Business of Banking Definition

Business banking is a division of a bank or financial institution that deals exclusively with businesses and corporate clients, providing products such as business loans, asset management, and electronic fund transfers that are tailored to their specific needs. Although banks place a strong emphasis on this area because it is a significant source of profit, interest rates and fees for corporate clients are often higher than for retail consumers.

Understanding Business Banking

Commercial or corporate banking are other terms for business banking. Small and medium enterprises, as well as larger corporations, need banks for financial and consulting services. These services are customised to meet the demands of each company. Deposit accounts and non-interest-bearing products, real estate loans, commercial loans, and credit card services are among these services. Asset management and securities underwriting are two services that banks may provide to their corporate and business clients.

The Glass-Steagall Act, commonly known as the Banking Act of 1933, mandated investment banks and retail/commercial banks to be separate organisations in the past. After portions of the statute were repealed in 1999, this changed. Banks could now offer corporate, retail, and investment banking services all under one roof under the new guidelines.

As the business sector in the United States grows, so does the demand for business banking. Since 2002, when there were 7,870 commercial banks, there have been 4,708 commercial banks, down from 7,870 in 2002. Mergers and acquisitions have had a major role in this. Wells Fargo, JPMorgan Chase, and Bank of America have the highest market share in corporate or business banking, with JPMorgan Chase being the largest commercial bank in the United States with $142 billion in revenue in 2019. It’s worth noting that these banks also function as investment banks and retail banks, allowing them to broaden their client base and product offerings.

1. Overdraft Facility

When a company’s cash requirements exceed the available balance in its current account, it often takes out an overdraft from a bank, for which the bank charges interest. Overdrafts are frequently used as a backup source of cash for unexpected expenses. For small and medium businesses, an overdraft is a typical source of liquidity.

Example- If a small retail company in New York needs emergency cash to pay suppliers, it can take out a secured overdraft against its bank’s fixed deposit. Because the overdraft is secured by a fixed deposit, the interest rate will be reduced, and the firm will be able to pay off the principal and interest on cash receivables.

2. Bank Loan or Term Loan

When a company wants to expand its operations, such as by purchasing a new property, plant, or machinery, it usually opts for a bank loan with a fixed duration and a fixed or variable rate of interest. The lending companies can expand their business with the help of the bank without depleting their cash reserves.

3. Letter of Credit

In international trade, a letter of credit, or LC, is commonly employed. If the importer (or buyer) is unable to complete the payment, the letter of credit agreement stipulates that the issuer of the LC, i.e., the bank, will make the whole or remaining payment to the exporter (or seller) on behalf of the buyer.

Types of Letter of Credits

• Standby Letter of Credit: In this sort of LC, the bank only pays the sum if the LC applicant is unable to pay.

• Traveller’s Letter of Credit: This sort of LC is beneficial to travellers because issuing banks honour payment requests made at banks in other countries.

• Revolving Letter of Credit: This sort of LC lets you to make as many payments as you like within a particular time frame.

• Confirmed Letter of Credit: There are two banks involved (the issuing bank and the confirming bank); if the issuing bank or the holder of the LCs is unable to make a payment, the confirming bank ensures that the seller gets paid.

Example-

Let’s say a furniture company in the United States, Ladder Inc., wishes to sell $100,000 worth of furniture to a company in Kenya, ABC. Nonetheless, Ladder Inc. is concerned about the ability of Kenyan businesses to pay them.

To deal with this, Company ABC obtains a letter of credit from its bank, Bank of Kenya, stating that either Company ABC would make good on the $100,000 payment within 60 days, or Bank of Kenya will pay the bill. The letter of credit is subsequently sent to Company Ladder Inc., which agrees to ship the furniture.

After the shipment is delivered, Company Ladder Inc. requests $100,000 from the Bank of Kenya by producing a written draft (also known as a bill of exchange).

4. Treasury and Cash Management Services

Treasury management services, such as payment collection, are provided by banks. Disbursements, trading, and bond and foreign exchange investments. Banks have a separate department dedicated to treasury management and charge a set fee for these services.

Example-Assume that a company in the export industry has a regular requirement for foreign currencies. The corporation can then use the treasury service of the bank to obtain the best foreign currency rate.

Conclusion

Business banking refers to a company’s financial dealings with a financial institution that specialises in providing business loans, credit, savings accounts, and checking accounts to businesses rather than individuals.

When a bank, or a subsidiary of a bank, only deals with businesses, it is known as business banking. A retail bank is one that mostly deals with individuals, whereas an investment bank is one that primarily deals with capital markets. Some financial institutions cater to both categories of customers.