What Are Banks? Definition and Explanation
You may think of a bank as simply a safe place to put your money. But banks do a lot more than accept deposits. They also extend loans, facilitate payments, exchange currency, set monetary policy, and provide a range of other financial services to individuals, businesses, and governments. Here are key things to know about banks, including how they work, how they make money, and the different products and services they offer.
What Is a Bank?
By definition, a bank is an institution that accepts deposits in checking and savings accounts and makes loans. In serving both functions, banks act as intermediaries between depositors (who essentially lend money to the bank) and borrowers (to whom the bank lends money). The money the bank pays to depositors and charges on loans is called interest.
Banks also offer a range of other financial products and services, including:
• Credit cards
• Investment accounts
• Wealth management services
• Individual retirement accounts (IRAs)
• Certificates of deposit (CDs)
• Money market accounts
• Currency exchange
• Safe deposit boxes
Banks also facilitate payments — from employers to employees, buyers to sellers, and taxpayers to the government — and play a major role in the nation’s economy. There are also many different types of banks, including retail banks, corporate banks, and central banks.
How Do Banks Make Money?
Banks typically generate revenue through a variety of channels. These include:
• Interest on loans: Banks lend money to individuals and businesses at higher interest rates than what they pay on deposits, earning the interest rate spread.
• Fees: Banks may charge fees for various services, including account maintenance, overdrafts, wire transfers, and out-of-network ATM usage.
• Investment income: Banks may invest in securities, bonds, and other financial instruments, earning returns on these investments.
• Interchange fees: When customers use their debit or credit cards, banks earn fees from merchants processing the transactions.
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A Brief History of Banks
The concept of banking dates back to ancient civilizations, when temples were used as safe places to store valuable items and grain, and priests would lend these resources to local farmers and merchants. The temples were also responsible for keeping records of these transactions, laying the groundwork for bookkeeping.
The first modern banks emerged in Renaissance Italy, with institutions like the Medici Bank setting the standard for banking operations. Over centuries, banks evolved, expanding their products and services and adopting technological advancements to meet the growing demands of consumers and businesses. Today, banks are integral to the global economy.
Modern Bank Products for Consumers
Modern banks offer a variety of products tailored to meet the financial needs of consumers. Common banking products include:
Loans
Banks provide various types of consumer loans, such as mortgages, personal loans, and auto loans. These loans help individuals finance large purchases and manage their cash flow.
Savings and Checking Accounts
Savings and checking accounts are fundamental banking products. A savings account is designed to hold cash you don’t need right away and allow you to earn interest and grow your money over time.
Checking accounts are set up to offer easy access to funds for everyday transactions. They come with checks and typically a debit card that can be used for purchases or to withdraw funds at an ATM. Checking accounts generally earn little or no interest, though some banks now offer high-yield checking accounts.
Mortgages
Banks offer mortgage loans to help individuals purchase homes. These long-term loans typically come with fixed or variable interest rates and generally require you to use the property being purchased as collateral for the loan. Mortgage terms are typically 15, 20, or 30 years.
Investing Accounts
Many banks offer investment accounts, including IRAs and taxable brokerage accounts. These accounts enable customers to invest in stocks, bonds, mutual funds, and other financial instruments designed for long-term growth.
Credit Cards
Credit cards provide consumers with a revolving line of credit, allowing them to make purchases and pay for them over time. Banks earn interest and fees from credit card users, making it a significant revenue source.
Certificates of Deposit (CDs)
CDs are time deposits that offer a fixed interest rate for a specified term. You agree to leave your money in the account for a set period of time (which generally range from three months to five years). In return, these accounts typically pay a higher interest rate than a standard savings account.
Money Market Accounts
A money market account is a hybrid account that offers competitive interest on your balance, along with the conveniences of a checking account, such as a debit card and checks. However, you may be limited to a certain number of withdrawals per month. Some money market accounts also have minimum balance requirements.
Useful Bank Features
In addition to products, banks offer various services to help customers manage their money. Here are some features you may want to look out for when exploring different bank options.
Customer Support
Banks typically offer customer support through various channels, including phone, email, online chat, and in-person assistance. Whether you need assistance with your checking account or help choose between two banking products, a customer service rep can generally point you in the right direction.
Credit Score Checkers
Many banks offer tools that allow customers to monitor their credit scores for free. This service allows you to stay informed about your credit health and, if necessary, take steps to build your scores. Having strong credit can help you unlock credit cards, mortgages, and other types of loans with attractive rates and terms.
ATMs
Whether you open an account at a traditional brick-and-mortar institution or an online-only bank, you’ll typically have access to a wide network of fee-free automated teller machines (ATMs). This allows you to withdraw cash or make deposits without needing to visit a branch during business hours.
Online/Mobile Banking
Online banking and mobile banking apps allow you to monitor your accounts, transfer money, pay bills, and deposit checks from your computer or mobile device.
Financial Planning Tools
Many banks offer financial planning tools that help customers budget, save, and invest wisely. These tools can include calculators, goal-setting features, and personalized financial advice.
Bank Regulations
While banks are typically privately owned entities that must answer to their shareholders, banking is a highly regulated industry. Regulatory bodies, such as the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC), oversee banks’ operations, ensuring they adhere to laws and maintain sufficient capital reserves. This is to minimize disruptions and ensure the U.S. banking system runs smoothly.
The majority of U.S. banks are also insured by the FDIC. This covers deposit accounts up to $250,000 per insured bank, per depositor. Co-owners of joint accounts at the same bank are typically each insured up to $250,000. The agency’s BankFind site can help you identify FDIC-insured banks throughout the country.
Types of Banks
There are several different types of banks, each serving different purposes and customer bases. The large global banks often operate separate arms or divisions for each of these categories.
Retail Banks
Retail banks focus on individual consumers, rather than businesses or other banks. They provide personal banking services, such as checking and savings accounts, personal loans, mortgages, auto loans, short-term loans like overdraft protection, and credit cards. They may also offer access to investment products, such as mutual funds and IRAs.
While some retail banks offer in-person services through brick-and-mortar locations, others operate exclusively online. Due to lower overhead costs, online banks tend to offer higher yields on savings accounts and charge lower (or no) fees.
Recommended: What Is Neobanking and How Does it Work?
Corporate Banks
Corporate banks (also known as commercial banks) cater to large businesses and corporations. They also serve government agencies and institutions like colleges and universities. Along with business checking and savings accounts, these banks offer business loans and lines of credit, letters of credit, payment processing, foreign exchange transactions, and more for their clients.
Investment Banks
Investment banks serve as intermediaries in large, complex financial transactions. They specialize in initial public offerings (IPOs), raising capital, facilitating mergers and acquisitions, and providing advisory services to corporations and governments. Unlike retail banks, they do not take deposits from or provide loans to the general public.
Central Banks
Central banks manage a nation’s monetary policy, regulate the banking industry, and act as a lender of last resort. The central bank in the U.S. is the Federal Reserve (a.k.a, “the Fed”). The Fed sets the federal funds rates, which impacts everything from the annual percentage yields (APYs) you earn on savings accounts to the interest rates you pay on credit card balances and loans. Unlike the banks types listed above, central banks do not deal directly with the public.
Pros and Cons of Banks
Retail and commercial banks offer myriad benefits, but they also have some downsides. Here’s a look at how the pros and cons stack up.
| Pros | Cons |
|---|---|
| Safe and secure | Potential fees for various services |
| Easy access to funds | Lower interest rates on deposits |
| Wide range of services | Potentially complex fee structures |
| Highly regulated | Potential for poor customer service |
Pros
• Safety: Banks provide a secure place to store money, reducing the risk of theft or loss. Deposits in most banks are federally insured (up to certain limits), which means that even if the bank were to fail, customers will still recover their funds, up to the insured limit.
• Convenient access to funds: Banks offer easy access to funds through a network of branches, ATMs, and digital banking platforms.
• One-stop shop: Banks provide a variety of financial services beyond basic checking and savings accounts, allowing you to manage all aspects of your finances under one roof.
• Regulatory protection: Banks are heavily regulated by government agencies. These regulations protect consumers from fraud, ensure the safety of deposits, and promote ethical banking practices.
Cons
• Fees: Banks often charge fees for their services, including fees for account maintenance, overdrafts, and wire transfers.
• Low interest rates: Many banks offer relatively low interest rates on savings accounts and other deposit accounts. These rates often fail to keep pace with inflation, which can diminish the purchasing power of your savings over time.
• Complex fee structures: The complexity of bank fees can create confusion for customers and result in unexpected expenses.
• Potential for poor customer service: Large banks may offer impersonal or poor customer service due to their size and scale.
Banks vs Credit Unions
While banks and credit unions offer similar financial services, there are key differences between them. Here’s a closer look:
Ownership
Banks,typically, are owned by shareholders and operate for profit. Credit unions, by contrast, are owned by their members and operate on a not-for-profit basis. The main goal of a credit union is to benefit its members.
Fees and Interest Rates
Credit unions often offer lower fees and better interest rates on loans and savings accounts compared to traditional banks, as they are not driven by maximizing profits.
Membership
Banks are open to the general public. Credit unions require membership, which may be based on specific criteria such as employment, geographic location, or affiliation with a particular organization.
Customer Service
Credit unions tend to provide more personalized customer service due to their smaller size and member-focused approach. While small banks can also offer personalized customer service, larger banks may lack the personal touch.
Getting Started Banking With SoFi
A bank is an excellent resource to help manage your money. You can deposit funds for safekeeping, manage everyday spending, and invest for the future. Understanding the products, services, and perks offered by different banks can help you find the institution for your needs.
Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.
FAQ
How do banks make money?
Banks primarily make money by lending out deposits at higher interest rates than they pay to depositors, earning the interest rate spread. They also earn money from the fees they charge for account maintenance, overdrafts, and transactions. Additionally, banks may invest in securities and earn returns.
Why do they call it a bank?
The term “bank” is thought to originate from the Italian word “banca,” which means bench or counter. In medieval times, moneylenders conducted their business on benches in marketplaces, and the term evolved to represent financial institutions.
What is a bank, simply put?
Simply put, a bank is a financial institution that accepts deposits and makes loans. Banks also play a key role in a nation’s economy, facilitating the management and movement of money for individuals, businesses, and governments.
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SoFi members with direct deposit activity can earn 4.00% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate. SoFi members with direct deposit are eligible for other SoFi Plus benefits.
As an alternative to direct deposit, SoFi members with Qualifying Deposits can earn 4.00% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant. SoFi members with Qualifying Deposits are not eligible for other SoFi Plus benefits.
SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.00% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.
SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.
Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.
Interest rates are variable and subject to change at any time. These rates are current as of 12/3/24. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.
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