What is a Bank ?
What is a bank?
According to Britannica.com, a bank
is:
an institution that deals in money and its substitutes and
provides other financial services. Banks accept deposits and
make loans
and derive a profit
from the difference in the interest rates paid and charged,
respectively.
Banks are critical to our economy. The primary function of banks
is to put their account holders' money to use by lending it out
to others who can then use it to buy homes,
businesses, send kids to college...
When you deposit your money in the bank, your money goes into a
big pool of money along with everyone else's, and your account
is credited with the amount of your deposit. When you write
checks or make withdrawals, that amount is deducted from your
account balance. Interest you earn on your balance is also added
to your account.
Banks create money in the economy by making loans. The amount of
money that banks can lend is directly affected by the reserve
requirement set by the Federal Reserve. The reserve requirement
is currently 3 percent to 10 percent of a bank's total deposits.
This amount can be held either in cash on hand or in the bank's
reserve account with the Fed. To see how this affects the
economy, think about it like this. When a bank gets a deposit of
$100, assuming a reserve requirement of 10 percent, the bank can
then lend out $90. That $90 goes back into the economy,
purchasing goods or services, and usually ends up deposited in
another bank. That bank can then lend out $81 of that $90
deposit, and that $81 goes into the economy to purchase goods or
services and ultimately is deposited into another bank that
proceeds to lend out a percentage of it.
In this way, money grows and flows throughout the community in a
much greater amount than physically exists. That $100 makes a
much larger ripple in the economy than you may realize!
Why does it work?
Banking is all about trust. We trust that the bank will have our
money for us when we go to get it. We trust that it will honor
the checks we write to pay our bills. The thing that's hard to
grasp is the fact that while people are putting money into the
bank every day, the bank is lending that same money and more to
other people every day. Banks consistently extend more credit
than they have cash. That's a little scary; but if you go to the
bank and demand your money, you'll get it. However, if everyone
goes to the bank at the same time and demands their money (a run
on the bank), there might be problem.
Even though the Federal Reserve Act requires that banks keep a
certain percentage of their money in reserve, if everyone came
to withdraw their money at the same time, there wouldn't be
enough. In the event of a bank failure, your money is protected
as long as the bank is insured by the Federal Deposit Insurance
Corporation (FDIC). The key to the success of banking, however,
still lies in the confidence that consumers have in the bank's
ability to grow and protect their money. Because banks rely so
heavily on consumer trust, and trust depends on the perception
of integrity, the banking industry is highly regulated by the
government.
Types of Banks
There are several types of banking institutions, and initially
they were quite distinct. Commercial banks were originally set
up to provide services for businesses. Now, most commercial
banks offer accounts to everyone.
Savings banks, savings and loans, cooperative banks and credit
unions are actually classified as thrift institutions. Each
originally concentrated on meeting specific needs of people who
were not covered by commercial banks. Savings banks were
originally founded in order to provide a place for lower-income
workers to save their money. Savings and loan associations and
cooperative banks were established during the 1800s to make it
possible for factory workers and other lower-income workers to
buy homes. Credit unions were usually started by people who
shared a common bond, like working at the same company (usually
a factory) or living in the same community. The credit union's
main function was to provide emergency loans for people who
couldn't get loans from traditional lenders. These loans might
be for things like medical costs or home repairs.
Now, even though there is still a differentiation between banks
and thrifts, they offer many of the same services. Commercial
banks can offer car loans, thrift institutions can make
commercial loans, and credit unions offer mortgages!
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