How Do Banks Work?
A bank is a type of financial institution authorized to grant loans and accept deposits for checking and savings accounts. Individual retirement accounts (IRAs), certificates of deposit (CDs), currency exchange, and safe deposit boxes are other services that banks offer.
Retail banks, commercial or corporate banks, and investment banks are just a few of the several sorts of banks.
In the United States, banks are subject to both federal and state regulation.
Banks: An Overview
At least since the 14th century, banks have existed. They give customers and business owners a secure place to store their money and a source of loans for both individual purchases and business endeavors. The money that is deposited is then used by the banks to provide loans and generate interest payments.
Since the Medici family began dabbling in banking during the Renaissance, the core business model hasn’t altered much, but the variety of products that banks offer has expanded.
Basic Bank Services Banks provide a variety of options to borrow money as well as ways to store your cash.
Savings Accounts
Consumers and businesses utilize checking accounts as deposits to pay their bills and withdraw cash. They often come with monthly fees, usage fees, or both and pay little to no interest.
Most modern consumers have one of these accounts regularly credited with their wages and other recurring payments.
Deposit Accounts
Savings accounts reward the depositor with interest. Account holders can open a certificate of deposit (CD), which pays somewhat higher interest, or a conventional savings account, which pays minimal interest, depending on how long they want to keep their money in the bank. The CDs can generate interest for a few months or for five years or longer.
It is crucial to remember that the federal government, through the Federal Deposit Insurance Corp., insures the funds in checking accounts, savings accounts, and CDs up to a limit of $250,000 in value (FDIC).
Loan Services
Banks give loans to consumers and companies. Their customers deposit cash, which is then lent to more customers at a higher interest rate than the depositor is paid.
At its core, this procedure is what keeps the economy growing. People deposit money in banks, and the banks lend it out in the form of business loans, mortgages, credit cards, and auto loans. The method keeps money flowing through the system as the loan recipients use the money they borrow and the bank makes interest on the loans.
A bank’s objective, like that of any other business, is to generate a profit for its shareholders. The majority of banks’ shareholders serve as their owners. Banks accomplish this by charging borrowers for loans and other debt at a higher rate of interest than they do for those who use their savings accounts.
For instance, a bank might charge 6% interest on home loans while paying 1% interest on savings accounts, resulting in a 5% gross profit for the bank’s shareholders.
Banks both offline and online
Small, locally based organizations up to large, international commercial banks make up the banking industry.
In the United States as of 2021, there were little over 4,200 commercial banks that were FDIC-insured.
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National banks, commercial banks, state-chartered banks, and other financial institutions are all included in this total.
Traditional banks today provide both online services and physical branch sites. In the early 2010s, online-only banks started to appear.
Customers select a bank based on a variety of criteria, including interest rates, fees, and geographical convenience.
Who Regulates Banks and How?
After the 2008 global financial crisis, U.S. banks came under increasing scrutiny. As a result, the regulatory environment for banks was significantly strengthened.
U.S. banks may be subject to state, federal, or both levels of regulation, depending on their organizational structures. Each state’s department of banking or department of financial institutions oversees the regulation of state banks. This organization is generally in charge of things like allowed practices, the maximum interest rate a bank can charge, and auditing and inspecting banks.
The Office of the Comptroller of the Currency oversees national banks (OCC). OCC regulations mainly deal with the capitalization rates, asset quality, and liquidity of banks. As mentioned above, the FDIC also controls institutions that have FDIC protection.
Dodd-Frank Act Following the financial crisis, the Wall Street Reform and Consumer Protection Act was passed in 2010, with the goal of lowering risks in the American financial system. Large banks are now subject to recurring examinations to see if they have enough capital to continue operating in uncertain economic times. The term “stress test” refers to this annual evaluation.
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Various Banks
The majority of banks fall into one of three categories: investment, commercial, or retail. For each of these categories, the large international banks frequently run distinct arms.
Consumer banks
Retail banks provide services to the general public and typically have branch locations in addition to their main locations for the benefit of their clients.
Numerous services are offered by them, including checking and savings accounts, loan and mortgage services, auto financing, and short-term loans like overdraft protection. Several also provide credit cards.
Additionally, they provide access to assets through mutual funds, individual retirement accounts, and CDs (IRAs). The largest retail banks also provide high-net-worth clients specialized services including wealth management and private banking.
TD Bank and Citibank are two instances of retail banks.
Corporate or commercial banks
Commercial or corporate banks customize their services for business clients, ranging from sole proprietors to major corporations. These banks provide trade finance, cash management, commercial real estate services, credit services, and employer services in addition to regular business banking, Commercial banks include JPMorgan Chase and Bank of America, although both have sizable retail banking departments as well.
Investment banks
Investment banks are primarily focused on offering complicated services and financial transactions to corporate clients, such as underwriting and aiding in merger and acquisition (M&A) activity. In these deals, they serve largely as financial mediators.
Large enterprises, other financial institutions, pension funds, governments, and hedge funds are just a few of their clientele.
Among the largest investment banks in the United States are Morgan Stanley and Goldman Sachs.
Banks, central
The public is not directly served by central banks, in contrast to the banks mentioned above. A central bank is an autonomous organization that has been given permission by the government to manage the country’s monetary policy and money supply.
As a result, central banks are in charge of maintaining the currency’s and the economy’s overall stability. Additionally, they play a part in governing the capital and reserve requirements for the country’s banks.
The central bank of the United States is the U.S. Federal Reserve Bank. Among its international counterparts are the People’s Bank of China, the European Central Bank, the Bank of England, the Bank of Japan, the Swiss National Bank, and the Bank of England.
Credit Union vs. Bank
Although credit unions provide banking services, they are not-for-profit organizations founded by and managed for the benefit of their members or consumers, as opposed to banks. Regular banking services are offered by credit unions to its members, who are typically their clients.
Credit unions are often tax-exempt organizations that are founded, owned, and run by their members. Shares in the cooperative are purchased by members, and the proceeds are used to support loans made by the credit union.
When compared to banks, they frequently offer a smaller selection of services. Additionally, they have fewer outlets and ATMs (ATMs).
How Can I Be Sure My Funds Are Secure in a Bank?
For the purpose of preserving stability and public confidence in the American financial system, Congress established the Federal Deposit Insurance Corporation (FDIC), an independent organization. To ensure that the money banks handle is secure, the FDIC monitors and audits them.
It also insures your financial assets. For each category of account ownership, the insurance maximum is $250,000 per depositor, per insured bank.
You are not required to get this insurance. You are automatically covered when you open a deposit at a bank that is FDIC-insured.
You can locate banks and branches that are FDIC-insured via the organization’s BankFind website.
Exist any insured non-bank accounts?
In the event that a member brokerage business collapses, the Securities Investor Protection Corporation (SIPCgoal )’s is to recoup funds and securities. Congress established SIPC as a nonprofit company in 1970. Customers of all U.S. registered brokerage businesses are safeguarded by SIPC. This is applicable to the cash and securities (stocks, bonds, etc.) that a brokerage business has. Brokerage businesses don’t frequently collapse or shut down suddenly, but if they do, the SIPC assists in liquidating the business and sets up claims procedures to safeguard investors. Your account is protected by SIPC for up to $500,000 in securities. This includes a cap on the amount of cash in your account of $250,000.
Which bank—retail, credit union, or commercial—should I pick?
You should think about whether you want to keep your personal and corporate accounts with the same bank or at different institutions. The best option for daily banking is a retail bank, which offers consumers basic financial services. If you don’t want or need to physically visit a bank branch, you can choose an online bank or a traditional bank with a physical location. You might think about joining a credit union, a nonprofit organization that can meet the requirements of people who share an employer, labor union, or professional interest.
What Other Elements Affect Bank Selection?
Another factor to consider is bank size. If you frequently travel for job or pleasure, it is advantageous since large retail banks frequently have facilities across the United States and are well-known, big-name institutions. When you’re abroad, it would be simpler for you to access your money, and you might be able to avoid paying foreign ATM fees.
Otherwise, you might discover that a smaller bank offers your preferred products and more individualized customer service. For instance, a community bank may provide a more individualized banking experience because it accepts local deposits and makes local loans.
If you are picking a brick-and-mortar bank, pick one that is in a handy location. You shouldn’t need to drive far to get money if you have a financial emergency.
Look into the availability of other services from the bank you are considering, such as credit cards, loans, and safe deposit boxes. Additionally, some banks have smartphone apps, which might be helpful.
Look up the costs for the accounts you want to open. In addition to monthly maintenance fees, overdraft fees, and wire transfer fees, banks often impose interest on loans. Overdraft costs are scheduled to be eliminated by certain major banks in 2022, so that could be a crucial factor.
The conclusion
At the absolute least, a bank is a place where you keep your money until you need it to make a withdrawal or pay your bills. It may also be the location where you obtain a mortgage to purchase a home or a loan to buy a car. If you own a small business, you might go there to obtain financing for growth or improvement.
You should compare the various fees and charges associated with your accounts and any loans you may require before selecting a bank. Finding the best option for managing your finances, building credit, making payments, requesting loans, getting money, and conserving money for purposes like retirement, emergencies, and home purchases will require some study and comparison shopping.
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