDIC-insured up to $250,000 for an individual, or $250,000 per co-owner in the case of joint accounts. In some cases investing in a money market account may earn a higher interest rate while still maintaining FDIC-insurance protection.

6. Mutual Funds and ETFs

Investors who don’t want to pick individual stocks and bonds to invest in can always look to mutual funds and exchange-traded funds (ETFs) that have an income investing strategy.

There are many passively and actively managed funds that invest in a basket of securities that provide interest and dividend income to investors. These funds allow investors to diversify their holdings by investing in a single security with high liquidity.

Understanding the Tax Implications of Income Investing

Another important aspect of investing for income is to consider the tax implications of different income-producing assets. Here are a few key considerations to be aware of:

•   Dividends. Most dividends are considered ordinary dividends and are taxed as income. Qualified dividends are taxed at the lower capital gains rate. Be sure to know the difference.

•   Real estate. Income from a rental property is generally taxed as income (although business deductions may apply). Dividend payouts from owning shares of a Real Estate Investment Trust (REIT) are typically higher than traditional equity dividends; these are also taxed as income. However, if there are profits from a REIT, these are taxed at the capital gains rate.

•   Bonds. Bond income may be taxable, or not, depending on the issuer. Some municipal bonds are tax free at the federal and state level (if you live in the state where the bond was issued). Corporate bond income is taxed at the state and federal levels. U.S. Treasuries are generally taxed at the federal level, but not the state.

You may also owe ordinary income or capital gains tax if you make a profit when selling a bond.

As you can see, tax issues can be complex and it’s often necessary to consult a tax professional.

Example of an Income Investing Portfolio

When building a portfolio for any investing strategy, investors must consider their financial goals, risk tolerance, and time horizon. As with any investment portfolio, it’s possible to have lower or higher exposure to risk.

Here are some examples of hypothetical income investment allocations.

Lower Risk Tolerance

This is an illustrative portfolio and not intended to be investment advice. Nor is it a representation of an actual ETF or mutual fund. Please consider your risk tolerance and investment objective when creating your investment portfolio.

Moderate Risk Tolerance

This is an illustrative portfolio and not intended to be investment advice. Nor is it a representation of an actual ETF or mutual fund. Please consider your risk tolerance and investment objective when creating your investment portfolio.

Higher Risk Tolerance

This is an illustrative portfolio and not intended to be investment advice. Nor is it a representation of an actual ETF or mutual fund. Please consider your risk tolerance and investment objective when creating your investment portfolio.

Benefits and Risk of Income Investing

Like any investing strategy, there are both advantages and drawbacks to focusing on earning income through investments.

Benefits

The potential benefits of income investing include receiving a steady stream of payments, which can help to smooth out fluctuations in the market. In other words, even with a certain amount of market volatility, an income-generating strategy may produce income that provides a certain amount of ballast.

If an investor reinvests some or all of the income generated from a certain assets, whether bonds or dividend-paying stocks, this can add to the overall growth of the portfolio, thanks to compounding.

An income investing strategy may also provide diversification. For example, investing in REITs is considered a type of alternative investment strategy. That means, REITs don’t move in tandem with conventional assets like stocks, which may provide some protection against risk (although REITs can have their own risk factors to consider).

Risks

Investors who are pursuing an income investing strategy should be aware that investments that offer high yields may also be more volatile. The income from these investments may be less predictable than from more established investments, like blue chip stocks that pay out reliable dividends.

For example, a company with a high dividend yield may not be able to sustain that kind of payout and could suspend payment in the future.

When investing in bonds, investors need to know about the potential risks associated with fixed-income assets:

•   Credit risk is when there is a possibility that a government or corporation defaults on a bond.

•   Inflation risk is the potential that interest payments do not keep pace with inflation.

•   Interest rate risk is the potential of fixed-income assets fluctuating in value because of a change in interest rates. For example, if interest rates rise, the value of a bond will decline, which could impact an investor who intends to sell some of their bond holdings.

Additionally, if investors take the income from their investment for day-to-day needs rather than reinvesting it, they may miss out on the benefits of compound returns. Investors could reinvest the income they earn on certain investments to take advantage of compounding returns and accelerate wealth building.

Factors to Consider When Building Your Income Investing Strategy

Building an income investing strategy takes work and time. Before creating a portfolio, you need to define your financial goals and consider your timeline for when you need the income streams. Below are some additional steps you could follow to create an income investing strategy:

•   Assess your risk tolerance: It’s important to determine whether you want to invest more heavily in riskier assets, like dividend-paying stocks that may fluctuate in share price, or relatively safer securities, like interest-paying bonds.

•   Choose your investments: As mentioned above, potential options for income investors include bonds, dividend stocks, and real estate investment trusts (REITs).

•   Be mindful of taxes: Different types of income-producing assets may be taxed in different ways. It’s generally desirable to keep your portfolio tax efficient.

•   Monitor your portfolio: It’s critical to regularly check in on your investments to ensure they are still performing according to your expectations.

•   Rebalance as needed: If your portfolio gets out of alignment with your goals, consider making adjustments to get it back on track.

The Takeaway

An income investment strategy is, as it sounds, focused on using specific assets to provide income, not only growth (although income and growth strategies can work in harmony). Investing in dividend-paying stocks, interest-paying bonds, and other income-generating assets allows you to get the benefits of regular income streams and potential capital appreciation.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

FAQ

What’s the difference between income investing and growth investing?

The goal of income investing is to create a certain amount of steady income from different types of assets. Investing for growth is focused on the potential gains of the securities in a portfolio. In a sense, income investing can be more present focused, while growth investing may be oriented toward the longer term.

What is the best investment for income?

There are various income-generating investments, each with its own risk profile and tax considerations. When choosing the best income investments for you, be sure to consider how different factors might impact your plan.

What investments give you monthly income?

While it’s possible to obtain monthly income from various types of investments, even dividend-paying stocks (dividends are often paid quarterly), a common source of monthly income is property. If monthly income is important to you, be sure to select assets that can meet your goal.

Photo credit: iStock/LeszekCzerwonka