How Banking Works, Types of Banks, and How To Choose the Best Bank for You

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A bank is a licensed financial institution that accepts deposits from the public and uses those funds to make loans. That pairing of deposit-taking and lending separates a bank from a broker, a payment app or a lender that only lends. Around that core, banks offer checking and savings accounts, certificates of deposit (CDs), credit cards, mortgages, business loans, payments, currency exchange and safe deposit boxes. In the United States, banks are chartered and supervised by state or federal regulators, and deposits at insured banks are protected by the Federal Deposit Insurance Corporation (FDIC) up to set limits.

How banking works

A bank sits between people who have more money than they need right now and people who need to borrow, judging borrowers, collecting payments and keeping deposits available.

The deposit and lending cycle

1. Customers deposit money. Paychecks, transfers, cash and checks land in checking, savings and CD accounts. The bank records each deposit as money it owes the customer.
2. The bank pays for those deposits. Checking accounts pay little or no interest. Savings accounts pay modest interest. CDs usually pay more in exchange for locking the money up for a set term, which can run from a few months to five years or longer.
3. The bank lends. Deposits fund car loans, credit cards, mortgages and business loans. Borrowers pay interest, usually at a higher rate than the bank pays depositors.
4. Money keeps moving. Borrowers spend what they borrow, that spending becomes someone else’s income, and much of it is deposited again at a bank.

The bank does not keep every depositor’s dollars in a vault. It holds part of its funds as cash and highly liquid assets so it can meet withdrawals and lends out much of the rest. That works because depositors rarely all ask for their money at the same moment. When too many do, the result is a bank run, which is one reason deposit insurance and capital rules exist.

How a bank makes money

A bank is a business, and most banks are owned by shareholders who expect a profit. The largest source is usually net interest income: the interest earned on loans and securities minus the interest paid on deposits and other borrowing. A second source is fees, such as monthly maintenance charges, overdraft and non-sufficient-funds fees, wire transfer fees, ATM fees for non-customers, and card interchange.

Worked example (hypothetical)

Assume a bank pays 1% a year on savings deposits and charges 6% a year on mortgages. It takes in $1,000,000 in savings deposits and lends $1,000,000 in mortgages.

• Interest paid to savers: $1,000,000 × 1% = $10,000
• Interest earned from borrowers: $1,000,000 × 6% = $60,000
• Gross interest margin: $60,000 − $10,000 = $50,000, or a 5 percentage point spread

That $50,000 is not pure profit. Out of it the bank pays staff, branches, technology, deposit insurance premiums and taxes, and it absorbs losses when borrowers default. A bank that lends too aggressively can see those loan losses wipe out the spread. That is why regulators require banks to hold capital as a cushion, measured by figures such as the capital adequacy ratio.

The core products

Checking accounts are for day-to-day money: paying bills, receiving direct deposits, using a debit card and withdrawing cash. They pay little or no interest and may carry monthly fees, usage fees or both, often waived if you meet a minimum balance or direct-deposit requirement.

Savings accounts pay interest on money you are not spending. They are meant to hold reserves, not to handle frequent payments.

Certificates of deposit pay a fixed rate for a fixed term. Pulling money out before the term ends usually triggers an early withdrawal penalty.

Loans and credit include mortgages, auto loans, personal loans, credit cards, lines of credit and overdraft protection. When comparing borrowing costs, the annual percentage rate (APR) folds in interest and certain fees so that offers can be compared on one basis.

Other services can include individual retirement accounts (IRAs), currency exchange, safe deposit boxes, wire transfers, cashier’s checks and, at larger banks, wealth management and private banking.

How banks developed

Banking dates back to at least 14th-century Europe, where houses such as the Medici of Florence took deposits, lent and handled payments. The basic model has changed less than how customers reach their bank: branches now sit alongside websites and apps, and online-only banks emerged in the early 2010s. The FDIC counted just under 4,000 FDIC-insured commercial banks in the United States in 2024, from small community banks to global institutions.

Types of banks

Most banks are retail, commercial or corporate, or investment banks. Central banks are a separate category because they do not serve the public. Large global banks often run several of these divisions under one name.

Retail banks

Retail banks serve individuals and households. They usually operate branch networks along with their main offices and offer checking and savings accounts, mortgages, auto financing, personal loans, overdraft protection and credit cards. Many also offer access to CDs, mutual funds and IRAs. Larger retail banks add private banking and wealth management for high-net-worth clients. TD Bank and Citibank are examples of banks with major retail operations.

Commercial or corporate banks

Commercial or corporate banks serve businesses, from sole proprietors to large corporations. Beyond business checking and savings, they provide credit lines and term loans, cash management, payroll and other employer services, commercial real estate lending and trade finance (such as letters of credit for importers and exporters). JPMorgan Chase and Bank of America are examples of banks with large commercial operations; both also run big retail divisions.

The term “commercial bank” also has a broader regulatory meaning in the U.S.: a deposit-taking, lending bank, as opposed to an investment bank. The FDIC count above uses that broader sense.

Investment banks

Investment banks work in the capital markets. They underwrite stock and bond issues, advise on mergers and acquisitions (M&A) and act as intermediaries in large, complex transactions. Their clients are corporations, other financial institutions, pension funds, governments and hedge funds rather than individual savers. Morgan Stanley and Goldman Sachs are among the largest U.S. investment banks.

Central banks

A central bank is an institution authorized by a government to manage the nation’s money supply and monetary policy. It aims to keep the currency and the economy stable, acts as a bank for commercial banks and, depending on the country, sets or enforces rules on bank capital and reserves. Central banks do not offer accounts to the public.

The Federal Reserve is the U.S. central bank. Its counterparts include the European Central Bank, the Bank of England and the Bank of Japan.

Community banks and online banks

Two other labels describe how a bank operates rather than what it does. A community bank is a smaller bank that takes deposits and lends within a local area, which can mean more personal service and local lending decisions. An online bank has no branches and serves customers through websites and apps. Online banks are still banks, chartered and potentially FDIC-insured like any other, which separates them from many fintech apps that partner with a bank rather than being one.

Banks vs. credit unions

Credit unions provide many of the same services as banks: checking (often called share draft accounts), savings, loans and cards. The difference is ownership and purpose.

Members buy shares in the cooperative, and that pooled money funds its loans. Surplus goes back to members rather than outside shareholders, but lower fees and better rates are a tendency, not a guarantee; compare actual terms.

How regulation and insurance protect your money

Who regulates U.S. banks

A U.S. bank can be regulated at the state level, the national level or both, depending on its charter:

• State-chartered banks are chartered, licensed and supervised by their state banking department, which also audits and examines them.
• National banks are chartered and supervised by the OCC, whose oversight focuses on capital levels, asset quality and liquidity.
• FDIC-insured banks are also supervised and examined by the FDIC, alongside the Federal Reserve for banks under its supervision.

Oversight tightened after the 2008 global financial crisis. The Dodd-Frank Act of 2010 set out to reduce risks in the financial system; among its measures, large banks must undergo regular stress tests to check they hold enough capital to keep operating under severe economic conditions.

How FDIC insurance works

The FDIC, an independent agency created by Congress, examines banks and insures their deposits.

• The limit: $250,000 per depositor, per insured bank, for each account ownership category.
• What it covers: deposit products such as checking, savings, money market deposit accounts and CDs.
• Cost to you: none. If you open a deposit at an FDIC-insured bank, coverage is automatic.
• Checking a bank: the FDIC’s BankFind tool lists insured banks and their branches.

The “per ownership category” part matters. Single accounts, joint accounts, certain retirement accounts and trust accounts are separate categories, each with its own coverage.

Hypothetical example. Assume you hold $300,000 in a single-owner savings account at one insured bank and nothing else there. Coverage is $250,000, so $50,000 is uninsured. Moving that $50,000 to a separately chartered insured bank, or into a different ownership category, would bring everything under coverage. A second single-owner account at the same bank would not, because coverage counts per bank and per category, not per account. Two brand names can belong to one chartered bank, so confirm the charter in BankFind.

What insurance does not cover

Not everything sold at a bank is a deposit. Stocks, bonds, mutual funds, annuities, life insurance and crypto assets are not FDIC-insured, even when you buy them through your bank’s branch or app. Safe deposit box contents are not covered either.

Are any non-bank accounts insured?

Brokerage accounts have their own protection. The Securities Investor Protection Corporation (SIPC), a nonprofit Congress created in 1970, steps in when a member brokerage firm fails: it works to recover customers’ cash and securities, helps liquidate the firm and runs the claims process.

• SIPC protects customers of registered member brokerage firms, covering securities such as stocks and bonds plus cash the firm holds for them.
• Coverage is up to $500,000 per customer, including a $250,000 limit for cash.
• SIPC replaces missing assets when a firm fails. It does not protect against investment losses when prices fall.

Payment apps are a third case. Balances held in services such as PayPal or Venmo are generally not bank deposits in your name, so standard FDIC coverage does not automatically apply to them. Some apps place customer funds at partner banks in ways that can qualify for pass-through coverage under specific conditions, so read the app’s own terms before parking a large balance there.

Brick-and-mortar vs. online banks

A traditional bank offers branches, in-person help, cash deposits at a teller and services such as notary or safe deposit boxes, plus online and mobile access. An online-only bank skips branches, which can lower its costs, and relies on its app, ATM networks and mobile check deposit. If you regularly deposit cash or need cashier’s checks on short notice, a nearby branch matters. If nearly all your money moves electronically, an online bank may cover everything. Many people use both: a local bank or credit union for checking and an online bank for savings.

How to choose a bank

1. Type of institution. A retail bank, online bank or credit union fits everyday personal banking. A business needs commercial services such as merchant accounts, payroll or trade finance, so decide whether to keep business and personal accounts at the same institution.
2. Fees. Check monthly maintenance fees and how to waive them, overdraft and non-sufficient-funds fees, and out-of-network ATM, wire and foreign transaction fees. These add up: even after many banks cut overdraft and NSF fees, U.S. consumers paid $5.8 billion in such fees in 2023, according to the Consumer Financial Protection Bureau.
3. Interest rates. Compare the annual percentage yield on savings and CDs and the APR on loans and cards you might need. A near-zero savings rate can still lose ground to inflation.
4. Convenience. If you use branches, pick one you can reach quickly in an emergency. Frequent travelers benefit from a bank with locations across the country or a broad ATM network.
5. Size and service. Large banks offer reach and a wide product range. Community banks may offer more personal service and local lending decisions.
6. Range of services. Check for the cards, loans, safe deposit boxes or investment access you expect to need, and whether the app handles check deposit, transfers and card controls.
7. Insurance. Confirm FDIC (or NCUA, for a credit union) coverage for the exact chartered institution, especially with online brands.

Limitations and common mistakes

Banks are safe places for deposits within insurance limits, but they are not designed to grow wealth. Checking pays little or nothing, and savings rates can trail inflation for long stretches. Money needed for long-term goals usually belongs in investments, which carry market risk and are not insured.

Insurance has a ceiling: balances above $250,000 per ownership category at one bank are exposed if it fails. Businesses holding payroll cash are the most likely to cross that line without noticing.

Several terms are often confused:

• Bank vs. central bank: your bank holds your account; the Federal Reserve manages monetary policy and opens no accounts for the public.
• Bank vs. credit union: similar services, different ownership, membership rules and insurer.
• Bank vs. payment app: an app may hold a balance without being a bank, which changes how it is protected.
• Deposit vs. investment at a bank: a CD is insured; a mutual fund bought at the same branch is not.

FAQs

The Bottom Line

Anyone opening a checking, savings or CD account benefits from knowing how banks earn money and how deposits are protected. Pick a bank on fees, rates, convenience and services, then confirm FDIC or NCUA coverage for the exact chartered institution. Keep balances within the $250,000 limit per ownership category at each bank, and remember that investments bought through a bank are not insured.