What Is a Bank?
A bank is a financial institution licensed to receive deposits and make loans. Banks may also provide financial services such as wealth management, currency exchange, and safe deposit boxes. There are several different kinds of banks including retail banks, commercial or corporate banks, and investment banks. In most countries, banks are regulated by the national government or central bank.
- A bank is a financial institution licensed to receive deposits and make loans.
- There are several types of banks including retail, commercial, and investment banks.
- In most countries, banks are regulated by the national government or central bank.
Banks are a very important part of the economy because they provide vital services for both consumers and businesses. As financial services providers, they give you a safe place to store your cash. Through a variety of account types such as checking and savings accounts and certificates of deposit (CDs), you can conduct routine banking transactions like deposits, withdrawals, check writing, and bill payments. You can also save your money and earn interest on your investment. The money stored in most bank accounts is federally insured by the Federal Deposit Insurance Corporation (FDIC), up to a limit of $250,000 for individual depositors and $500,000 for jointly held deposits.
Banks also provide credit opportunities for people and corporations. The bank lends the money you deposit at the bank—short-term cash—to others for long-term debt such as car loans, credit cards, mortgages, and other debt vehicles. This process helps create liquidity in the market—which creates money and keeps the supply going.
Just like any other business, the goal of a bank is to earn a profit for its owners. For most banks, the owners are their shareholders. Banks do this by charging more interest on the loans and other debt they issue to borrowers than what they pay to people who use their savings vehicles. For a simple example, a bank that pays 1% interest on savings accounts and charges 6% interest for loans earns a gross profit of 5% for its owners.
Banks make a profit by charging more interest to borrowers than they pay on savings accounts.
A bank's size is determined by where it is located and who it serves—from small, community-based institutions to large commercial banks. According to the FDIC, there were just over 4,500 FDIC-insured commercial banks in the United States as of 2019. This number includes national banks, state-chartered banks, commercial banks, and other financial institutions. Though traditional banks offer both a brick-and-mortar location and an online presence, a new trend in online-only banks emerged in the early 2010s. These banks often offer consumers higher interest rates and lower fees. Convenience, interest rates, and fees are some of the factors that help consumers decide their preferred banks.
How Are Banks Regulated?
U.S. banks came under intense scrutiny after the global financial crisis of 2008. The regulatory environment for banks has since tightened considerably as a result. U.S. banks are regulated at a state or national level. Depending on the structure, they may be regulated at both levels. State banks are regulated by a state's department of banking or department of financial institutions. This agency is generally responsible for regulating issues such as permitted practices, how much interest a bank can charge, and auditing and inspecting banks.
National banks are regulated by the Office of the Comptroller of the Currency (OCC). OCC regulations primarily cover bank capital levels, asset quality, and liquidity. As noted above, banks with FDIC insurance are additionally regulated by the FDIC.
The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 with the intention of reducing risks in the U.S. financial system following the financial crisis. Under this act, large banks are assessed on having sufficient capital to continue operating under challenging economic conditions. This annual assessment is referred to as a stress test.
Types of Banks
Retail banks deal specifically with retail consumers, though some global financial services companies contain both retail and commercial banking divisions. These banks offer services to the general public and are also called personal or general banking institutions. Retail banks provide services such as checking and savings accounts, loan and mortgage services, financing for automobiles, and short-term loans such as overdraft protection. Many larger retail banks may also offer their customers credit card and foreign currency exchange services. Larger retail banks also often cater to high-net-worth individuals with specialty services such as private banking and wealth management. Examples of retail banks include TD Bank and Citibank.
Commercial or corporate banks provide specialty services to their business clients, from small business owners to large, corporate entities. Along with day-to-day business banking, these banks also provide their clients with credit services, cash management, commercial real estate services, employer services, and trade finance, among other services. JPMorgan Chase and Bank of America are two popular examples of commercial banks, though both have large retail banking divisions as well.
Investment banks focus on providing corporate clients with complex services and financial transactions such as underwriting and assisting with merger and acquisition (M&A) activity. As such, they are known primarily as financial intermediaries in most of these transactions. Clients commonly range from large corporations, other financial institutions, pension funds, governments, and hedge funds. Morgan Stanley and Goldman Sachs are examples of U.S. investment banks.
Unlike the banks listed above, central banks are not market-based and don't deal directly with the general public. Instead, they are primarily responsible for currency stability, controlling inflation and monetary policy, and overseeing a country's money supply. They also regulate the capital and reserve requirements of member banks. Some of the world's major central banks include the U.S. Federal Reserve Bank, the European Central Bank, the Bank of England, the Bank of Japan, the Swiss National Bank, and the People’s Bank of China.
Bank vs. Credit Union
Credit unions vary in size from small, community-based entities to larger ones with thousands of branches across the country. Just like banks, credit unions provide routine financial services for their clients, who are generally called members. These services include deposit, withdrawal, and basic credit services.
But there are some inherent differences between the two. A bank is a profit-driven entity, while a credit union is a nonprofit organization traditionally run by volunteers. Created, owned, and operated by participants, they are generally tax-exempt. Members purchase shares in the co-op, and that money is pooled together to provide a credit union's credit services. Because they are smaller entities, they tend to provide a limited range of services compared to banks. They also have fewer locations and automated teller machines (ATMs).
How Do I Know My Money Is Safe in a Bank?
The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by Congress to maintain stability and public confidence in the U.S. financial system. The FDIC insures deposits; supervises and examines banks for safety and consumer protection. The standard insurance amount is $250,000 per depositor, per insured bank, for each account ownership category. You don't have to purchase this insurance—if you open a deposit in an FDIC-insured bank, you are automatically covered. This site can help you find FDIC-insured banks and branches.
Are Any Non-Bank Accounts Insured?
The mission of the Securities Investor Protection Corporation (SIPC) is to recover cash and securities in the event a member brokerage firm fails. SIPC is a nonprofit corporation that Congress created in 1970. SIPC protects the customers of all registered brokerage firms in the U.S. This applies to stocks and bonds (securities) and cash that a brokerage firm holds. Brokerage firms rarely fail or close suddenly, but if this occurs, the SIPC helps close the firm through liquidation and establishes claims processes by which it can protect the investor. SIPC protects your account for up to $500,000 in securities. This includes a limit of $250,000 in cash in your account. This link will show you a list of all registered SIPC members.
Should I Choose a Retail Bank, Credit Union, or Commercial Bank?
You should consider whether you want to keep both business and personal accounts at the same bank, or whether you want them at separate banks. A retail bank, which has basic banking services for customers, is the most appropriate for everyday banking. You can choose a traditional bank, which has a physical building, or an online bank if you don't want or need to physically visit a bank branch. You might consider a credit union, which is a nonprofit institution and is available to serve the needs of people with a common employer, labor union, or professional interest.
What Other Factors Go Into Choosing a Bank?
Bank size is another consideration. Large retail banks are often well-known, big-name banks and have locations throughout the U.S., which is convenient if you travel often for work or vacation. You would have easier access to your funds when you're away and may be able to avoid foreign ATM fees.
Otherwise, you might find that a smaller bank would offer more personalized customer service and the products you prefer. A community bank, for example, takes deposits and lends locally, which could offer a more personalized banking relationship.
Choose a convenient location if you are choosing a bank with a brick-and-mortar location. If you have a financial emergency, you don't want to have to travel a long distance to get cash.
See if the bank you are choosing offers other services such as credit cards, loans, and safe deposit boxes. Some banks also offer smartphone apps, which can be useful.
Check the fees associated with the accounts you want to open. Banks charge interest on loans as well as monthly maintenance fees, overdraft fees, and wire transfer fees. Some large banks are moving to end overdraft fees in 2022, so that could be an important consideration.
The Bottom Line
There are many types of banks offering varying levels of service and products so that they can meet virtually any banking need. A little bit of research and comparison will ensure you find the right fit for safeguarding your money, establishing credit, making payments, applying for loans, receiving funds, and saving money for future needs such as retirement, emergencies, homebuying, and so on.