How Do Banks Work?

Banks offer products and services to help you manage your money, but do you know how they actually work?

If you have a checking account or savings account, or if you’ve ever opened a credit card or applied for a loan, then banks are an integral part of your financial life. Banks and the financial services industry are an important part of the economy because they provide the means for people to borrow money, make investments, save for the future and handle smaller tasks (like paying bills).

Here’s a closer look at banks, how they work and why they matter.

How Banks and the Banking Industry Work

Banks, whether they be brick-and-mortar institutions or online-only, manage the flow of money between people and businesses. More specifically, banks offer deposit accounts that are secure places for people to keep their money. Banks use the money in deposit accounts to make loans to other people or businesses.

In return, the bank receives interest payments on those loans from borrowers. Part of that interest is then returned to the original deposit account holder in the form of interest—generally on a savings account, money market account or CD account. Banks primarily make money from the interest on loans as well as the fees they charge their customers.

These fees can be tied to specific products, such as bank accounts, or related to financial services. For example, an investment bank that offers portfolio management to investors can charge a fee for that service. Or, a bank may collect an origination fee when granting a mortgage loan to a homebuyer.

Banking is a highly regulated industry. The Federal Reserve System oversees banks and other financial institutions and coordinates with state regulatory agencies to help ensure banks follow the proper guidelines. Banks are also subject to regulation by other federal agencies, including the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC).

The FDIC does many things, but one of the most important for banking customers is insuring deposits. The FDIC insures deposits at banks for up to $250,000 per depositor, per insured bank, for each account ownership category. This means if your bank fails for any reason, the FDIC can help you recover the money in your accounts, up to the allowed limits.Types of Banks

Banks aren’t identical and several different types of banks handle financial transactions. These include:

Central banks

Retail banks

Commercial banks

Investment banks

Shadow banks

Savings and loan associations

Credit unions

Central Banks

Central banks manage the supply of money for a country or group of countries. These banks are responsible for setting monetary policy, overseeing the movement of currency and establishing interest rate baselines. In the U.S., the Federal Reserve is the central bank.

Retail Banks

Retail banks are probably what most people think of when they think of banking. These banks offer loans, deposit accounts and other banking services to everyday customers. Retail banks can be brick-and-mortar institutions with branches or online banks.

Commercial Banks

Commercial banks typically cater to businesses or corporations, although they also can serve the needs of individual banking customers. Similar to retail banks, commercial banks also can make loans and offer deposit accounts and other banking services.Investment Banks

Investment banks can take part in securities trading, manage investor accounts or do a little of both. An investment bank can act as a go-between for investors who want to put money into the markets by helping with the purchase or sale of securities. They also can offer investment advice to clients.

Shadow Banks

Shadow banks aren’t like traditional banks in terms of what they do or how they’re regulated. These nonbank financial institutions are generally unregulated and primarily focus on making investments in credit and debt instruments. Insurance companies and hedge funds are examples of shadow banking institutions.

Savings and Loan Associations

Savings and loan associations aren’t strictly banks either. These financial institutions specialize in helping people borrow money to buy a home or refinance a home they already own.