Banking Basics
Everyone understands what a bank is, but many fail to understand the fundamentals associated with them. This includes knowing how the industry works, the different types of banks there are, and the types of accounts they offer. If you find yourself not knowing the answers to these questions don’t worry, we have provided some clarity below.
How does the banking industry work?
Banking is an industry that works with investments, storage for cash, credit facilities, and other financial transactions. Banking is a key driver in the economy because it channels funds to borrowers with fruitful investments. The banks themselves perform many functions including deposits, withdrawals, currency exchange, wealth management and foreign trading. In addition, banks also act as a bridge between depositors and borrowers who use the funds deposited by customers to provide credit facilities to those who want to borrow it. Many people wonder how banks make money and the answer is much simpler than you think. Banks make money by charging interest rates on the money they loan. By charging higher interest rates than the interest rate they pay on their customers deposits, the bank makes money. In addition to simply enforcing higher interest rates, the bank must also comply with all regulations set by the national government and central bank.
In the United States, all banks are regulated by the Federal Reserve. The Federal Reserve requires banks to retain at least 10% of each deposit on hand while the other 90% can be used for loans. The 10% of funds the bank is required to keep can be held as a deposit in the local Fed bank or as cash in the vault. Requirements from the Federal Reserve apply to all types of banks licensed in the United States.
The requirements on reserves are determined by the Federal Reserve Board of Governors. When the reserve requirements for member banks are reduced the Fed is implementing an expansionary monetary policy that helps increase the money in the economy. However, when it increases the requirements, they are implementing a contractionary monetary policy that reduces liquidity in the economy.
Most Common Types of Banks
Contrary to the popular belief that all banks are the same, there are several different types of banks that provide different services and benefits. Below are the three most common banks found in the United States.
Commercial Banks
Commercial banks are the number one most common type of bank found in the United States. These banks provide members with various types of services including providing business loans, accepting deposits and withdrawals, offering basic investment products and much more to both organizations and businesses. In addition, commercial banks also offer financial services including merchant services, global trade services, treasury services, insurance products, and retirement products. These banks make money by giving individual and corporate borrowers business loans and earning interest income from them. In addition, the bank also makes money by charging service fees to its users.
Credit Unions
Credit Unions are a type of bank that is only open to a certain category of people. These individuals are eligible for membership and can utilize the bank for its many services. Credit Unions traditionally serve either residents of a community, members of a specific company or school, members of a church, etc. The bank is a member-owned establishment and is operated using a people-serving-people philosophy. The structure of these banks allows its owners to offer a personalized lower cost banking experience to their members. Due to their generally smaller operating size these unions may provide its users with higher interest rates then banks. In addition, its users usually develop better and more personal relationships with the banking staff.
Investment Banks
Investment banks cater to corporate clients. They provide clients access to the capital markets in order to raise funds for expansion. These banks help companies to raise funds in the stock and bond markets to help finance their expansion, acquisitions, and other financial plans. In addition, these banks also help buyers identify viable companies for mergers and acquisitions that meet their criteria. Investment banks earn money by providing its clients with advisory services, trading in the financial markets, and assisting clients in acquisitions and mergers.
Most Common Types of Bank Accounts
Savings Account
One of the most common bank accounts is a savings account. This type of account provides a customer with the ability to deposit money into it that they do not intend to use right away. However, though this account is deemed a “savings” account the customer still has the ability to withdraw from the account when needed. Savings accounts pay an interest rate to its customers for keeping their money in the bank; this interest is generally quite low, but it’s better and safer than stuffing it under the mattress.
Checking Account
Another common bank account is a checking account. These accounts allow customers to access their deposited money easily and provides them with the ability to make financial transactions such as paying bills and shopping online. In addition, these accounts allow customers the option to access their funds by writing checks, withdrawing money, or making payments using a debit card or by setting up transfers to other accounts automatically.
Certificate of Deposit
A certificate of deposit is a bank account that allows customers to place a fixed amount of money into it for a defined period. Generally, the money is held for an extended period of time such as three, six months, one year, or two years and longer. The account also allows the customer to receive a fixed interest rate on the amount held in the account; this interest rate is usually higher than a savings account.
Want to learn more?
If you want to know more about topics regarding banking, feel free to access the links below. Each one provides information regarding a different topic that could help you understand the different fundamentals associated with banking a little better.