How Your Bank Really Works (2024)

Retailbankingprovides financialservices for individuals and families. The three most important functions are credit, deposit, and money management.

First, retail banks offer consumerscreditto purchase homes, cars, and furniture. These includemortgages, auto loans, andcredit cards. The resultingconsumer spendingdrives almost 70% of the U.S. economy. They provide extraliquidityto the economy this way. Credit allows people to spend future earnings now.

Second, retail banks provide a safe place for people todeposittheir money. Savings accounts, certificates of deposit,and other financial products offer a better rate of return compared to stuffing their money under a mattress. Banks base their interest rates on thefed funds rateand Treasury bond interest rates. These rise and fall over time. TheFederal Deposit Insurance Corporationinsures most of these deposits.

Third, retail banks allow you, the customer, tomanage your moneywith checking accounts and debit cards. You don't have to do all your transactions with dollar bills and coins. All of this can be done online, making banking an added convenience.

Types of Retail Banks

Most of America's largest banks have retail banking divisions. These include Bank of America, JP Morgan Chase, Wells Fargo, and Citigroup. Retail bankingmakes up50% to 75% of these banks' total revenue.

There are many smaller community banks as well. They focus on building relationships withthe people in their local towns, cities, and regions. They haveless than $10 billion in total assets.

Credit unionsare another type of retail bank. They may restrict services to employees of companies or schools. They operate as nonprofits. Theymay offer better terms to savers and borrowersbecause they aren't as focused on profitability as the bigger banks.

Savings and loansare retail banks thattarget mortgages. They've almost disappeared since thesavings and loans crisis of the 1980s.

Lastly, Sharia banking conforms to Islamic prohibition against interest rates. So borrowers share their profits with the bank instead of paying interest.This policy helped Islamic banks avoid the 2008 financial crisis. They didn't invest in risky derivatives. Thesebanks cannot invest inalcohol, tobacco, and gambling businesses.

How Retail Banks Work

Retail banks use the depositors' funds to make loans.To make a profit, banks charge higherinterest rateson loans than they pay on deposits.This is how they make a profit.

TheFederal Reserve,the nation'scentral bank, regulates most retail banks. One of their regulatory powers is to require banks to maintain a percentage of their deposits on an account at the Fed. They must meet the reserve requirement set by the Fed or restrict business growth.

At the end of each day, some banks might be a little short of the Fed'sreserve requirement. But this usually isn't a problem because banks that have excess reserves will lend them the necessary difference to make up for the shortfall. The amount borrowed is called the"fed funds." The average rate they're lent at is referred to as the "fed funds rate." That rate is tied closely to the "discount rate," which is the rate the Fed charges them if they have to loan them the overnight funds.

The discount rate is the only rate the Fed actually sets. The Fed funds rate is a target range that the Fed hopes to influence the banks to maintain. As goes the discount rate, so moves the Fed funds rate, then other overnight and short-term lending rates to bank customers.

How They Affect the U.S. Economy and You

Retail banks create thesupply of moneyin the economy. As you can imagine, this is a powerful tool for economic expansion. To ensure proper conduct, the Fed controls this as well.It sets the interest rate banks use to lend fed funds to each other. That's called thefed funds rate. That's the most important interest rate in the world. Why? Banks set all other interest rates against it. If the fed funds rate moves higher, so do all other rates.

Most retail banks sell their mortgages to large banks in the secondary market. They retain their large deposits. As a result, they were spared from the worst of the2007 banking crisis.

Retail Banking History

In the Roaring 20s, banks were unregulated. Many of them invested their depositors' savings in the stock market without telling them. After the 1929 stock market crash, people demanded their money. Banks didn't have enough to honor depositors' withdrawals. That helped cause the Great Depression.

In response,President Franklin D. Rooseveltcreated theFDIC. It guaranteed depositors' savings as part of theNew Deal.

The Federal Home Loan Bank Act of 1932 created the savings and loans banking system to promote homeownership for theworking class. They offered lowmortgagerates in return for low interest rateson deposits. They couldn't lend forcommercial real estate, business expansion, or education.They didn't even provide checking accounts.

In 1933, Congress imposed theGlass-Steagall Act. It prohibited retailbanksfrom using deposits to fund riskyinvestments. They could only use their depositors' funds for lending. Banks could not operate across state lines. They often could not raise interest rates.


In the 1970s, stagflation created double-digit inflation. Retail banks' paltry interest rates weren't enough of a reward for people to save. They lost business as customers withdrew deposits. Banks cried out to Congress forderegulation.

The 1980 Depository Institutions Deregulation and Monetary Control Act allowed banks to pay interest on certain types of accounts. In 1982,President Ronald Reagansigned the Garn-St. Germain Depository Institutions Act. Itremoved restrictions onloan-to-value ratiosforsavings and loanbanks. It also allowed these banks to invest in risky real estate ventures.

The Fedlowered its reserve requirements. That gave banks more money to lend, but it also increased risk. To compensate depositors, the FDICraised its limit from $40,000 to $100,000 of savings.

Deregulation allowed banks to raise interest rates on deposits and loans. In fact, it overrode state limits on interest rates.Banks no longer had to direct a portion of their funds toward specific industries, such as home mortgages. They could instead use their funds in a wide range of loans, including commercial investments.

By 1985, savings and loansassets increased by 56%. But many of their investments were bad. By 1989, many had failed. The resultantS&L crisiscost $160 billion.

Large banks began gobbling up small ones. In 1998, Nations Bank bought Bank of America to become the first nationwide bank. The other banks soon followed. That consolidation created the national banking giants in operation today.

In 1999, the Gramm-Leach-Bliley Act repealed Glass-Steagall. It allowed banks to invest in even riskier ventures. They promised to restrict themselves to low-risksecurities. That woulddiversify their portfolios and lower risk. But as competition increased, even traditional banks invested in risky derivatives to increase profit and shareholder value.

That risk destroyed many banks during the 2008 financial crisis. That changed retail banking again. Losses from derivatives forced many banks out of business.

In 2010, President Barack Obama signed theDodd-Frank Wall Street Reform Act. It prevented banks from using depositor funds for their own investments. They had to sell any hedge funds they owned.It also required banks to verify borrowers' income to make sure they could afford loans.

All these extra factors forced banks to cut costs. They closed rural branch banks. They relied more on ATMs and less on tellers. They focused on personal services to high-net-worth clients and began charging more fees to everyone else.

How Your Bank Really Works (2024)


How do banks really work? ›

Banks typically accept deposits from, and offer loans to, their customers. They may also offer check-cashing or issuing services, credit or debit cards, and insurance options.

How to answer why banking in an interview? ›

Example Answer: “The banking industry fascinates me due to its dynamic nature and its vital role in the economy. I'm particularly interested in [mention the specific area of banking, e.g., financial services, customer service] and believe my skills in [mention relevant skills] would be a valuable asset to your team.

What does a bank need to be successful? ›

The top-performing banks understand the importance of developing strong relationships with their customers, vendors, and employees. Strong relationships are built on trust and respect. Management visibility and direct communication is crucial for employee awareness and morale.

How it works in a bank? ›

Banks are intermediaries between depositors (who lend money to the bank) and borrowers (to whom the bank lends money). The amount banks pay for deposits and the income they receive on their loans are both called interest.

What are the five most important banking services? ›

The 5 most important banking services are checking and savings accounts, loan and mortgage services, wealth management, providing Credit and Debit Cards, Overdraft services. You can read about the Types of Banks in India – Category and Functions of Banks in India in the given link.

Do banks actually use your money? ›

Only a small portion of your deposits at a bank are actually held as cash at the bank. The rest of your money (the majority of the bank's assets) is invested by the bank into vehicles such as consumer or business loans, government bonds and credit cards. Borrowers have to pay the bank back with interest.

Why banking best answers? ›

Sample Answer:

The banking industry is lucrative and plays an important role in our economy. It offers challenging roles and opportunities to develop skills and knowledge. The dynamic nature of the industry and its relevance in the economic scenario is why I want to pursue a career in the banking sector.

What are your three weaknesses? ›

Some skills that you can use as weaknesses include impatience, multitasking, self-criticism, and procrastination.

What to say in a bank interview? ›

Here are a few interview tips to help you prepare for this question:
  • Take some time to consider your career goals and what you want to accomplish. ...
  • Explain how your skills and experience have prepared you for this role.
  • Describe what makes banking a good fit for you and how you can contribute to the industry.
Nov 9, 2022

What are the qualities of a good banker? ›

Top bankers possess exceptional financial acumen, enabling them to analyse complex data, interpret financial reports, and make informed decisions. Their ability to identify profitable investment opportunities and manage risk effectively is crucial in guiding their clients and organisations towards success.

What is your strength as a banker? ›

Some examples of strengths that are valued in investment banking include analytical skills, problem-solving skills, attention to detail, communication skills, and teamwork skills.

What are the three most important things to look for in a bank? ›

The three most important factors when choosing a bank for checking and savings accounts are the type of bank, the rates and fees it charges, and the extra features it offers.

What do we do in a bank answer? ›

Banks allow the customer to take a loan against a mortgage of certain property (tangible assets and / guarantees). Cash credit is given to any type of account holders and also to those who do not have an account with a bank. Interest is charged on the amount withdrawn in excess of the limit.

What is banking in simple words? ›

Banking is the business of protecting money for others. Banks lend this money, generating interest that creates profits for the bank and its customers. A bank is a financial institution licensed to accept deposits and make loans. But they may also perform other financial services.

What are the three main types of bank transactions? ›

The three main types of bank transactions are deposits, withdrawals, and transfers. Deposits put money into an account, withdrawals take money out, and transfers move money between accounts.

How do banks actually make money? ›

Commercial banks make money by providing and earning interest from loans such as mortgages, auto loans, business loans, and personal loans. Customer deposits provide banks with the capital to make these loans.

How banks actually create money? ›

Banks create money when they lend the rest of the money depositors give them. This money can be used to purchase goods and services and can find its way back into the banking system as a deposit in another bank, which then can lend a fraction of it.

What do banks really do with your money? ›

It doesn't remain locked away in the bank vault – instead, the money you deposit into a savings account is used by the bank to make loans to other people and businesses in your community so that they have the money to pay for big expenses like houses and cars, or even to operate a business.


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