Banks and various financial entities provide tools and services essential for managing your finances. Whether dealing with a checking or savings account, navigating credit card usage, or managing a loan, your financial well-being is closely linked to these institutions. They play a crucial role in the economic landscape by offering avenues for lending, investing, saving, and conducting everyday financial operations such as deposits and bill payments.
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Let’s define what a Bank is.
A bank is a financial entity subject to regulation by federal and state authorities. Its core function involves accepting deposits and providing loans. However, banks also deliver a diverse array of products and services, encompassing:
- Deposit accounts (checking accounts, savings accounts, CDs, money market accounts)
- Loans, including mortgage loans, car loans and personal loans
- Credit cards
- Check-cashing services
- Wealth management services
- Insurance
- Business Banking
In the United States, most banks are protected by the Federal Deposit Insurance Corporation (FDIC). This means that if a bank goes under, the FDIC ensures that depositors’ accounts are covered up to certain limits. Presently, the coverage provided by the FDIC is up to $250,000 for each depositor, for each type of account ownership, at each insured bank.
There are various categories of banks, each serving different needs (refer to the section below on Types of Banks). In this context, our focus is primarily on retail banks.
What exactly is a Financial Institution?
A financial institution is an organization that provides financial services to its clients or members. These services can include various financial transactions and activities, such as accepting deposits, providing loans, offering investment products, managing assets, and facilitating payments.
Examples of financial institutions include:
- Banks
- Investment broker-dealers
- Small business investment companies
- Insurance companies
- Credit unions
- Mortgage lenders
- Credit card companies
Its category usually determines the activities or financial transactions a financial institution undertakes. For instance, institutions specializing in mortgages provide home loans, whereas credit card firms offer consumers access to revolving credit. Additionally, these institutions often fall under the regulatory oversight of government bodies. For example, the Securities and Exchange Commission (SEC) oversees investment brokers and dealers, ensuring they adhere to legal standards and practices.
How Do Banks and the Banking Industry Operate?
Banks, including traditional physical branches and digital platforms, facilitate the movement of funds among individuals and enterprises. They provide deposit accounts as safe havens for customers to store their money. Banks then utilize the funds accumulated in these accounts to extend credit to other individuals or businesses needing financing.
In exchange, banks earn interest from the loans they provide to borrowers. A portion of this interest income is paid back to the depositors, usually through interest on savings accounts, money market accounts, or certificates of deposit (CDs). Banks’ primary sources of income are the interest collected from loans and the various fees charged to their customers for different banking services.
Fees charged by banks can be associated with particular products, like bank accounts, or linked to financial services they offer. For instance, an investment bank providing portfolio management to its investors might impose a service charge for this assistance. Similarly, when a bank issues a mortgage loan to a home purchaser, it might levy an origination fee for processing the loan.
The banking sector operates under strict regulation. The Federal Reserve System supervises banks and financial institutions, working with state regulatory bodies to ensure adherence to appropriate guidelines. Additionally, banks fall under the regulatory purview of other federal entities, such as the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and the Federal Deposit Insurance Corporation (FDIC), which help maintain the integrity and stability of the banking system.
Types of banks
The term “bank” covers a wide array of financial institutions, each distinct in the services and products they offer and their roles within the economy. While some banks are consumer-oriented, directly serving individuals and businesses, others fulfil more specialized functions that influence the overall movement of money in the economy. Diving into the spectrum of banking, you’ll discover a variety of types, including:
- Central banks
- Retail Banks
- Commercial banks
- Investment banks
- Shadow banks
- Savings and loan associations
- Credit unions
Central Banks
Central Banks are pivotal institutions that regulate a nation’s or a group of nations’ money supply. They are crucial in formulating monetary policy, supervising currency circulation, and determining foundational interest rates. Essentially, they are the main support structure for a country’s banking system, ensuring stability and guiding economic policy.
In the United States, the Federal Reserve serves as the central bank. It is structured around 12 regional Federal Reserve Banks. The Federal Reserve generates income through interest on its securities, and its net earnings are transferred to the U.S. Treasury. Within the Federal Reserve System, banks carry out four key responsibilities, which include:
The Federal Reserve System banks have specific roles crucial to the functioning of banking in the U.S. These roles enable a wide range of financial activities for consumers, from online purchases using a debit card to securing a home loan. Their duties include:
1. Supervising and inspecting banks that are members of the state system to ensure they comply with financial regulations.
2. Providing loans to deposit-holding institutions to maintain liquidity and stability in the financial system.
3. Offering essential financial services that support the operation of the nation’s payment system, facilitating transactions efficiently.
4. Conducting examinations of financial institutions to uphold the integrity and safety of the banking ecosystem.
These functions form the backbone of the U.S. banking system, ensuring its smooth operation and the availability of financial services to the public.
Retail Banks
Retail banks are the type of banks that typically come to mind for most individuals when they think about banking. They provide various services such as loans, deposit accounts, and other banking services to individual consumers and small business owners.
Retail banks can operate as traditional brick-and-mortar establishments with physical branches where customers can conduct transactions in person or as online banks that offer the convenience of managing finances entirely through a digital app.
Banking services provided by non-traditional bank entities also fit into this broad category. For instance, an emerging group of financial technology startups, known as neobanks, provide deposit accounts similar to those at a traditional bank.
These companies collaborate with established banks to deliver FDIC-insured banking products and services despite not being banks in their own right.
Commercial banks
Commercial banks are primarily focused on serving businesses or corporations, but they can also address the banking needs of individual customers. Like retail banks, commercial banks offer various services, including making loans, providing deposit accounts, and other banking services such as international banking and payment processing.
These banks offer a broad spectrum of services to their clients. For instance, a commercial bank might provide loans for real estate or business equipment, charging interest and fees to borrowers to use the funds. Additionally, many commercial banks offer commercial and retail banking services under the same roof, allowing them to cater to various financial needs.
Investment banks
Investment banks engage in activities such as trading securities, managing investor portfolios, or combining services. They serve as intermediaries for investors looking to enter the financial markets, aiding in the buying and selling securities. Additionally, they provide investment advice to their clients.
Beyond serving individual investors, investment banks play several other critical roles. They are involved in the underwriting process for companies preparing to go public through an Initial Public Offering (IPO).
Investment banks also play a pivotal role in facilitating mergers and acquisitions for corporate clients, ensuring these complex financial transactions are executed smoothly.
Shadow banks
Shadow banks differ significantly from traditional banking institutions regarding their operations and regulatory oversight. These nonbank financial entities typically operate outside the conventional banking regulatory framework and mainly concentrate on investing in credit and debt markets.
Examples of shadow banking institutions include insurance companies and hedge funds, which engage in activities similar to those of banks but without the same level of regulation.
The shadow banking system and its institutions were critical players in the 2008 financial crisis, contributing to the complexity and severity of the economic downturn due to their significant involvement in the credit markets without the regulatory safeguards that apply to traditional banks.
Savings and loan associations
Savings and loan associations, also known as thrifts, are specialized financial institutions that primarily focus on assisting individuals with borrowing money to purchase or refinance homes. Historically, these institutions were limited to offering savings deposit accounts, which is how they earned the nickname “thrift.”
Unlike traditional banks, which are usually insured by the Federal Deposit Insurance Corporation (FDIC), savings and loan associations are often insured by the Savings Association Insurance Fund (SAIF), providing a different layer of security for depositors’ funds.
This distinction highlights their unique position in the financial services sector, particularly in supporting homeownership.
Credit unions
Credit unions, or cooperative financial institutions, provide services similar to traditional retail banks. However, the critical difference lies in their operational model: credit unions operate not-for-profit, unlike retail banks, which aim to generate profits.
Credit unions are established and run by members who contribute their funds to the pool and have a say in the institution’s governance. To become a part of a credit union and open an account, one must meet specific membership criteria, which could be related to where they live, their place of employment, religious beliefs, or military service.
Instead of being covered by the Federal Deposit Insurance Corporation (FDIC) like most traditional banks, credit unions are typically insured by the National Credit Union Administration (NCUA), offering a different form of protection for members’ deposits.
Banks vs credit union
Banks and credit unions share the goal of assisting consumers and small businesses in managing their finances. They often provide comparable banking products, including:
- Checking accounts
- Car loans
- Certificates of deposit (CDs)
- Business bank accounts
- Business loans
- Money market accounts (MMAs)
- Home loans
- Savings accounts
- Personal loans and lines of credit
- Credit cards
The primary distinction between banks and credit unions lies in their operational models. Banks typically function to generate profit, which can lead to higher fees for their customers or higher interest rates on loans. In contrast, credit unions operate not-for-profit, often resulting in lower costs and more favourable loan interest rates for their members.
Regarding the protection of deposits in the event of institutional failure, both banks and credit unions offer similar levels of security. However, each insurance provider is different: banks are insured by the Federal Deposit Insurance Corporation (FDIC), while the National Credit Union Administration covers credit unions.
Additionally, unlike banks, credit unions have membership requirements that must be met to open an account, which can be based on factors such as geography, employment, religious affiliation, or military service.
Here’s a comparison table highlighting 10 key differences between banks and credit unions:
| Feature | Banks | Credit Unions |
|---|---|---|
| Ownership | Owned by shareholders and investors. | Owned by members (customers) of the institution. |
| Profit Orientation | Generally, higher fees compared to credit unions. | For-profit institutions aim to maximize profits for shareholders. |
| Fees | Generally higher fees compared to credit unions. | Often lower fees due to the not-for-profit model. |
| Interest Rates (Loans) | Tend to have higher loan interest rates. | Typically offer lower loan interest rates to members. |
| Interest Rates (Deposits) | May offer lower interest rates on deposits. | Often provide higher interest rates on savings and CDs. |
| Membership Requirements | No membership is required; services are available to the general public. | Membership required, often based on geography, employment, religious affiliation, or military service. |
| Insurance | Deposits insured by the Federal Deposit Insurance Corporation (FDIC). | Deposits are insured by the National Credit Union Administration (NCUA). |
| Customer Service | Can vary widely; sometimes perceived as less personal due to the larger size. | Often more personalized service is due to a focus on member satisfaction and community. |
| Accessibility | Large banks offer extensive branch and ATM networks nationally or globally. | May have more limited branch and ATM access but often participate in ATM networks or offer shared branching. |
| Product and Service Range | Typically offer a wider range of financial products and services. | While comprehensive, the range of products and services might be more limited compared to banks. |
Bank Account types
Consumers typically regard banks as institutions for depositing or borrowing money. The variety of accounts and financial products available at banks often includes:
- Checking accounts
- Money market accounts
- Certificates of Deposit
- Savings accounts
- Auto loans
- Mortgage loans
- Credit card accounts
- Student loans
Checking account
A checking account is a type of deposit account that enables you to deposit funds, settle bills, and make purchases either by writing checks or using a debit card. It is intended to store the money you expect to spend shortly. Some banks charge a monthly maintenance fee for having a checking account. Additionally, there can be other fees, such as overdraft fees, depending on the bank’s policies.
Money market accounts
Money market accounts offer a blend of features from both savings and checking accounts. Like savings accounts, they earn interest on the deposited funds, but they also provide flexibility similar to checking accounts, allowing for various withdrawal options. This means you can write checks, use ATMs for cash withdrawals, or make purchases with a debit card. However, it’s important to note that banks may restrict the withdrawals you can make from money market accounts and savings accounts each month.
A money market account can be an attractive option for holding funds for future expenditures. For instance, if you are accumulating savings for a down payment on a house, placing those funds in a money market account could be advantageous, especially if the account offers check-writing features. This way, when you make your down payment, you can quickly write a check or arrange for a wire transfer directly from the account.
Certificates of Deposit
Certificate of Deposit accounts are fixed-term deposits that earn interest over a predetermined period. The duration of CD terms can vary widely, typically from 28 days up to 60 months, and it’s not uncommon to find CDs with terms extending up to 10 or even 20 years. Generally, CDs offer a higher interest rate for longer terms, rewarding you for committing your money for a more extended period. However, banks may impose a penalty if you withdraw your funds from the CD before maturity.
CDs are an ideal option for parking funds. You’re sure you will only need immediate access to them after the end of the term. For instance, choose a CD to save for a future car purchase in a couple of years or a wedding about 18 months away. CDs are less liquid than savings or money market accounts, meaning they’re not as easily accessible until the term concludes.
Savings accounts
Savings accounts are intended to store money you plan to use after some time. These accounts typically earn interest, with rates varying significantly across different banks.
You can access the funds in your savings account through various means, such as visiting a branch, using an ATM, or managing your account online. Although federal restrictions on the maximum monthly withdrawals from savings accounts have been lifted, banks might still impose their limits. Additionally, some banks may levy fees for withdrawals that exceed a certain threshold, often set at six per month.
Auto loans
Auto loans are financing options specifically designed for the purchase of vehicles. When you take out an auto loan, a lender gives you the money to buy a car. In return, you agree to pay back the loan amount plus interest over a set period, typically two to seven years. The vehicle you purchase is collateral for the loan, which means if you fail to make the payments, the lender has the right to repossess the car.
Interest rates on auto loans can vary based on factors such as your credit score, the loan term, and whether the car is new or used. Generally, individuals with higher credit scores receive lower interest rates. Some lenders offer pre-approval for auto loans, allowing you to know the loan terms in advance, which can help you negotiate better prices with car dealers. Auto loans are available through various sources, including banks, credit unions, online lenders, and directly from car dealerships through their financing arms.
Mortgage loans
Mortgage loans are specialized loans for purchasing real estate, such as homes or commercial properties. When you take out a mortgage, a lender provides you with the capital to buy the property, and in return, you agree to repay the loan, plus interest, over a set period. This term is typically 15 to 30 years for residential properties but can vary.
The property you purchase serves as collateral for the mortgage. If you fail to make payments, the lender has the right to foreclose on the property, taking ownership to recover the loan amount.
Mortgages come in various types, including fixed-rate, where the interest rate remains the same throughout the life of the loan, and adjustable-rate (ARM), where the interest can change at specified times based on market conditions. Other variations include government-insured loans such as FHA (Federal Housing Administration) loans, VA (Veterans Affairs) loans, and USDA (United States Department of Agriculture) loans, each designed to assist different groups of buyers or properties in specific areas.
Interest rates and eligibility for mortgage loans depend on several factors, including your credit score, income, down payment size, and the property’s loan-to-value ratio. Mortgages often require a down payment, a percentage of the purchase price, although some programs allow for low or no down payment options for qualified borrowers.
Credit card accounts
Credit card accounts allow you to borrow up to a specific limit to make purchases, withdraw cash, or transfer balances. You must pay at least a minimum of the balance owed each month. Any unpaid balance incurs interest, with rates varying based on the card issuer and your creditworthiness.
Credit cards can offer rewards such as cash back, travel points, or other benefits based on your spending. They also provide a way to build credit history when used responsibly. However, high-interest rates and fees for late payments can make managing these accounts challenging if not handled carefully.
Student loans
Student loans are financial aid designed to help students cover the cost of higher education, including tuition, books, and living expenses. These loans can come from the government or private financial institutions. Federal student loans typically offer lower interest rates and more flexible repayment options than personal loans.
Repayment usually begins after the student graduates leaves school or drops below half-time enrollment, with various plans available to accommodate the borrower’s financial situation. Interest may accrue during the study period, depending on the type of loan. Borrowers must understand the terms and conditions, as student loan debt can impact financial stability and credit scores long-term.
HOW TO SELECT A BANK
Selecting the right bank requires careful consideration. Begin by evaluating the range of products and services a bank provides. Your goal should be to choose a bank that meets your specific needs, whether for a checking account, savings account, or any form of loan.
Additionally, assess the potential interest earnings on your deposits if you’re considering opening a savings account, a CD, or a money market account. It’s also worth checking if the bank pays interest on checking account balances, although this feature is relatively rare.
While banks offer interest earnings on deposits, they may also impose various fees. Standard charges you might encounter include:
- Monthly service charges
- Fees for withdrawing more than the allowed number of times
- Penalties for withdrawing from CD accounts before the term ends
- Charges for overdrafts or insufficient funds
- Fees for using ATMs outside the bank’s network
- Costs for replacing a lost or stolen debit card
- Fees for issuing cashier’s checks, certified checks, and money orders
Opting for an online bank instead of a traditional one could help you sidestep many standard banking fees. Online banks usually incur lower operational costs than their brick-and-mortar counterparts, allowing them to offer the benefit of reduced payments to their customers. Additionally, the savings from lower overhead costs often result in more attractive interest rates on deposit accounts offered by online banks.
When evaluating a bank’s convenience and customer service, consider the following: For a physical bank, check the number and location of branches – are they conveniently located near your home or workplace? Assess the bank’s online and mobile banking interface for ease of use.
For online banks, evaluate the functionality of their mobile app. Determine the accessibility of your accounts through ATMs and whether there are associated fees for such services. Asking these questions can guide you in refining your choices and selecting the bank that best fits your needs.
CONCLUSION
In summary, when selecting a bank, it’s crucial to assess the variety of products and services available alongside the fees and interest rates associated with saving or borrowing money. Additionally, consider the convenience factor, including how easily you can access your funds through various channels. Making an informed decision involves weighing these factors in choosing a bank that aligns with your financial needs and lifestyle preferences.
Frequently Asked Questions (FAQs)
1. Can I open a bank account online?
Yes, many banks offer the option to open accounts online.
2. Are online banks safe to use?
Yes, online banks are safe as long as they are FDIC or NCUA-insured.
3. Do all banks charge monthly maintenance fees?
No, some banks offer accounts with no monthly fees.
4. Can I access my money at any ATM?
Yes, but using an ATM outside your bank’s network may incur fees.
5. Do savings accounts earn interest?
Yes, savings accounts typically earn interest, though rates vary by bank.
