What this lesson teaches
I can explain the roles of central banks and commercial banks.
Syllabus K343, 3.1.2. Banking: role and importance of central banks; role and importance of commercial banks
Make a guess
You deposit $10,000 in a bank. What does the bank mostly do with it?
- Keeps it locked in a vault in case you want it back.
- Lends most of it out to borrowers.
- Sends it to MAS, which keeps deposits safe.
Show the answer
Lends most of it out to borrowers.
Banks keep only part of deposits as cash. Lending the rest earns interest and lets savings fund homes and businesses.
Commercial banks take deposits, make loans and handle payments, linking savers with borrowers.
A commercial bank is a bank that deals with the public and businesses. It is usually a private firm that aims to make a profit. In Singapore, DBS, OCBC and UOB are examples.
It accepts deposits and keeps people's money safe. It makes loans to households and firms, such as home loans and business loans. It handles payments, through cards, transfers and cheques.
Banks make profit by charging a higher interest rate on loans than they pay on deposits. They also earn fees for services such as currency exchange and financial advice.
Commercial banks matter to the economy because they channel savings to borrowers. Firms can borrow to invest in new machines, and households can borrow to buy homes. This supports growth.
- Commercial bank
- Deals with the public and firms; usually profit-making.
- Main roles
- Accept deposits, lend, handle payments.
- Importance
- Channels savings into loans for investment and home buying.
Worked example: Following a deposit through the bank
Suppose Mrs Tan deposits $10,000 in a savings account.
- The bank pays Mrs Tan 1% interest a year: $100.
- It lends most of the money to a small firm buying a delivery van, charging 6% interest.
- The firm grows and hires a driver, so the saving has funded investment.
- The gap between 6% and 1% is the bank's income, from which it pays its costs and earns profit.
Watch out for this
Banks keep all their customers' deposits locked in a vault.
Banks keep only a part as cash. They lend most of it out, which is how they earn interest and how savings reach borrowers.
Check your understanding
Which of these is a service a commercial bank offers households?
- Taking deposits and lending to buy homes
- Issuing the country's own notes and coins
- Deciding the exchange rate policy for the whole country
Show the answer
Taking deposits and lending to buy homes
Right. Commercial banks hold savings and make loans to households and firms.
Check your understanding
How does a commercial bank mainly make a profit?
- It collects taxes for the government from each customer
- It keeps every deposit safe in its vault without lending it
- It prints extra money whenever it needs more cash
- It charges more interest on loans than it pays on deposits
Show the answer
It charges more interest on loans than it pays on deposits
Right. The gap between the two interest rates is the bank's main income.