The nuts and bolts behind business banking

Andrew George

If you think banking is all about checking accounts and CDs, you’re in for a surprise. These products, called retail banking, actually cost banks money in the form of interest paid on customers’ deposits. For most banks to survive and prosper today requires them to actively pursue various money making activities. Commercial lending is just one type of activity that banks have at their disposal. Lending money to businesses is one way to create interest income for banks, allowing them to pay their bills and pay the interest on customers’ savings accounts.

Commercial lending is an attractive method for banks to make money. Typically a business, be it large or small, is in a better position to require large amounts of capital (money) than an individual. Lending larger amounts of money means receiving more interest which means more revenue for the banks. Many banks have a variety of lending options to offer to businesses. Some of the most popular include: term loans, lines of credit, letters of credit and corporate credit cards. When businesses are looking to borrow money they sit down and talk with a representative of their bank to determine which lending facility best fits their individual needs.

Term loans are probably the most familiar lending activity for most people and businesses. A bank gives a business a certain dollar amount and expects a repayment of the total amount plus interest within a specified time period. Mortgages are a type of term loan.

Lines of credit are similar to term loans. For example, when a business receives a $1 million dollar line of credit, it now has the option to use or not to use any portion of that sum to finance parts of the business. Lines of credit can be used to buy inventory and equipment among other things.

Letters of credit are basically promises of guaranteed payment. Letters of credit are often used for security in large construction jobs. If the contractor wants to be assured payment by the business that hired him, he can request a letter of credit from the business for the amount of the project. Then, if the business goes bankrupt in the middle of the construction, the builder can draw on the letter of credit and still get paid.

Corporate credit cards are similar to the credit cards that populate almost every college student’s wallet. The only difference is that a business can get multiple credit cards that are connected to the same credit limit. While a personal credit limit may only be $5,000, a corporate credit limit can easily reach hundreds of thousands of dollars.

A number of factors affect the type of lending facility a borrower will request. Of course the amount of the facility is important, but the repayment terms, the potential risk and the purpose for the facility should also be considered.

As with any business, banks also face risk through their operations. The old saying “lending friends money erases their memory” applies to commercial lending. There are a variety of reasons for missing a payment or defaulting on the entire loan that a bank must consider before approving a lending facility for a business.

To make a comparison, look at commercial lending departments and restaurants. The visible retail service that banks provide is similar to the fancy entrées that restaurants tout. Both are what people remember, but are not the primary money maker for either the bank or restaurant. In this respect, commercial lending is similar to soda. Nobody remembers that a restaurant makes more money off of the soda then an entrée. The same goes for the bank. Commercial lending makes more money for the bank than its retail deposit accounts.

Commercial lending is just one part of banking. Within the banking industry departments exist retail, personal and corporate investment banking, foreign currency exchanges and interest rate swaps.

This combination of services that banks provide ensure that they attract new customers, retain old ones and continue to create a revenue for themselves.