What Is a Bank?

A bank is a financial institution licensed to receive deposits and make loans. Banks may also provide financial services such as wealth management, currency exchange, and safe deposit boxes. There are several different kinds of banks including retail banks, commercial or corporate banks, and investment banks. In most countries, banks are regulated by the national government or central bank.

Key Takeaways

  • A bank is a financial institution licensed to receive deposits and make loans.
  • There are several types of banks including retail, commercial, and investment banks.
  • In most countries, banks are regulated by the national government or central bank.

Understanding Banks

Banks are a very important part of the economy because they provide vital services for both consumers and businesses. As financial services providers, they give you a safe place to store your cash. Through a variety of account types such as checking and savings accounts, and certificates of deposit (CDs), you can conduct routine banking transactions like deposits, withdrawals, check writing, and bill payments. You can also save your money and earn interest on your investment. The money stored in most bank accounts is federally insured by the Federal Deposit Insurance Corporation (FDIC)

Banks also provide credit opportunities for people and corporations. The money you deposit at the bank—short-term cash—is used to lend to others for long-term debt such as car loans, credit cards, mortgages, and other debt vehicles. This process helps create liquidity in the market—which creates money and keeps the supply going.

Just like any other business, the goal of a bank is to earn a profit for its owners. For most banks, the owners are their shareholders. Banks do this by charging more interest on the loans and other debt they issue to borrowers than what they pay to people who use their savings vehicles. Using a simple example, a bank that pays 1% interest on savings accounts and charges 6% interest for loans earns a profit of 5% for its owners.

Banks make a profit by charging more interest to borrowers than they pay on savings accounts.

Banks range in size based on where they're located and who they serve—from small, community-based institutions to large commercial banks. According to Statista, there were just over 4,700 FDIC-insured commercial banks in the United States as of 2018. This number includes national banks, state-chartered banks, commercial banks, and other financial institutions. While traditional banks offer both a brick-and-mortar location and an online presence, a new trend in online-only banks emerged in the early 2010s. These banks often offer consumers higher interest rates and lower fees. Convenience, interest rates, and fees are some of the factors that help consumers decide their preferred banks.

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Special Considerations

U.S. banks came under intense scrutiny after the global financial crisis that occurred in 2007 and 2008. The regulatory environment for banks has since tightened considerably as a result. U.S. banks are regulated at a state or national level. Depending on the structure, they may be regulated at both levels. State banks are regulated by a state's department of banking or department of financial institutions. This agency is generally responsible for regulating issues such as permitted practices, how much interest a bank can charge, and auditing and inspecting banks.

National banks are regulated by the Office of the Comptroller of the Currency (OCC). OCC regulations primarily cover bank capital levels, asset quality, and liquidity. As noted above, banks with FDIC insurance are additionally regulated by the FDIC.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 with the intention of reducing risks in the U.S. financial system following the financial crisis. Under this act, large banks are assessed on having sufficient capital to continue operating under challenging economic conditions. This annual assessment is referred to as a stress test.

Types of Banks

Retail banks deal specifically with retail consumers. These banks offer services to the general public and are also called personal or general banking institutions. Retail banks provide services such as checking and savings accounts, loan and mortgage services, financing for automobiles, and short-term loans like overdraft protection. Most retail banks also offer credit card services to their customers, and may also supply their clients with foreign currency exchange. These banks also cater to high-net-worth individuals, giving them specialty services such as private banking and wealth management. Examples of retail banks include TD Bank and Citibank.

Commercial or corporate banks provide specialty services to their business clients from small business owners to large, corporate entities. Along with day-to-day business banking, these banks also provide their clients with other things such as credit services, cash management, commercial real estate services, employer services, and trade finance. JPMorgan Chase and Bank of America are two popular examples of commercial banks.

Investment banks focus on providing corporate clients with complex services and financial transactions such as underwriting and assisting with merger and acquisition (M&A) activity. As such, they are known primarily as financial intermediaries in most of these transactions. Clients commonly range from large corporations, other financial institutions, pension funds, governments, and hedge funds. Morgan Stanley and Goldman Sachs are examples of U.S. investment banks.

Unlike the banks listed above, central banks are not market-based and don't deal directly with the general public. Instead, they are primarily responsible for currency stability, controlling inflation and monetary policy, and overseeing a country's money supply. They also regulate the capital and reserve requirements of member banks. Some of the world's major central banks include the U.S. Federal Reserve Bank, the European Central Bank, the Bank of England, the Bank of Japan, the Swiss National Bank, and the People’s Bank of China.

Bank vs. Credit Union

Credit unions vary in size from small, community-based entities to larger ones with thousands of branches across the country. Just like banks, credit unions provide routine financial services for their clients who are generally called members. These services include deposit, withdrawal, and basic credit services.

But there are some inherent differences between the two. While a bank is a profit-driven entity, a credit union is a nonprofit organization traditionally run by volunteers. Created, owned, and operated by participants, they are generally tax-exempt. Members purchase shares in the coop, and that money is pooled together to provide a credit union's credit services. Because they are smaller entities, they tend to provide a limited range of services compared to banks. They also have fewer locations and automated teller machines (ATMs).