The rapid growth of a country in its various sectors of the economy is positively correlated to the sound and effective role of the banking system of that country. Commercial banks nonetheless play an active and essential role in the economic development of the country. The significance of the commercial banks in the economic development is derived from its visible influence on the money supply and the rate of investments within the economy.
Commercial Banks is defined as a bank that offers services to the general public and to companies. According to Prof. Kinley, “A bank is an establishment which makes to individuals such advances of money as may be required and safely made, and to which individuals entrust money when not required by them for use.” These institutions gained this name primarily in the US to merely get distinguished from the investment banks, however, and through the years this latter gained a special position within the US economy and become one of the pillars of the American and the world economies. This essay will briefly describe the history of commercial banks in the US and how they gained its throne in the kingdom of the banking system and in the American economy as well. Second, we will examine the different functions of commercial banks that lead to this position, and compare its impact on the financial system compared to another type of banks. Finally, I will try to evaluate the overall role of commercial banks within the American economy, and their financial scope.
Earlier in the 19th century, commercial banks were so common in the US. Although their role was not as sound and transparent as today, however, they conducted partially the same role played by the modern commercial banks of our time. Commercial banks started then as a hedging technique/investments for the wealthy individuals to participate in the entrepreneurial activities without bearing too much risk, thus its main customers were the entrepreneurs who had potentials but lacked the money and the rich people who had the money but lacked insurance to be involved in such investments. Although these forms of commercial banks were lacking transparency and soundness however it was thriving and assisted greatly in building the American economic evolution for years to come. However, In the other hand, the legislators saw it differently and decided to call for more organized and transparent financial institutions, their solution was to call for the establishment of a national bank.
In 1781, an act of the Congress of the Confederation established the Bank of North America in Philadelphia, and after 10 years in 1791, Congress chartered the First Bank of the United States to succeed the Bank of North America under Article One, Section 8. The bank, which was jointly owned by the federal government and private stockholders, was a nationwide commercial bank which served as the bank for the federal government and operated as regular commercial bank acting in competition with state banks..( Bowden, Elbert V. (1989). Money, Banking, and the Financial System. St. Paul, MN: West Publishing Company. p. 97. ISBN 0-314-72626-8). The failure of such organism called for more disciplined measures and the necessity for more regulated reforms. Unfortunately, This urge for controlling the banking system in America lead to a more complicated problem mostly developed in time within the Jackson era after the president of the United States Andrew Jackson, then a new problem of political origins that demonstrated the grave impact of political interference in the banking system could have a negative and destructive impact on the banking system operations. Eventually, this menace was gone by the introduction of a new era that freed the banking system with the introduction of the Michigan Act. That led to the Born of the “free banking era” which was derived by the encouragement of the creation of banks and that allowed the automatic chartering of banks that could fulfill the Michigan's chartering requirements so as to no longer require the special consent of the state legislature. However, this golden rash for the creation of banks created another problem knowing as the seigniorage caused by the issuance of notes against little or no security at all and the over expanded credits.
In 1864, the National Banking Acts of 1863 and 1864 was introduced by the Congress to correct the effect of the “free banking era” which created the United States National Banking System and provided for a system of banks to be chartered by the federal government. The National Bank Act encouraged the development of a national currency backed by bank holdings of U.S. Treasury securities. It established the Office of the Comptroller of the Currency as part of the United States Department of the Treasury, authorizing it to examine and regulate nationally-chartered banks.
In the early 20th century, the banking system and the legislators in the US saw the need for a more regulatory organism that oversees the banking system regulation and requirement and needs to ensure and better operation and more stable and safe economic environment. Therefore, in 1907, the Federal Reserve System was created by the Federal Reserve Act of 1913; this act created the present day Federal Reserve System and brought all banks in the United States under the authority of the Federal Reserve.
Today, commercial banks are the financial institutions where most of the people do their banking. They perform a variety of functions which commonly known in the developed and developing countries as “general banking” functions. These functions can be categorized into two categories; the first category is for its primary functions which include acceptance of deposits by mobilizing households savings or businesses; advancing loan (business, personal or mortgages); creation of credit by issuing bank deposits to traders; promote the use of cheques which is an easy medium of exchange for its customers transactions: financing and facilitating internal and foreign trade by issuing short-term loans to traders; and finally remittance of funds which is an operation that help customers to remit funds from one place to another by issuing bank draft, mail transfer, or telegraphic transfers. The second category is for its secondary function that includes first agency services which are the set of tasks that the bank do on behalf or at the request of its customers such as the collection and payment of credit instruments; purchase and sale of securities; collecting of dividends on shares; correspondent duties; income-tax consultancy; execution of standing orders and also as a trustee and executors. Besides the agency services the secondary functions include the general utility services that also include locker facilities; travelers cheques and credit cards; letter of credit ; collection of business statistics; acting as recommendation referee; underwriting securities; accepting bills of exchange on behalf of customers that import foreign goods; and finally it provides merchants banking services.
All these functions of commercial banks are a part of the household and businesses financial cycle and define and characterize the commercial banks as financial institutions.
The commercial banks' identity and much-defined functions are established in purpose to be differentiated from other types of banks especially investment banks. Although commercial banks deals only with businesses and individuals versus investment banks that only deals with institutions and high net clients this separation of functions and tasks was necessary to maintain and ensure the sound operation of these two separate institutions which the Glass-SteaGall Act of 1932 made sure to exist in order to ensure a more stable financial markets.
The commercial banks' role goes beyond its financial functions because they also have an economic role that can be summarized into two roles. The first role is that commercial banks constitute a payment system, this system makes sure on the effectiveness of our modern economy that has become based mostly on cheques, credit cards or online banking. In other words, most of the money supply within the economy is supplied by these institutions and the rest is issued through the Federal Reserve Bank. The second economic function is financial intermediation through lending or investing the money deposits into businesses, entrepreneurs or even governments. Therefore, create cash inflow and outflow in the economy, thus creating economic growth and development. This function is extremely important because it helps a generation of entrepreneurs to build the American economy and to for the ordinary businesses to keep their doors open from year to year.
Commercial banks are one of the strongest pillars of the American and the world economy, however with this great influence comes with its great impacts because besides of its financial functions commercial banks can influence the interest rates and thus influence inflation within the country, also the risk that can be correlated with the banking functions and practices that can literary cause for financial crisis such as the sub-prime mortgage loan crisis in 2008, in the other hand commercial banks have shown through its history that crisis only strengthen it's existing through more sophisticated regulation and through the introduction of new technologies that can make people’s lives easier.
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