Banking is an industry that handles cash, credit, and other financial transactions. Banks provide a safe place to store extra cash and credit. They offer savings accounts, certificates of deposit, and checking accounts. Banks use these deposits to make loans. These loans include home mortgages, business loans, and car loans.
Banking is one of the key drivers of the U.S. economy. Why? It provides the liquidity needed for families and businesses to invest for the future. Bank loans and credit mean families don't have to save up before going to college or buying a house. Companies use loans to start hiring immediately to build for future demand and expansion.
How It Works
Banks are a safe place to deposit excess cash. The Federal Deposit Insurance Corporation (FDIC) insures them. Banks also pay savers interest rates or a small percent of the deposit.
Banks can turn every one of those saved dollars into $10. They are only required to keep 10 percent of each deposit on hand. That regulation is called the reserve requirement. Banks lend the other 90 percent out. They make money by charging higher interest rates on their loans than they pay for deposits.
Types of Banks
Commercial banks provide services to private individuals and to businesses. Retail banking provides credit, deposit, and money management to individuals and families.
Community banks are smaller than commercial banks. They concentrate on the local market. They provide more personalized service and build relationships with their customers.
Internet banking provides these services via the world wide web. The sector is also called also called E-banking, online banking, and net banking. Most other banks now offer online services. There are many online-only banks. Since they have no branches, they can pass cost savings onto the consumer. Some of the best are Ally Bank, ING, Synchrony, and Discover.
Savings and loans are specialized created to promote affordable homeownership.
Credit unions are owned by their customers. This ownership structure allows them to provide low-cost and more personalized services. You must be a member of their field of membership to join. That could be employees of companies or schools or residents of a geographic region.
Investment banking finds funding for corporations through initial public stock offerings or bonds. They also facilitate mergers and acquisitions. Third, they operate hedge funds for high net worth individuals. The largest U.S. investment banks are Bank of America, Merrill Lynch, Citi, Goldman Sachs, J.P. Morgan, and Morgan Stanley. Large European investment banks include Barclays Capital, Credit Suisse, Deutsche Bank, and UBS.
After Lehman Brothers failed in September 2008, signaling the beginning of the global financial crisis of the late-2000s, investment banks became commercial banks. That allowed them to receive government bailout funds. In return, they must now adhere to the regulations in the Dodd-Frank Wall Street Reform Act.
Merchant banking provides similar services for small businesses. They provide mezzanine financing, bridge financing, and corporate credit products.
Central Banks Are a Special Type of Bank
Banking wouldn't be able to supply liquidity without central banks. In the United States, that's the Federal Reserve. The Fed manages the money supply banks are allowed to lend. The Fed has four primary tools:
Open market operations occur when the Fed buys or sells securities from its member banks. When it buys securities, it adds to the money supply.
The reserve requirement lets a bank lend up to 90 percent of its deposits.
The Fed funds rate sets a target for banks' prime interest rate. That's the rate banks charge their best customers.
The discount window is a way for banks to borrow funds overnight to make sure they meet the reserve requirement.
In recent years, banking has become very complicated. Banks have ventured into sophisticated investment and insurance products. This level of sophistication led to the banking credit crisis of 2007.