How Do Banks Work?

Banks allow people to borrow and loan money, and continue in business by their ability to earn interest off the money that is banked in their institution.

When people place their money into a bank, they are essentially loaning this money to the bank. A bank ensures their customers money is safe and this money is actually insured up to the level of $100,000 through the FDIC (temporarily $250,000 due to recent changes in the laws to restore confidence in the credit system). Checking accounts allow people greater access to their money, but pay almost no interest. Savings account allow more limited access to their money (but not much more limited access), but allows you to draw about 3% interest on your savings.

Types of Banks Loans

The types of bank loans offered are personal loans, home equity loans, car loans, mortgage loans, business start up loans and car loans.

Of course, banks also loan money to people for various rates. Banks charge interest on these loans and require credit checks and sometimes even collateral for larger loans. People get loans if they meet the bank’s qualifications. The better your credit rating, the lower your interest rate will be.

Interest rates are determined by a combination of credit score and income. Credit scores are determined by your credit history, essentially how you well you’ve payed off your debts in the past.

Bank Transaction Fees

how-banks-work

Bank transaction fees are charged to cover bank expenses and to add disincentives for customers who aren’t responsible with their money. For instance, if you overdraw your account, the bank has to allocate money it could be drawing interest on to cover the charges, so the overdrawn customer must pay an overdraft fee. Also, this gives the customer incentive not to write “hot” checks.

Banks charge ATM fees if they you aren’t one of their customers, because their employees must take time to interact with the bank across town whose ATM machine you used. So while these fees are annoying at times, they serve a purpose. Generally, banks don’t make money off their fees, but off the interest a bank draws off of loans.

Bank Investments

Your local bank can also help you invest your money for retirement or simply for profit. Banks can help you with most of the big investment types, and many people buy CDs or bonds through their local bank. Also, bank customers often keep an IRA account at their bank. You can even invest in stocks and mutual funds through your bank, though many people without investment expertise will go through a stock broker or investment professional when investing.

Investments on stock pay off a lot money placed in bonds, CDs and IRAs. The risk is a lot higher, though, because you can actually lose money when investing in the stock market. Mutual funds also offer big potential profits and certain risks, though the mutual fund tends to be less risky, because you are diversifying over a larger range of stocks.

So banks can handle most of your money needs. If a bank is responsible in who it loans money to and has a loyal customer base, banks can stay in communities for generations.