Understanding How Banking Works: Types of Banks and 4 Tips for Choosing the Best Bank

Banking is an essential aspect of our lives and it is important to understand how it works, the types of banks available, and how to choose the best one for you. A bank is a financial institution that accepts deposits, makes loans, and provides other financial services to its customers. It’s an important factor in the economy, and understanding how it works can help you make informed decisions about your finances.

There are different types of banks, such as retail banks, commercial banks, investment banks, and central banks. Each type of bank offers different services and caters to different customer needs. Choosing the best bank for you depends on a number of factors, including the services you need, the fees associated with those services, and the reputation of the bank.

In this blog post, we’ll give you a comprehensive guide to how banks work, the types of banks available, and how to choose the best one for you. Whether you’re opening your first bank account or looking to switch banks, this article will give you the knowledge you need to make informed decisions about your finances. 

What is a bank?

A bank is a licensed financial institution that accepts savings deposits and checks and makes loans. Banks also offer related services such as individual retirement accounts (IRAs), certificates of deposit (CDs), currency exchanges, and safes.

There are several types of banks, including retail banking, commercial or corporate banking, and investment banking.

In the United States, banks are regulated by the national government and by individual states.

KEY POINTS TO REMEMBER

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

Learn about the Bank

Banks have been around since at least the 14th century. They provide consumers and business owners with a safe place to store their money and a source of loans for personal and business purchases. In return, banks use deposits to lend and earn interest.

The basic business plan hasn’t changed much since the Medici family started banking during the Renaissance, but the range of products the banks offered has expanded.

Basic banking services

Banks offer a variety of ways to hide your money and a variety of ways to borrow money.

Account Verification

Checking accounts are deposits used by consumers and businesses to pay bills and withdraw cash. They pay little or no interest and often come with a monthly fee, a usage fee, or both. Consumers today typically have their wages and other regular payments automatically deposited into one of these accounts.

Saving account

Savings accounts pay interest to depositors. Depending on how long the account holder hopes to keep their money in the bank, they can open a regular savings account that pays little interest or a certificate of deposit (CD) that pays a little more. CDs can generate interest in just a few months or as long as five years or more.

It is important to note that funds in checking accounts, savings accounts, and CDs are insured by the federal government for up to $250,000 through the Federal Deposit Insurance Corporation. (FDIC).

Loan service

Banks provide loans to consumers and businesses. Deposits by their customers are lent to other customers at a higher interest rate than paid to depositors.

At the highest level, it’s the process that keeps the economy running. People deposit their money in banks; Banks lend money in the form of auto loans, credit cards, mortgages, and business loans. The recipient of the loan spends the money they borrow, the bank collects interest on the loan, and this process allows the money to flow through the system.

Like any other business, the goal of a bank is to make a profit for the owner. For most banks, the owners are their shareholders. To do this, banks charge higher interest rates on loans and other liabilities they pay borrowers than they pay to users of their savings vehicles.

For example, a bank might pay 1% interest on savings accounts and charge 6% interest on mortgages, yielding 5% gross profit to owners. Banks make a profit by charging a higher interest rate on loans than they pay on savings accounts.

Physical banking and online banking

Banks vary in size, from small community organizations to global commercial banks.

According to the FDIC, there are just over 4,200 FDIC-insured commercial banks in the United States in 2021.  

This number includes national banks, state-chartered banks, commercial banks, and other financial institutions.

Traditional banks now offer both physical branches and online services. Online-only banks started appearing in the early 2010s.

Consumers choose a bank based on interest rates, the fees the bank charges, and the convenience of locations, among other factors.

How are banks regulated?

U.S. banks were heavily regulated after the 2008 global financial crisis. As a result, the regulatory environment for banks has been significantly tightened.

Depending on their business structure, US banks can be regulated at the state or national level, or both. State banks are regulated by each state’s banking department or financial institution division. This agency is usually responsible for matters such as permitted practices, how much interest a bank can charge, and banking audits and inspections.

National banks are regulated by the Office of the Comptroller of Currency (OCC). OCC regulations mainly cover the bank’s capital level, asset quality, and liquidity. As noted above, banks with FDIC insurance are also regulated by the FDIC.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 after the financial crisis with the goal of reducing risk in the US financial system. Under the law, large banks are now required to undergo regular checks to assess whether they have enough capital to continue operating in difficult economic conditions. This annual assessment is called a stress test.

Types of Banks

Most banks can be classified as retail, commercial or corporate, or investment banks. The major global banks typically operate separate branches for each of these categories.

Retail bank

Retail banks offer their services to the general public and often have branches and main offices for the convenience of their customers.

They offer a wide range of services such as checking and savings accounts, mortgage and loan services, auto financing, and short-term loans like overdraft insurance. Many also offer credit cards.

They also provide access to investments in CDs, mutual funds, and individual retirement accounts (IRAs). Large retail banks also cater to high-net-worth individuals with specialized services such as private banking and wealth management services.

Examples of retail banks include TD Bank and Citibank.

Commercial or Corporate bank

Commercial or corporate banks tailor their services to commercial customers, from small business owners to large corporations. In addition to day-to-day business banking, these banks also provide credit, cash management, commercial real estate, employment services, and trade finance,

JPMorgan Chase and Bank of America are examples of commercial banks, although both have large retail banking divisions.

Investment bank

Investment banks are focused on providing corporate clients with complex financial services and transactions such as underwriting and supporting mergers and acquisitions (M&A) operations. They are mainly financial intermediaries in these transactions.

Their clients include large corporations, other financial institutions, pension funds, governments, and hedge funds.

Morgan Stanley and Goldman Sachs are among the largest US investment banks.

Central Bank

Unlike the banks above, central banks do not deal directly with the public. A central bank is an independent organization authorized by the government to oversee the money supply and monetary policy of a country.

As such, central banks are responsible for the stability of the currency and the entire economic system. They also play a role in regulating the capital and reserve requirements of domestic banks.  

The Federal Reserve Bank of the United States is the central bank of the United States. The European Central Bank, Bank of England, Bank of Japan, National Bank of Switzerland, and People’s Bank of China are among its partners in other countries.

Bank vs Credit Union

Credit unions provide banking services, but unlike banks, they are nonprofit organizations founded and operated by their members or customers. Credit unions provide daily banking services to their customers, commonly referred to as members.

Credit unions are founded, owned, and operated by their customers and are generally tax-exempt. Members buy shares in the cooperative and this money is pooled to finance loans from the credit union.

They tend to offer a limited range of services compared to banks. They also have fewer locations and automated teller machines (ATMs).

How do I know if my money is safe in the bank?

The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by Congress to maintain stability and public confidence in the US financial system. The FDIC monitors and evaluates banks to ensure the funds they handle are safe.

Plus, it secures your money. Maximum coverage is $250,000 per depositor, per insured bank, and per type of account held.

You are not required to purchase this insurance. If you open a deposit at an FDIC-insured bank, you are automatically insured. The agency’s BankFind website can help you identify FDIC-insured banks and branches.

Are some non-bank accounts insured?

The mission of the Securities Investor Protection Corporation (SIPC) is to recover cash and securities in the event of a member brokerage firm’s bankruptcy. SIPC is a not-for-profit corporation established by Congress in 1970. SIPC protects clients of all registered brokers in the United States.

This applies to stocks and bonds (stocks) and cash held by brokerage firms. Brokerage firms rarely go bankrupt or close unexpectedly, but if they do, SIPC helps close the company through liquidation and establishes complaint processes that can protect investors. SIPC protects your account up to $500,000 in securities. This includes a $250,000 cash limit on your account. This link will show you a list of all registered SIPC members.

Should I choose a retail bank, credit union, or commercial bank? You need to determine whether you want to keep your business and personal accounts in the same bank or you want them in separate banks. A retail bank, providing basic banking services to customers, is best suited for everyday banking. You can choose a brick-and-mortar bank, with a physical building, or an online bank if you don’t want or need to visit a branch in person.

You might consider a credit union, a nonprofit organization, and a willingness to serve the needs of people who share a common employer, association, or professional interest.  

What other factors go into choosing a bank?

The size of the bank is another consideration. The big retail banks are usually those with big and well-known names and have offices throughout the United States, which is very convenient if you are frequently traveling for work or on vacation. You’ll have easier access to your money while you’re away and can avoid ATM fees abroad.

On the other hand, you may find that a smaller bank will offer more personalized customer service and products you like. For example, a community bank that accepts deposits and lends locally can result in a more personalized banking relationship.

Choose a convenient location if you choose a bank with a physical location. If you have a financial emergency, you don’t want to have to go a long way to get cash.

See if your chosen bank offers other services like credit cards, loans, and safes. Some banks also offer smartphone apps, which can be helpful. Check the fees associated with the account you want to open. Banks charge interest on loans as well as monthly maintenance fees, overdraft fees, and wire transfer fees. Some major banks are considering ending overdraft fees by 2022, which could be an important consideration.

The need

At the very least, a bank is where you keep your money until you use it to pay your bills or withdraw cash. It could also be where you get a loan to buy a car or a mortgage to buy a house. If you run a small business, this could be where you borrow money to grow or improve.

Before choosing a bank, you should compare the various fees and charges that come with your account or any loan you may need. A little research and comparison will help you find the right solution to protect your money, build credit, make payments, apply for loans, get money, and save money for future needs like vacations. retirement, emergencies, and home purchases.