Banking Explained: How It Works and Why It Matters to You

Banking is the business of protecting and managing the money of others. It is the heart of the financial system dealing with cash, credit, and other financial transactions for individuals, businesses and even governments.

Banking is also one of the major drivers of the U.S. economy.

banking over the phone

Key Takeaways

  • Banking is the business of protecting and managing money, providing safe storage and loan services to individuals, businesses, and governments, and driving the U.S. economy.
  • Various types of banks exist, including retail banks, savings and loan associations, commercial banks, investment banks, online banks, and credit unions, each catering to different financial needs.
  • Banks offer common products and services like checking and savings accounts, certificates of deposit, loans, debit and credit cards, and money market accounts, providing security, convenience, and wealth-growing opportunities.

How Banking Works

Essentially, banking works by providing a safe place for customers to both store their cash and source loans for personal and business ventures. Banks make money by charging interest on their loan products, which they can offer because of their large cash deposits.

Banking is an old industry that has existed at least since the 14th century. The basic blueprint of banking remains the same, although banks today offer significantly more variety of financial products.

The Federal Reserve system does not currently require banks to keep any percentage of each deposit in liquidity, unless specified by the Federal Reserve. This type of regulation is known as reserve requirement.

The Banking System

Central banks exist to manage and oversee the liquidity and money supply for all other banks. In the United States, the central bank is known as the Federal Reserve. Central banks are established in most countries around the world.

To operate, a bank must be licensed to accept deposits for checking and savings, as well as issue loans. When it comes to regulation, in the U.S., there are both national and state charters. In addition, the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.

In addition to the traditional financial institution, neobanks have recently become popular. These are financial technology companies which partner with established banks to offer online banking services.

Because they are partnered with FDIC-insured financial institutions, these online banks can be just as safe as regular money banks.

What is the definition of a Bank?

A bank can be defined as any financial institution licensed to accept checking and savings deposits, as well as to make loans. There are several types of banks, each geared towards a certain sector of the financial market. 

Some banks focus on providing services and products for the average consumer, while others focus on investments or large corporations. Let’s take a closer look at the various types of banks that exist today:

Retail or Consumer Banks

Most banks that exist are known as retail or consumer banks. This means they are geared towards offering banking products and services to the public. Checking accounts, savings accounts and personal loans are the most basic services offered by these banks.

Savings and Loan Associations

Also known as thrifts or S&Ls, savings and loan associations are primarily focused on offering loan and savings products. As a type of savings bank, an S&L is mostly used by young families who are building towards becoming homeowners.

Commercial Banks

Commercial banking services are offered to businesses, corporations, and the general public. They are often established as standalone institutions or departments within a retail bank. Commercial banks tend to focus on loan and savings products for larger entities and corporations.

Investment Banks

Investment banks are high-level financial institutions which provide more complex financial services to their clients. Investment banks are primarily known for acting as intermediaries between corporations and the financial markets.

These banks also advise businesses, governments and large corporations on how to manage their finances.

Online Banks

Also known as neobanks, online banks provide virtual banking services designed to both complement and compete with traditional banks. Because online-only banks don’t have any brick-and-mortar branches, the reduced overhead costs allow them to offer more competitive banking services.

Credit Unions

Although not technically considered banks, credit unions are regulated and insured just as banks are. The major difference is that credit unions are not-for-profit institutions. As a result, they are often prepared to offer better rates on savings and loans compared to banks.

Credit unions are owned by members, and membership is usually exclusive to people working or living in their community.

See also: Credit Unions Anyone Can Join

Common Banking Products and Services

As we’ve seen, different banks provide a different focus of services to various customer bases. That said, the banking industry does provide some common services that are widely available through the vast majority of consumer banks and credit unions.

Checking Accounts

Checking accounts are the foundation of the consumer banking industry. These are designed to securely store and quickly access your money on a daily basis. Checking accounts also facilitate the use of direct deposit, ATM transactions and debit cards.

See also: Best Checking Accounts

Savings Accounts

Savings accounts are also a staple of consumer banking. These accounts are designed to securely hold and grow your money by accumulating interest. A savings account is often used alongside a checking account, which allows people to easily separate the money they want to spend from their savings.

See also: Best Savings Accounts

Certificates of Deposit

A certificate of deposit, or CD, can be thought of as a more advanced type of savings account. These accounts are designed to put your savings away for a specified period of time, typically from six months up to four or five years. The benefit of agreeing to store your money for an extended period is a higher interest rate.


Consumer banks and credit unions often provide customers with several types of loan products. These can include personal loans, auto loans, mortgages and home equity loans. Depending on your bank or credit union, they may offer other loan products such as refinancing, credit builder loans, and more.

Debit Cards & Credit Cards

A debit card is connected to your checking account, and allows you to easily pay for goods and services directly from that account. Debit cards are a popular and common financial product, as they remove the need to carry cash and are also relatively secure. Also, unlike credit cards, they don’t run the risk of getting you into debt.

Credit cards can be issued by banks or credit unions, and allow you to make purchases on a personal line of credit. Each time you use a credit card to make purchases, you are borrowing money from your bank, which will be paid back with interest.

Credit cards also come with other fees attached, and can lead you into debt if you are not able to keep up your balance paid regularly.

Money Market Accounts

A money market account is another type of savings account that offers higher interest rates compared to a traditional savings account. The catch is that they require a high minimum deposit to open, as well as a minimum balance to maintain.

In addition to stronger interest rates, money market accounts usually come with debit cards, checks, and FDIC or NCUA insurance protection.

See also: Best Money Market Accounts

Benefits of Using a Bank

Security & Insurance

First, banks are a secure way to protect your money from theft, fires and floods. Storing money without a bank account is possible, but a bank is extremely convenient and safe.

Of course, banking security is not just related to physical protection. Any legitimate bank will also insure your assets up to $250,000 by the federal government in the event that the bank collapses. This is known as FDIC insurance and applies to banks. The NCUA insures assets of credit unions.


Using a bank means you can have quick and secure access to your money at all times. Banks also function as a hub for your various financial needs, including loans, investments and retirement accounts.

Wealth Growing Services

Many banks also offer services that can help you grow your money. In addition to traditional and high-yield savings accounts, you could use CDs, IRAs, or a 401k to save aggressively.

How to Choose a Bank

With online banks, credit unions, and traditional big banks, there are plenty of financial institutions to choose from. Knowing how to choose the right bank for you requires some consideration. Here are some tips to help you make the right choice.

Necessary Services

Your decision will be easier if you can narrow down the services that are most important to you. If you know what services you need, that can help you narrow things down.

Most people need both a checking a savings account, ideally one with a good interest rate. Credit cards, loan products and other services should also be considered.


The fees you pay for various banking services can differ widely depending on the bank, as well as your account type. Monthly maintenance fees, ATM fees, and overdraft fees are all examples of typical banking fees.

However, it helps to shop around first. Some banks offer much better fee policies, especially online banks, some of which claim to be no-fee.

Understanding what you need and how you bank will help you understand how banking fees might affect your finances.


If having the ability to visit a brick and mortar bank branch is important to you, then location will be a big consideration. Alternatively, you can look for an online bank that provides all services via the internet.


Finally, it’s always a good idea to look online for customer reviews for any bank you’re considering. Comparing ratings on customer service can help you feel confident and comfortable with your choice.

Bottom Line

Banking services are integral to the economy, and allow people to conveniently and safely store their money. In addition to savings accounts, the benefits of the banking system also come in terms of loans, which many consumers rely on to purchase cars and homes.

Bank loans are also incredibly important for small business owners who need to borrow money to get established.

When looking to open a new bank account, be sure to compare the various fees and products available. The clearer you are when it comes to what you need from your bank, the easier it will be to find the best fit for you and your money.

A good bank can help consumers manage their expenses, borrow money and improve credit, among other things.

Frequently Asked Questions

What is banking, in simple words?

In simple terms, banking is the business of protecting other people’s money while providing loan services to others. Banks operate by maintaining checking accounts, savings accounts and loan products for customers.

How does a bank make money?

By securely storing large amounts of money, banks are in a position to then loan that money out to others, with interest. This interest charged on loan products allows banks to make a profit, as well as offer interest on savings to customers. Eventually, banks with good profits can improve the quality and number of their financial products.

How are banks regulated?

In the U.S. banks can be regulated at the state level, national level, or both. Each state has a department of banking or financial institutions, which regulates state banks. Generally, this department will be responsible for overseeing permitted practices, interest levels and bank audits.

When it comes to national banks, the Office of the Comptroller of the Currency (OCC) is the regulator. OCC regulations cover things like bank capital levels, asset quality, and liquidity.

U.S. banks are also regulated under the Dodd-Frank Wall Street Reform and Consumer Protection Act, which passed in 2010. This act holds large banks an annual stress test, designed to measure whether the bank has the capital required to operate safely and responsibly.

How do I know my money is safe in a bank?

The US financial system is also protected by The Federal Deposit Insurance Corporation. The FDIC is a government agency designed to maintain stability and confidence in the banking system, by supervising and examining all banking activity.

The FDIC also insures your money in the bank, up to $250,000 per depositor, for each account category you hold. This insurance doesn’t require additional purchase or any fee. As long as your bank is FDIC-insured, you benefit from this cover.

Should I use a retail bank or credit union or commercial bank?

Retail banks, credit unions and commercial banks all come with their own pros and cons. Knowing which one is best for you will depend on how well you know your own banking needs.

You might also consider opening accounts at more than one of these financial institutions, in which case you’ll want to think about how you will manage multiple accounts.

Retail banks provide the most variety of financial services, while a credit union can provide you with access to better rates. Commercial banks, on the other hand, are more suited towards business banking and loans for small businesses.

Steven Brennan
Meet the author

Steven Brennan is a freelance writer specializing in finance and cryptocurrency. He has an MA in Literature from Maynooth University in Ireland, and lives in the Pacific Northwest with his wife and young daughter.