A bank provides a safe place to store your cash and offer credit. The banking industry handles cash, credit, and other financial transactions. They also offer savings accounts, certificates of deposit, checking accounts, and other ways to lend money.
Banking is a key driver of the U.S. economy and it provides the liquidity many people and families need to make larger purchases and investments, like buying a home for the first time.
How It Works
A bank has many types of accounts you can take advantage of. Primarily people use banks for their checking accounts and savings accounts.
The FDIC, or the Federal Deposit Insurance Corporation, insures all banks in the USA for a set amount. This means your money is safe if anything were to happen to the bank. Typically this amount is capped at $250,000.
The banks typically don’t keep large amounts of money in their building. Instead they take advantage of the Federal Reserve. The Federal Reserve houses the money and requires the bank to hang onto a certain amount of cash, which is called the reserve requirement.
A bank makes money in a few ways but most of the time they make money on banking fees, like late payment fees, and interest payments on money they lend.
Types of Banks
There are several types of banks, but there are three primary types: Commercial, Community and Investment Banks.
A commercial bank provides services to individuals and businesses and typically operates in a much larger geographic area. These types of banks also back other financial services, like retailers. There is a good chance if you open a retail credit card you’ll be opening an account with a larger bank or credit provider.
A community bank, or credit union, is much smaller than a commercial bank. These are typically targeted towards a certain market, demographic or geographic area. For example, a community bank would be one that was created by a regional company to help their employees buy cars, houses, open savings accounts and more. Not all, but many of these are funded and run by their community members. In some cases they have stricture requirements but they usually have more favorable rates, terms and acceptance criteria once you’re a member.
An investment bank is strictly focused on investments in the stock market, bonds, mutual funds and other means of long and short-term investment plans. These types of banks not only manage a person’s money for them, they also help businesses with mergers and acquisitions. You most likely will never hear someone call them investment banks anymore as they are usually referred to as commercial banks.
The 10 largest banks in the United States:
- JP Morgan Chase
- Bank of America
- Wells Fargo
- Goldman Sachs
- Morgan Stanely
- U.S. Bancorp
- TD Bank, N.A.
- PNC Financial Services
- Capital One
Central Banks aka The Federal Reserve
A central bank is the backbone of the modern banking system. It’s an independent authority that polices money and regulates banks. It also provides resources into financial research and education. The primary goal of a central bank is to regulate and stabilize the nation’s currency.
In the United States, we call this the Federal Reserve.
The Federal Reserve has four primary tools to stabilizing and regulating the US currency:
- They buy and sell securities from banks. If the Federal Reserve buys securities from banks it is adding money back into the economy. If it sells securities to the banks it is pulling money out of the economy. Typically we see interest increase and decrease as the Federal Reserve adds and removes money.
- They set a reserve requirement that lets a bank lend a certain amount compared to its deposits. This is something many don’t know or realize – banks are heavily regulated in how much money they can give out.
- The Federal Reserve sets a prime interest rate for banks and lenders that they must follow. This is the rate for their best candidates and not all candidates, they are able to increase the interest rate based on creditworthiness.
- They manage a discount window which allows the banks to borrow funds to support liquidity and transactions (like a business buying another business).
Banking History in the USA
1775 – 1791
In 1775 the, after the start of the American Revolutionary war, the Continental Currency was created as a way to provide American’s with money that wasn’t regulated by the British government.
1791 – 1836
In 1791, the First Bank of the United States opened up under the control of Congress. The bank’s sole purpose was to manage and handle the debt from the war, create a currency and raise money.
In 1816, the Second Bank of the United States opened up.
Both of these banks closed as they essentially caused the wealthy to get richer and didn’t help the greater good.
1836 – 1863
During this time period there were “free banks”, this era is noted as the Free Banking Era. They essentially had several pop up banks that were issuing their own paper currency and there was little to no regulation.
They soon ran into problems with tons of different currencies and no way to manage who paid what. To combat this, the Automated Clearing House (ACH) was formed. You’ve probably heard or have seen the acronym ACH in your bank statements or when you pay a bill. This process dates all the way back to 1853.
The National Banking Act was passed to fund the Civil War. This act created national banks with paper currency that was backed by the U.S. government. It created bank charters, required banks to hold cash reserves and created a uniform currency.
1873 – 1907
No regulation of banking or the National Banking Act caused a depression in 1893. J.P. Morgan, as you have probably heard of, stepped in and bailed everyone out. J.P. Morgan bailed everyone again a second time during this period in 1907 when the banks triggered another depression.
1908 – 1913
The Federal Reserve Act was signed into law in 1913 created by the central bank we all call the Federal Reserve. It was responsible for regulating the economy and ensuring money was there when it was needed based on the current standing of the economy.
The ‘20s was a rough decade for the banking industry. It is the worst depression in American history and the Federal Reserve almost didn’t make it.
Due to the depression, nearly 10,000 banks across the United States had to close.
The ‘30s brought in more legislation to put a barrier between investment bankers and commercial banks. This was meant to stop people from being too risky with their investments having direct access to their cash.
The Treasure Accord was signed giving more transparent power to the Department of the Treasury and the Federal Reserve.
This established that there was a definitive line where each had power and where their power stopped.
The ‘70s saw the entire world in a global depression.
1980 – 1999
The Federal Reserve kept America afloat in nearly every downfall the banking or economy had during these years. It finally started doing what it was supposed to do to protect the American economy.
Due to the Federal Reserve stepping in, the United States economy started to grow and pick up dramatically.
1999 – 2007
The repealed part of the Glass-Steagall Act which forced banks to separate their investment banking and “normal” banking.
This allowed banks to combine their service offering with more gray areas.
This effectively caused another depression like it did in the early 1900s.
2007 – 2010
The real estate market crashed and dropped the value of securities down drastically. It crippled banks as they just spent the last 8 years handing out blank checks for houses and they were not in more debt than they could liquidate (house prices fell and no longer matched the loans).
The Troubled Asset Relief Program (TARP) bailed out the big banks for ~$700 billion.
2010 – Now
The term “fintech” is used now more than ever. We are seeing a boom in online banking and online investment technology allowing individuals to manage their finances and not rely on the brick and mortar banks .
These types of firms offer the exact same services as your traditional bank with much less overhead. These online banks still tap into the same resources that standard banks have and many of them even partner with larger banks for funding.