Learn more about banks and what they offer, how they work, the types and alternatives, and why you might want to use one.
Definition and Examples of Banks
Banks are financial institutions that offer various services to the public that make handling daily financial activities easier. They exist as safe places to deposit your money and receive a return you wouldn’t get by keeping your money at home. In addition, they provide credit for consumers, governments, and businesses short on cash.
Banks exist on federal and state levels. Each type may provide different services.
For example, Chase is a major bank. It offers services and products such as checking or savings accounts, loans, credit cards, investment and portfolio management, and wire transfers. It also provides business banking services for handling customer transactions and borrowing cash for daily operations and investments.
How Does a Bank Work?
In its most basic form, a bank accepts money from a customer and stores it safely. However, there is much more to banking than storing money—otherwise, you’d need to pay the bank to store your money for you. To keep from charging you for using their money-storing services, banks use small amounts of your money to help them stay in business. Some of the money you deposit in a savings account is used to offer financial services to other customers. In return, you’ll be paid interest.
For example, when a customer borrows money, the bank uses money from several customers’ accounts to fund the loan. The borrower pays the bank interest over the life of the loan, and the bank pays interest to the accounts it borrowed from. The bank’s profit is the difference between the borrower’s interest payments and the interest it pays you.
To ensure they have money to give customers when demanded, banks maintain a specific amount of reserves. These funds can come from customer cash deposits and other sources, such as purchased securities and money owed by other banks. The excess funds will be available for activities such as investing in securities and making loans.
While the Federal Reserve used to set a minimum deposit reserve ratio to help control the money supply, this requirement was waived on March 26, 2020.
Using customer deposits plays a crucial role in helping the economy function. For example, if a bank lends money to a customer, the lent money still shows as available in the accounts it is borrowed from, but the borrower has those funds also.
Essentially, money has been created in this process. This helps to increase the supply of money available to consumers within the economy, which encourages spending and increases aggregate demand. This stimulates production and sales, which help businesses grow.
Banks also make money by charging fees for various financial products and services. For example, you might pay a monthly maintenance fee for your checking account. Banks can charge overdraft and insufficient-funds protection fees if you go over your account balance. Other fees banks might charge are:
- ATM use
- Excess monthly withdrawals
- Wire transfers
- Safety-deposit-box rentals
- Online bill payments
- Loan origination and closing costs
- Paper statements
Examples of Bank Services
While specific products and services can depend on the type of bank, some common offerings include:
- Checking and savings accounts
- Certificates of deposit (CDs)
- Credit and debit cards
- Investment accounts
- Financial-planning advice
- Personal and business loans
- Mortgages and home equity loans, and lines of credit
- Safety-deposit-box rentals
- Merchant services
- Currency exchange
- Insurance products such as life and disability coverage
- Auto loans
- Student loans
- Online banking and ATM access
Bank Regulation and Deposit Insurance
The Federal Reserve oversees all national banks and state banks that opt to become members. State banks that aren’t Federal Reserve members are governed by the Federal Deposit Insurance Corporation (FDIC) and their state banking departments. In addition, the Office of the Comptroller of the Currency (OCC) oversees federal savings associations and national banks.
When you deposit money in a covered account type at an FDIC-insured bank, you get up to $250,000 in coverage for each depositor per bank. This coverage is for products such as checking and savings accounts and certificates of deposit, but it doesn’t extend to stocks, bonds, annuities, or similar investments.
Types of Banks
When choosing which bank to work with, consider that different types of banks cater to specific customers’ needs. Some common types of banks include central, retail, online, commercial, and investment banks.
Central banks such as the U.S. Federal Reserve System oversee the monetary policy of one or more countries. Some of their duties include controlling how much money is available, regulating overseen banks to protect customers, ensuring safe payment settlement, and stabilizing a country’s economic system.
Retail banks focus on individual customers rather than businesses. They’re where the average person would go to open a savings account, apply for a personal loan, or get a credit card. These banks usually also have convenient branches for in-person customer service.
Online banks do not offer branches you can physically visit. Instead, you handle all transactions remotely, such as through the bank’s app, website, or an ATM. This often means you can easily make account transfers and deposit checks, but you may not be able to deposit cash. In exchange for not having access to traditional in-person services, you may get better rates and experience lower fees with these banks.
Brick-and-mortar banks usually offer the convenience of internet banking services.
Commercial banks offer similar services as retail banks but focus on corporate customers. These banks supply credit for property and equipment, currency exchange, merchant accounts, and payroll services. They also offer solutions to help businesses with managing cash flow.
Investment banks help businesses and governments raise money and handle transactions such as acquisitions and mergers or initial public offerings (IPOs). Other investment banking services include asset management and securities trading.
Alternatives to Banks
Other financial institutions such as savings and loan associations and credit unions might cater to a specific group or offer narrower products and services than banks usually provide.
Savings and Loan Associations
Also known as a thrift, a savings and loan association focuses on offering mortgages to facilitate homeownership. Like banks, these financial institutions accept customer deposits that they can use to extend mortgages and other loans. Other financial services offered include car loans, home equity loans, credit cards, and some business services. In addition, many of them have FDIC coverage.
Credit unions offer similar services to banks but operate as member-focused not-for-profit institutions. Unlike most banks, credit unions require you have a specific association to join. For example, you might need to live in a particular community or have a specific occupation. These institutions usually have a maximum of $250,000 in deposit insurance for qualifying accounts through the National Credit Union Administration.
Credit unions tend to offer better interest rates for loans and deposits than banks.
Do I Need a Bank?
Banks play such a significant role in everyday financial transactions that you’ll likely need one. For example, you’d need a bank account if you want your paychecks or tax refund directly deposited. Plus, unless people are willing to lend you money personally, you’ll need a bank for a loan for a home, car, or other major purchase. Banks also can provide professional financial advice for significant decisions such as saving for retirement.
In addition, you’re given the security that you can’t get by keeping your cash at home or in your wallet. There’s less chance of having your money lost or stolen at a bank. You can also access it conveniently through debit cards, ATMs, online transfers, checks, and in-person transactions.
- Banks use money deposited by customers to extend loans to those who need money.
- To ensure safety and fairness for customers, various federal and state agencies oversee banks.
- Along with various checking and savings accounts, banks offer credit cards, personal and business loans, investment management, currency exchange, and safety deposit boxes.
- Central, investment, commercial, retail, and online banks serve different customers’ needs, while credit unions and savings and loan associations offer alternatives to banks.
- You’ll need a bank to receive or use money electronically, get a home loan, open a retirement account, or receive interest on your cash savings.
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