Banks generally help people and businesses manage cash and liquidity. They typically organize around a specific customer type, providing services that the customer needs most. Commercial banking, for example, caters to small and mid-size businesses.
Read on to learn what commercial banks do, how they differ from retail or investment banks, and what to look for when choosing a commercial bank.
What is commercial banking?
Commercial banking is a set of financial services designed for businesses. Those services include things you'd expect from any bank, such as checking accounts, savings accounts, and loans. But commercial banks also have business-specific offerings like payment processing, lockbox services, international trade support, letters of credit, payroll support, asset-based loans, and working capital lines of credit.
Not all businesses need those added services, of course. That's one reason why entrepreneurs initially operate side hustles through their personal bank accounts. But there are milestones that can prompt the start of a commercial banking relationship. These include:
- Accepting check payments
- Applying for a federal employee identification number (EIN)
- Incorporating the business
- Requiring financing for business expansion
- Opening a retail location that accepts credit card payments
The IRS does require limited liability corporations (LLCs) and corporations of any size to maintain separate accounting records. Managing the business's cash flow through deposit accounts at a commercial bank supports that requirement.
Commercial banks vs. digital payments accounts
Commercial banking services overlap with financial services offered by nonbank providers -- namely PayPal (PYPL -0.55%) and Venmo. PayPal and Venmo both hold business deposit balances. They also both accept customer payments and offer easy transfers from business to personal accounts. PayPal additionally provides business loans through a partner.
Although these nonbank providers are easy to use, they have some drawbacks relative to commercial banks, including:
- Not directly insured. PayPal and Venmo don't have FDIC insurance on deposits. Some balances may qualify for pass-through insurance from partner banks. Unfortunately, this depends on the use of specific services such as a debit card. Also, pass-through insurance only applies if the partner bank fails. There's no protection against PayPal or Venmo failure.
- No interest on deposits. Neither PayPal nor Venmo currently pay interest on business deposits.
- Limited options for check and cash deposits. Depositing cash and check payments to PayPal or Venmo can be difficult. PayPal doesn't accept check deposits in business accounts, for example. You can deposit cash, but you must go to a partner store, show a barcode, and pay a fee. Venmo does not support check deposits in business accounts.
Given those limitations, it usually makes sense to combine a digital payment account with a traditional commercial bank account. Even if you plan to lean heavily on the nonbank provider for customer payments, you can use a low-fee commercial bank account to streamline cash and check deposits and, possibly, earn some interest income. You'll also get the peace of mind that comes with FDIC insurance on your deposits.
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