The ABC's of Banking: What is a Bank and How Does it Work?

If you have a few hundred dollars that you want to hold on to but don't want to spend, where do you put it? Or, say you want to buy a new car, but you need $30,000 to pay for it. This is where a bank can help.

Banks help the economy run by keeping individuals' money safe and lending out money when people need to make large purchases, such as for a house or a new car. But they offer more than a place to save or borrow money. Learn more about what a bank technically is, and the many different types of banks—and bank accounts!—that power modern commerce. 

What is a Bank?

A bank is a company licensed to hold and lend money to the public. Individuals can deposit their money into a bank and apply for loans, such as mortgages or car loans. 

Banks also offer checking and savings accounts, debit and credit cards and insurance. Banks even offer opportunities such as certificates of deposits and individual retirement accounts (IRAs).

History of banks

The concept of getting loans has been around for centuries. In Roman times, coins and jewels were stored in temples. It's believed that temples also served as an early precursor to banks.¹ Modern-day banking in the U.S. started in 1791, when Alexander Hamilton pushed for a central bank to help the post-Revolution economy recover.²

Today, banks are highly regulated on both the federal and state level. Most also offer deposit insurance for customers through the Federal Deposit Insurance Corporation. This ensures an individual's deposits are safe even if the bank fails, usually up to $250,000 per account owner, per ownership category.³

How Does a Bank Work?

Banks help manage the flow of money. They take in money via deposits, pool that money together and then lend it to people and businesses who need it — in exchange for a fee, known as interest. Banks make money from the interest as well as fees charged for specific services. 

Through this process, banks act as a go-between for depositors and borrowers. They can also pay interest to people who keep their money at the bank for a specific time, help borrowers find other creditors and help process payments between consumers and businesses.

Different Types of Banks

There were 4,236 banks in the U.S. in 2021, and over 72,000 branches.⁴ While the term "bank" is used to refer to financial institutions, there are many different categories of banks. Not all banks offer the same services or are regulated in the same way. Some banks work directly with consumers, for example, while others work behind the scenes to keep the economy going. In general, there are six different types of banks or financial institutions:

Retail banks

A retail bank is what many people think of when they think about a bank. These banks work with everyday customers and small businesses. They offer loans and deposit accounts such as checking and savings accounts. Some may also offer access to investments, high-yield savings accounts and credit cards. Larger retail banks may also cater to high-net-worth individuals and offer wealth management services.

Online banks

Online banks are retail banks that only operate online, often through mobile apps. In other words, they do not offer brick-and-mortar branches like many traditional retail banks. These banks offer similar types of services as a traditional bank, but may have fewer features than a larger bank, lacking offerings such as wealth management services. But they may have lower fees and are easy to use. 

Neobanks, which are nontraditional companies that offer checking and savings account online, or fintech firms, which use technology to automate or streamline financial services, are sometimes also considered to be online banks. Some neobanks may partner with existing banks to offer FDIC-insured banking products and accounts, but they are not actually banks. 

Investment banks

An investment bank focuses on financial activities like securities trading and managing investor accounts. In general, they act as the middleman for investors by buying and selling securities on their behalf. They may also offer investment advice and research equities. They can also help facilitate larger financial transactions. For example, investment banks often help underwrite Initial Public Offerings (IPOs) when a company wants to go public, or help manage mergers and acquisitions. ⁵

Commercial banks

Commercial banks cater to businesses or corporations, although they may sometimes also offer individual banking services as well. Like retail banks, commercial banks offer loans, deposit accounts and other services that a corporation might need, like payment processing, commercial real estate loans or international banking.

Central banks

A central bank controls the distribution of money and credit in a country or for a group of nations. The central bank is authorized by the government and is responsible for monetary policy and regulating banks. Unlike other types of banks, a central bank does not work with the public. Instead, it deals with financial institutions.

In the U.S., the Federal Reserve is responsible for making sure the U.S. dollar and the overall economy are stable. They also make sure that the nation's larger banks are regulated.⁶

Credit unions

A credit union offers similar services as a retail bank, but they don't operate for profit. Generally, credit unions are founded by members who pool their funds together. Membership is usually required to open an account, and requirements are based on various factors, including geography, type of employment, religious affiliation, or military affiliation. The National Credit Union Administration insures credit unions for up to $250,000 per account.⁷

Different Types of Bank Accounts and Loans

A bank can offer several different services to its clients, depending on the type of bank it is. Here are some of the most common types of accounts and loans that a bank offers:

• Checking accounts. A checking account is a deposit account that is used for everyday spending and is often linked to a debit card. You can use this account to make purchases, pay your bills and transfer money.
• Savings accounts. A savings account is an account that earns interest and is designed to hold money that you don't plan to spend in the short term.
• High yield savings accounts. A high yield savings account is like a savings account but usually offers a more competitive interest rate than a traditional savings account.
• Money market accounts. A money market account is an interest-bearing account that is easier to access than a regular savings account. In many cases, it is linked to a debit card.
• Certificates of Deposit (CDs). A certificate of deposit is an account with a fixed interest rate and a set term amount. In other words, you must keep your money in the account for a specified time. If you need to pull the money out before then, you will generally need to pay a penalty. 
• Credit cards. A credit card allows the cardholder to pay for goods up to a set amount and then pay back by a specific due date before paying interest. 
• Brokerage account. A brokerage account is an investment account that can hold bonds, stocks and other assets. Not all banks offer brokerage accounts.
• Mortgage loans. A mortgage is a loan you take out from the bank to buy a home.
• Auto loans. Auto loans are money you borrow from the bank to buy a car.
• Personal loans. Some banks may offer personal loans, which is money you borrow for personal use, such as paying for medical bills, debt consolidation or renovations.

The Bottom Line

Whether it's to take out a loan, earn interest on money you aren't planning to use for a while, or transfer funds between accounts, banks play a vital role in helping the economy run. The type of bank or bank account you open will depend on your circumstances and the features you are looking for so choose wisely! 

LEARN MORE: Find out more about the different accounts that Synchrony Bank offers.