What Is a Bank and How Does It Work?
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A bank is a financial institution that allows customers to deposit money, take out loans, and perform other financial transactions. Most people have a checking and savings account, although banks offer many other financial products designed to help you keep your money safe and earn interest on your savings.
The banking industry offers consumers a safe way to store their money and potentially earn interest on their funds. When customers deposit money in checking or savings accounts, banks can use these funds to make loans and charge interest, thus making a profit.
The banking industry is heavily regulated to help prevent fraud and to protect consumers and their hard-earned money. Additionally, deposits are usually insured up to $250,000 per depositor by the federal government, so you donโt need to worry about losing your money.
Learn more about the banking industry, the types of accounts most banks offer, and the regulations in place to protect banks and their customers.
There are several types of accounts you can get through a bank. The obvious ones are checking and savings accounts, though you can also get credit cards and loans through many banks.
A checking account is designed to be used as your everyday bank account. Most checking accounts come with a debit card that can be used to pay for routine purchases, like groceries or gas. Some also come with physical checks, though some newer banks have phased checks out completely as they have become much less frequently used than in the past.
You can set up direct deposit into your checking account, automatic bill payments for your utility and other bills, and automatic transfers to other accounts, such as savings. Checking accounts generally donโt pay interestโif they do, the rate will likely be minimal.
Savings accounts are designed to pay you a modest amount of interest on your money. Having at least one savings account you can access as needed is a good ideaโfor example, to house an emergency fund to help pay for unexpected home repairs, car repairs, or medical bills. You might also open a savings account to save for a specific purpose, such as a vacation or a down payment on a house.
Interest rates on regular savings accounts can be surprisingly low. However, some banks offer high-yield savings accounts, allowing you to maximize your returns and help your savings grow even faster.
A money market account (MMA) is a type of savings account that pays interest but comes with other benefits, such as a debit card or check-writing privileges. This generally makes a money market account easier to access than a traditional savings account.
Since you can spend the money from an MMA using a debit card or a check, itโs a good option if youโre saving for a large purchase, like a vehicle or a down payment for a home. When youโve reached your savings goal, you can simply write a check and have the money taken directly from your MMA rather than needing to transfer it to a checking account first.
Certificates of deposit, or CDs, offer an additional way to save money. Unlike with a traditional savings account or MMA, the money in a CD remains in the account for a predetermined period, which can be as little as a few months or as much as several years. The bank will determine the interest rate for a CD based on the term of the account. In general, the longer the term, the higher the interest rate. During the CD term, you canโt access the money without paying a penalty, which can negate the interest you earn on the money.
A CD is a good option if you have a lump sum of cash you want to save for a specific purpose. Keeping the money in a CD means youโre unlikely to dip into the funds since you wonโt want to risk paying a penalty. This allows the money to grow for the term of the account, and once the term is up you can either withdraw the money to use for a purchase or roll the funds into a new CD.
A credit card is a line of credit you can borrow against as needed to pay for everyday and unexpected expenses. When the bank approves you for a credit card, you can borrow up to a preset limit determined by the bank. If you carry a balance month to month, the bank will charge you interest.
A mortgage is a type of home loan you can get through a bank, credit union, or other financial institution. Mortgages allow you to borrow money to purchase a home and pay it back over the term of the loan, which is typically between 15 and 30 years.
If you own your home or have at least 20% equity (the amount you owe compared to the amount you owe on your mortgage), you may qualify for a home equity loan or a home equity line of credit (HELOC) from a bank. Borrowing from your home equity can help fund home improvements, education, medical expenses, or anything else you may need it for.
The main services banks offer are money management through checking and savings accounts or lending through credit cards or loans. However, many banks provide additional services, such as the following:
If you need a specific service from a bank, make sure it offers what you need before you sign up.
Although most banks provide the same types of banking services, not all banks are the same. Some operate out of physical locations, while others exist online only. Understanding how different types of banks work can help you find the right one for you.
Online banks do not have a physical location and exist solely online. If you use an online bank, you can transfer funds via the website or mobile app, and you can withdraw money from an in-network ATM. If the online bank doesnโt have its own branded ATMs, it may offer perks such as ATM fee reimbursement to make it easier for you to take out cash when you need it.
Online banks often provide higher APRs on savings than traditional banks, and many do not charge monthly maintenance or overdraft fees. However, depositing cash can be cumbersome. While you can usually deposit a check using a bankโs mobile app, thereโs often no easy way to make cash deposits in an online-only bank account.
Traditionally, banks had brick-and-mortar locations that you could visit to make transactions. Although there has been huge growth in the online banking industry, there are still many traditional banks that have physical locations where you can speak to a representative in person and perform actions such as cash deposits.
Brick-and-mortar banks also have online banking and mobile apps, but they may have a lower APR on savings and charge more fees than an online-only bank because they have higher overhead.
A neobank is a type of financial technology (fintech) company that provides banking services in partnership with a bank. Neobanks tend to offer unique benefits such as the ability to earn cash rewards on debit card purchases or free budgeting software to help you better manage your money. Neobanks mainly offer checking and savings accounts, though many also offer credit cards and loan services.
Banks in the U.S. are regulated by the Federal Reserve System (also called The Fed), as well as state entities. Banks that operate nationally are regulated by the Office of the Comptroller of the Currency (OCC), and those that carry insurance through the Federal Deposit Insurance Corporation (FDIC) are regulated by the FDIC.
Following the 2008 recession, the federal government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 to help measure the financial health of a bank on an annual basis. This legislation requires large national banks to undergo a โstress testโ each year that looks into their capital to ensure they have enough funds to continue operations if adverse economic or other conditions put them to the test. The act is designed to help prevent big banks from failing like they did in 2008.
Banks and credit unions perform similar functions; however, banks are for-profit entities, whereas credit unions are not-for-profit and are member-owned. Both offer similar services, including checking accounts, savings accounts, credit cards, and loans. However, credit unions tend to have higher interest rates on savings accounts and lower interest rates on loans and credit cards. Credit unions may also offer fewer services than banks.
Eligible bank deposits are insured up to $250,000 per depositor by the FDIC. Credit Union deposits are insured for up to $250,000 but are covered by the National Credit Union Administration (NCUA).
The choice between a bank and a credit union is an individual one. A credit union is likely the best choice if you want a say in how your financial institution is run and receive dividends as a member-owner. But if you prefer the perks of a larger bank, such as a more widespread ATM network or a more advanced mobile app or website, you may want to opt for a bank over a credit union.
With so many options available, choosing a bank can seem dauntingโbut it doesnโt need to be. By following a few simple steps, you can find your ideal bank and feel confident that your money is in good hands.
Before you start looking for a bank, you need to understand what types of accounts you want to have. For example, is there a specific type of savings account you want to open, such as a high-yield savings account or a CD? Do you want to be able to get a mortgage loan in the future from the same bank where you hold your checking and savings accounts? Make a list of the types of accounts youโll need, and check to see which banks or credit unions have these on offer.
Once you know what types of bank accounts you want, itโs time to decide which bank you want to work with. Do you want to be able to visit a brick-and-mortar location or are you okay with online-only banking? Are you interested in opening an account with a neobank to take advantage of any unique features they offer?
The next step is to understand your priorities. Is earning a high savings interest rate the most important factor? Do you want to use the latest mobile banking technology? Do additional features like budgeting tools or cash-back on debit purchases appeal to you? Make a list of your priorities and look for options that check those boxes.
Now that you know what youโre looking for from a bank, itโs time to see which ones will cater to your needs and compare them. List several banks that may work for you and write down what each one offers. Compare them to see which will be the best fit.
Once youโve decided which bank to work with, itโs time to open an account. Start with a basic checking and savings account, and once you have those you can look into any additional offerings you might be interested in.
Although it might sound tempting to hide your money under your mattress or tape it inside your toilet tank, depositing it into a bank account is the best way to keep it safe. Checking accounts are best for making everyday purchases with a debit card or with cash, while savings accounts hold your money in a safe location where it can earn interest.
Banks also offer loans, credit cards, and other services designed to help you successfully manage your money. Each bank is different, so itโs important to do your research and find one that best fits your financial goals.
Central banks exist to ensure the banking industry doesnโt fail, which would cause enormous ripple effects on customers and the economy. A countryโs central bank controls the nationโs money supply, which can help keep inflation levels low and the banking industry stable.
Investment banks, like Goldman Sachs and Morgan Stanley, cater to institutional investors (companies and other entities) versus individual investors (people). They make money by helping companies raise money and advising them on mergers and acquisitions, among other activities. For example, an investment bank would earn fees for issuing securities on behalf of a company, such as stock in an initial public offering (IPO).
The best place to bank will depend on your priorities. If you want to be able to visit your bank in person, you'll need to work with a bank that has brick-and-mortar locations. However, online banks and neobanks may offer additional perks that traditional banks canโt, so itโs important to do your research before deciding the best place for your banking needs.
A checking account is designed to be used for your everyday expenses, such as paying bills, buying groceries, filling your car with gas, or paying for streaming subscriptions. Checking accounts come with a debit card you can use at the point of sale, and many offer checks that you can write to pay for items where debit cards arenโt an option.
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