What Is a Bank?

Quick Answer

A bank is a financial institution that provides a place to hold your money. Banks are an important part of a country’s financial system. Most provide checking and savings accounts, as well as other financial products and services such as loans and other financing options.

Bank employees taking at a table

Whether you're talking about a traditional bank, online bank or credit union, financial institutions play an important role in consumer banking. They accept deposits, extend loans and usually provide other key financial services and products. Banks are also a central part of a functioning economy.

Chances are the bulk of your money is within various bank accounts. Let's take a look at how they work, the common types of banks and bank accounts, and how to choose the best bank for you.

How Does a Bank Work?

Banks are for-profit financial institutions that provide a holding place for your money. They typically serve three main functions:

  • Taking deposits: This is done through deposit accounts like checking and savings accounts, certificates of deposit (CDs) and money market accounts. Consumers earn interest on some of these accounts, though banks may charge various fees.
  • Extending loans: Financing can include mortgages, auto loans, personal loans, business loans and more. The borrower is charged interest and possibly other fees.
  • Providing other financial services and products: Many banks also provide other products and services, such as credit cards, investment accounts, wealth management services and more. Fees are standard.

With a traditional bank or online bank, there is a constant flow of depositing and lending. They make money in the following ways:

  • Customer banking fees
  • Financial products and services
  • Interest on securities the bank holds
  • Interest on loans they provide (minus the interest they pay depositors)

Banks are privately owned entities that answer to their shareholders, but it's a regulated industry—that means there's oversight and consumer protections in place. The majority of U.S. banks are insured by the Federal Deposit Insurance Corporation (FDIC). This covers deposit accounts up to $250,000 per insured bank, per depositor. (Ownership categories determine exact coverage amounts.)

The Office of the Comptroller of the Currency, which is part of the U.S. Department of the Treasury, regulates all national banks and federal savings associations. The Federal Reserve Board supervises and regulates financial institutions as well.

Legislation like the Dodd-Frank Act also protects consumers. It was introduced in response to the Great Recession and overhauled regulation in the financial industry. It also created the Consumer Financial Protection Bureau (CFPB).

Types of Banks

There are a variety of different types of banks. The one you choose will depend on your individual needs.

Traditional Bank

When you think of a bank, a traditional bank is probably what comes to mind. These are brick-and-mortar branches where you can open deposit accounts, make withdrawals, take out loans and access other financial services and products. These kinds of neighborhood banks are known for their ATM availability and in-person customer service representatives. You may also find additional products such as safe deposit boxes.

Online Bank

While most traditional banks offer an online banking component, a strictly online bank is fully digital. They function like a traditional bank, but everything is done on a mobile app or online. Consumers can transfer funds online or visit an in-network ATM to withdraw money or deposit cash or checks. An online bank may offer lower fees and better interest rates than a traditional bank. However, depositing cash may be cumbersome. Your options are to visit a local branch (if there is one), find an ATM that allows cash deposits or deposit your cash into another account and transfer the funds.

Commercial Bank

While many traditional banks provide banking services to small businesses, a commercial bank caters to large businesses and corporations. Most provide business checking and savings accounts, along with financing through loans and lines of credit. A commercial bank can be a reliable source of capital, especially for companies that need significant funds. It can also help companies build their business credit.

Investment Bank

An investment bank serves as an intermediary between businesses and investors. They tend to play an important role in initial public offerings (IPOs). When a private company goes public, its IPO allows them to sell stock shares and generate capital from new investors. This is often done through an investment bank or brokerage firm that facilitates these transactions. An investment bank can also arrange mergers and acquisitions. In short, this kind of bank specializes in corporate deals, IPOs and raising capital.

Central Bank

A central bank handles a country's monetary policies to keep its economy stable and to manage inflation. The Federal Reserve (or the Fed, for short) is the central bank of the United States. The Fed establishes the federal funds rate, which sets the tone for the interest rates financial institutions use. That includes the interest they charge on loans and the interest they pay out on deposit accounts.

Lower interest rates make it cheaper for consumers and businesses to borrow money. That can stimulate the economy if it leads to increased spending and more jobs. Higher interest rates make it more expensive to borrow money. That can discourage spending, which may help curb inflation. The upside is that interest rates on savings accounts, CDs and money market accounts tend to increase as interest rates rise.

Bank vs. Credit Union

Banks and credit unions typically offer many of the same financial products and services. The main difference is that, unlike banks, credit unions are not-for-profit organizations. They're owned by members, not shareholders. The main goal of a credit union is to benefit its members. If it generates more revenue than it needs, those proceeds may allow them to offer lower interest rates on loans—and higher rates on savings accounts. Member requirements vary from credit union to credit union. Some serve:

  • Certain employee groups
  • People who work in a specific field or industry
  • Folks who live, work or worship in the community the credit union serves

With a credit union, your money is insured up to $250,000 per account, per account holder by the National Credit Union Association (NCUA).

Types of Bank Accounts

Just as there are a number of types of banks, there are a variety of account types offered by those banks. Here are some of the most common ones.

Checking Account

This type of bank account is used for frequent transactions like paying bills and covering everyday spending. They generally don't earn interest, though some do if you maintain a certain minimum account balance. A checking account comes with a debit card that can be used while shopping or to deposit and withdraw funds from ATMs. Checkbooks are another common feature.

Savings Account

A savings account is designed to hold cash reserves. That makes it a great place to keep your emergency fund or money you're setting aside for other financial goals. Savings accounts also earn interest, allowing your money to work a little harder for you. Annual percentage yields (APYs) vary, but high-yield savings accounts are known for their competitive rates. At the time of this writing, rates are as high as 4.75%. The average rate for traditional savings accounts is 0.39%, according to the FDIC.

Certificate of Deposit

With a CD, you invest a certain amount of money for a set period of time, called the maturity period. When that period ends, you'll receive your money back—plus interest. Generally speaking, the longer the maturity period, the higher the interest rate. Just keep in mind that pulling your money out early usually triggers a penalty. Interest rates vary but are currently as high as 5.15%.

Money Market Account

A money market account is a cross between a checking account and a savings account. It earns interest and can be a great holding place for your cash savings. At the same time, most come with a debit card or checkbook to allow for easier accessibility. One potential drawback is that you may be limited to a certain number of convenient withdrawals per month. (Every financial institution is different.) Some money market accounts also have minimum balance requirements. At the time of this writing, some money market accounts have interest rates as high as 4.75%.

How to Choose a Bank

Here are a few simple steps for choosing the best bank for your needs.

  1. Figure out which kind of bank accounts you need.
  2. Decide between a traditional bank, online bank or credit union.
  3. Compare fees. They can include:
    • Monthly service fees
    • Overdraft fees
    • ATM fees
    • Excessive withdrawal fees
  4. Think about other features like introductory bonuses, rewards, money management tools, ATM availability and online banking.

The Bottom Line

Banks are an important part of a country's financial system. The right bank for you will depend on your financial situation and needs. Benefits, interest rates and fees vary from one bank to the next.

No matter where you do your banking, healthy credit is a key part of financial wellness. Whether you're buying a home, taking out an auto loan or opening a new credit card, your credit score will factor into the lending decision. Experian allows you to check your credit score and credit report for free at any time.