How Do Banks Work? | Banking Advice

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What is a bank? A bank is a financial institution authorized to provide service options for customers who want to save, borrow or accrue more money.

Banks typically accept deposits from, and offer loans to, their customers. They may also offer check-cashing or issuing services, credit or debit cards, and insurance options.

Banks are not the only place where you can seek financial services; check-cashing businesses can help you receive funds without a checking account, for example. Credit unions also allow you to deposit and withdraw funds. But while banks may offer similar financial services as credit unions, banks are for-profit businesses that direct most of their financial returns to their shareholders. Learn more about how banks work and what services they offer.

Think of a bank as the intermediary that manages and enables a connected chain of interrelated financial activities. When you deposit money into a bank account, the bank takes that money and uses it to provide loans to other people. Those borrowers then pay the loan back to the bank, with interest, over a fixed time. As the borrowers pay off their loans, the bank pays a fraction of the paid interest to its account holders for allowing it to use the deposited money for issued loans.

To further your personal and business interests, banks provide a large variety of financial services. Here are some of the many services a bank may offer you:

  • Certificates of deposit, or CDs, are financial products through which the bank pays you a fixed interest rate for making a deposit, an amount you can’t touch without incurring a penalty before a predetermined date.
  • Checking accounts allow you to deposit and withdraw money and manage your everyday finances., although checking accounts are used to make daily purchases while savings accounts are intended for protecting and slowly growing your funds.
  • Credit cards are a type of revolving credit line that allows you to make purchases without paying cash. Most banks offer credit cards and some, like Chase, offer a wide variety of cards.
  • Loans are issued by financial institutions to individuals or businesses seeking to make large purchases for which they currently do not have the cash to afford. An interest rate is generally included in the repayment of the loan to incentivize its origination.
  • Money market accounts are savings products that also include checking account features, like debit card transactions.
  • Safe deposit boxes are containers held in a secure facility, like a bank vault, where a key holder can place and remove valuable objects like jewelry or important documents.
  • Savings accounts earn a higher interest rate than checking accounts and are a good place to keep your money liquid while it grows.

What Are the Different Types of Banks?

Banks are not one-size-fits-all operations. Different types of customers will find that some banks are better financial partners for their goals and needs than others. Here are some types of banks:

  • Central banks, like the Federal Reserve System in the U.S., help manage the monetary policy considerations of a country or a collection of countries by setting interest rates and handling inflation. The Federal Reserve regulates other banks based in the U.S., although it is not the only government agency that does so.
  • National Banks offer a wide breadth of services with ATMs and branches all across the country.
  • Community banks may offer fewer financial services across a smaller geographic footprint, compared to national banks. However, unlike national banks, regional banks thrive along with the community they serve – often incentivizing them to work more closely with their patrons.
  • Online banks do not have physical locations but tend to provide better interest rates on loans or accounts than banks with physical locations. Transactions with these online-only institutions generally occur over a website or mobile app and thus are best for someone who does not require in-person assistance and is comfortable with doing most of their banking digitally.
  • Investment banks are financial institutions that help broker major asset transactions, like mergers and acquisitions of large corporations.

The practice of seeking and issuing loans has been in place for millennia, with the earliest examples stemming from ancient Mesopotamian grain trades and transactions. Coins were later developed in 700 B.C. in a region that is now western Turkey, while the Chinese invented paper money during the Tang Dynasty, which ruled between A.D. 618 and 907.

The first modern bank in the U.S. didn’t emerge until after the Revolutionary War, when Alexander Hamilton, the first secretary of the Treasury of the U.S., persuaded lawmakers to issue a charter for a national bank. In late 1791, the first Bank of the United States opened in Philadelphia. Numerous branches opened in cities along the East Coast in the following years.

These are the five largest U.S.-headquartered banks in terms of consolidated assets as of March 31, 2023, according to the Federal Reserve System.

  1. JPMorgan Chase Bank – $3.27 trillion in assets.
  2. Bank of America Corp. – $2.52 trillion in assets.
  3. Citibank Inc. – $1.72 trillion in assets.
  4. Wells Fargo & Co. – $1.69 trillion in assets.
  5. U.S. Bancorp – $590 billion in assets.

Unless you plan to stash your cash under your mattress, you will eventually need to interact with a financial institution that can safeguard your money or issue you a loan. While a bank may not be the institution you eventually choose for your financial needs, understanding how banks operate and the services they provide can help you decide what to look for when making your selection.

How to Choose a Bank

You have a lot of options when picking a bank – make sure to find one that best suits your financial situation. The different types of banks all offer unique products and experiences. When choosing the best bank for you, consider the type of accounts and experience you want.

Once you’ve narrowed down your search, research the banks you are considering to get a better understanding of the experience they offer. Be aware of the interest rates and fees associated with the bank. Make sure whatever bank you choose is FDIC insured. This guarantees up to $250,000 per depositor and protects against bank failures.

Why Do You Need a Bank Account?

Having a bank account is an important part of navigating daily life. Really, you should have at least two accounts: a checking account and a savings account. As more transactions happen digitally, having a checking account becomes even more essential. A checking account lets you schedule automatic payments and pay bills online, and also receive paychecks and other regular transfers. The good news is that fewer and fewer households are “unbanked,” meaning they don’t have a checking or savings account.

A common reason people give for not having a checking or savings account is they say they can’t meet minimum balance requirements. The good news is more and more banks are offering free checking accounts with no fees or account minimums.

How Do Banks and Credit Unions Compare?

Banks and credit unions generally do the same thing – help you manage your money. There are a bunch of differences under the hood, however. A credit union is a nonprofit financial institution owned by its members. A bank is a for-profit institution owned by shareholders. Banks are typically larger than credit unions, with the largest banks offering services at thousands of branches and ATMs. With their larger size banks can offer a wider range of services, but credit unions offer a more personal experience. Learn more about the differences between banks a credit unions.

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