How do Banks Work?

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Banks provide goods and services to assist you in managing your finances, but do you understand how they work?

 

Banks are an important aspect of your financial life if you have a checking or savings account or if you’ve ever opened a credit card or applied for a loan. Banks and the financial services industry play an essential role in the economy because they enable people to borrow money, invest, save for the future, and manage a variety of other responsibilities (like paying bills).

 

Here’s a closer look at banks, their operations, and why they’re important.

The Workings of Banks and the Banking Industry

 

Banks regulate the money flow between people and businesses, whether they are physical locations or operate online. Banks, in particular, provide deposit accounts, which are safe places for consumers to keep their money. In addition, the deposit money is used by banks to provide loans to other persons and businesses.

 

In exchange, the bank receives interest payments from borrowers on those loans. Part of that interest is then returned to the original deposit account holder in the form of interest, which is usually on a savings, money market, or CD account. Thus, banks make money mostly from interest on loans and fees they charge their customers.

 

Fees may be associated with specific items, such as bank accounts or with financial services. An investment bank that provides portfolio management to investors, for example, can charge a fee for this service. Likewise, when a bank grants a mortgage loan to a homebuyer, it may charge an origination fee.

 

Banking is a heavily regulated field. The Federal Reserve System oversees banks and other financial institutions and coordinating with state regulatory bodies to guarantee that banks adhere to the rules. In addition, other government agencies, such as the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and the Federal Deposit Insurance Corporation, regulate banks (FDIC).

 

The FDIC is responsible for various things, but deposit insurance is one of the most critical for banking clients. For each account ownership type, the FDIC guarantees deposits at banks for up to $250,000 per depositor, each insured bank. This means that if your bank fails for whatever reason, the FDIC may be able to assist you in recovering the funds in your accounts, up to the limits set by law.

Banks are divided into several categories.

Banks are not all the same, and different types of banks handle different types of financial operations. These are some of them:

  • Central banks
  • Retail banks
  • Commercial banks
  • Investment banks
  • Shadow banks
  • Savings and loan associations

 

Central banks are in charge of a country’s or a group of countries’ money supply. These institutions are in charge of setting monetary policy, monitoring currency movements, and establishing interest rate benchmarks. The Federal Reserve is the central bank of the United States.

Banks for the general public (Retail Banks)

 

When most people think of banking, they generally think of retail banks. These banks provide everyday clients with loans, deposit accounts, and other banking services. Retail banks can be either brick-and-mortar or online institutions with branches.

Commercial Banks

Commercial banks mostly service businesses and corporations, but they can also serve individual banking consumers. Commercial banks, like retail banks, can provide loans, deposit accounts, and provide other banking services.

Investment Banks

Investment banks can trade securities, manage investor accounts, or execute a combination of the two. As a result, the investment bank can operate as a go-between for investors who want to put money into the markets. By assisting with the acquisition or sale of assets, Clients can also get investment advice from them.

Shadows Banks

shadow banks aren’t like ordinary banks in terms of what they do and how they’re regulated; instead, these nonbank financial institutions are largely unregulated and specialize in credit and debt instrument investments. Hedge funds and insurance businesses are examples of shadow banking entities.

Associations of Savings and Loans

Banks aren’t the only ones who aren’t strictly banks. Instead, these financial companies specialize in assisting consumers in borrowing money to purchase or refinance a property.

Credit unions are a type of cooperative financial institution.

Credit unions, often known as cooperative banks, provide a wide range of services similar to those provided by typical retail banks. The difference is that, unlike retail banks, credit unions do not operate for profit. In addition, credit unions usually have membership requirements that clients must complete joining. Finally, credit unions are normally insured by the National Credit Union Administration rather than the Federal Deposit Insurance Corporation (NCUA).

Read more: FBN at a Glance – The Largest Banks in Africa

What a Bank Does

Individuals, businesses, and other entities are principally served by banks, which lend money to them. This money comes from a pool of other people’s, businesses’, and entities’ deposits. In essence, a bank borrows from its depositors when it provides a loan to someone else.

 

Banks can also borrow money from other financial institutions and the Federal Reserve. Interbank lending, or loans between banks, is often done for a brief period. The goal of these loans is to ensure that banks can meet the Federal Reserve’s liquidity requirements. In addition, these regulations ensure that banks have sufficient assets to manage withdrawal requests.

 

The Federal Reserve can make loans to banks and other financial institutions to help them deal with short-term funding issues. If banks cannot obtain the loans they require in the interbank lending market; they can explore this option. The Federal Reserve lends money to banks at a greater interest rate than those loans.

 

Banks have a role in the transmission of monetary policy in addition to borrowing and lending. This has to do with how the Federal Reserve handles monetary policy in the face of economic fluctuations. When the Federal Reserve adjusts its monetary policy, it usually does so for one of three reasons: slow or accelerate economic development, manages inflation, or respond to changing unemployment rates.

 

The Federal Reserve, for example, can lower interest rates to encourage consumer borrowing and boost economic development. As a result, banks may be able to lower their lending interest rates. This, in principle, encourages more people to borrow, boosting the economy. The downside is that rate cuts aren’t restricted to loans; banks can also lower the interest rates they pay savers.

 

When the Federal Reserve raises interest rates, banks can follow suit and raise the rates they charge on loans and deposit accounts. As a result, borrowing becomes more expensive, but it also encourages people to conserve money to earn a greater interest rate.

Bank Accounts

There are Several Types of Bank Accounts. Banks are typically thought of as facilities where people keep their money or go to borrow money. The following are some of the several types of accounts you can open with a bank:

  • Checking accounts
  • Savings accounts
  • Certificate of deposit accounts
  • Money market accounts
  • Credit cards
  • Auto loans
  • Mortgage loans
  • Student loans

By writing checks or using your debit card, you can deposit money, pay bills, and make purchases with a checking account. Another crucial task for banks is transaction processing.

When you use your debit card or ATM card to make a withdrawal, your bank must first approve the transaction before it can be executed. Individuals, organizations, and financial institutions can also use banks to perform electronic Automated Clearing House transfers or wire transfers.

 

Money can be saved in various ways, including savings accounts, CD accounts, and money market accounts. These accounts can pay savers interest, but they all work in different ways.

 

Savings accounts, for example, allow you to put money aside that you don’t need to spend but still have access to. You may be able to access your money in a branch, an ATM, or online, depending on the bank.

 

CDs are time deposits that pay interest over a certain period. CD periods typically range from 30 to 60 months. However, CDs with maturities as long as 10 or 20 years are available. The higher the interest rate you can earn, the longer the duration. If you take money out of a CD before it matures, the bank may charge you a penalty.

 

Money market accounts generate interest in the same way as savings accounts but also have the same withdrawal choices as checking accounts. For example, you might be able to use a debit card to write checks, withdraw money from an ATM, or make purchases. BOnthe other hand, banks might limit the number of withdrawals you can make each month from your savings and money market accounts.

Typical Bank Fees

While banks can offer savers interest, they can also charge them fees to create revenue. The following are some of the most typical bank fees:

  • Checking account maintenance fees are charged monthly
  • Savings and money market accounts have monthly maintenance fees.
  • Fees for excessive withdrawals from savings or money market accounts
  • CD accounts have penalties for early withdrawals.
  • Fees for overdrafts and insufficient money
  • Fees for ATM withdrawals (if you use an out-of-network ATM)
  • Fees for replacing debit cards
  • Fees for a cashier’s check, a certified check, and a money order

 

Compared to a traditional bank, many of these fees can be avoided by using an online bank. In addition, because online banks have lower overhead expenses than traditional banks, they may pass those savings on to their consumers in the form of cheaper fees. For the same reason, online banks may provide special interest rates on deposit accounts.

Conclusion

When comparing banks, look at the products and services they provide, as well as the fees and interest rates they charge for borrowing money. Also, when it comes to the various methods you can access your money, keep convenience in mind.

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