How different types of banks operate in the financial system
Banks are financial intermediaries that collect money from people who have excess funds and use it to provide loans and financing to individuals, businesses, and governments. They also help customers conduct financial transactions, often through an affiliated broker-dealer and/or wealth management division.
Broadly speaking, banks in the United States fall into two categories: commercial banks and investment banks. Commercial banks offer savings, checking, and lending services, and they are usually regulated by the Office of the Comptroller of the Currency (OCC). Investment banks help corporations and governments raise money through stocks and bonds, and they are usually regulated by the Securities and Exchange Commission (SEC).
Banks that are part of the Federal Deposit Insurance Corporation (FDIC) system pay premiums into the FDIC. In return, the FDIC insures depositors up to $250,000 in the case of a bank failure. The Federal Reserve also has regulatory oversight duties for banks as well as “nonbank financial intermediaries.” The Fed is responsible for checking and maintaining the overall safety and soundness of the banking system. It conducts audits and stress tests designed to ensure the entire financial ecosystem is prepared for a potential crisis.
Key Points
- Banks are financial intermediaries that connect people who have excess capital and people who need additional capital.
- Commercial banks work with savers that make deposits and individuals and businesses that need to borrow money.
- Investment banks work with businesses that need to raise money through stock or bond offerings, or that are making mergers and acquisitions.
Commercial banks
Commercial banks are the most common type of banks. They serve businesses and consumers in two ways:
- Retail services. Banks provide services to individual consumers and small businesses. They offer basic financial products such as checking and savings accounts and certificates of deposit (CDs), personal loans, mortgages, and credit cards. Retail banks typically have a wide network of branches and automated teller machines (ATMs) for easy access to their services. Some operate entirely online.
- Business services. Commercial banks primarily serve businesses, corporations, and large institutions. They offer a range of financial services tailored to the needs of businesses, including business loans, lines of credit, cash management, and treasury services. Commercial banks also provide services like payroll processing, merchant services, and foreign exchange.
Banks vs. credit unions: What’s the difference?
Although there are many similarities between banks and credit unions, there are a few key differences, including the regulator (FDIC or NCUA), ownership structure, product and service availability, and interest rates. Compare banks and credit unions.
The largest commercial banks are known as money center banks. These operate in such global financial capitals as New York, London, and Tokyo. Money center banks provide a wide range of financial services, including commercial banking, investment banking, asset management, and international banking. Money center banks typically have extensive international operations and serve multinational corporations, governments, and institutional clients such as hedge funds, private equity groups, and venture capitalists.
Money centers and other megabanks
When we think of money center banks in the United States, four names come to mind: JPMorgan Chase (JPM), Bank of America (BAC), Citi (C), and Wells Fargo (WFC). Two large legacy investment banks, Goldman Sachs (GS) and Morgan Stanley (MS), were granted banking charters during the financial crisis of 2008 and now have commercial banking arms.
Globally, the top four banks in terms of assets are majority-owned by the Chinese government. The so-called “China big four” include the Industrial and Commercial Bank of China (ICBC), the China Construction Bank (CCB), the Agricultural Bank of China (ABC), and the Bank of China (BoC). Learn more about China’s financial sector.
Investment banks
Investment banks are financial institutions that work with large investors, corporations, and governments. They work in the capital markets (primarily stocks and bonds) to connect investors to companies and governments that need to raise money. They also provide corporations with advisory services on corporate strategy, mergers, and acquisitions.
Many investment banks also have broker-dealer operations, meaning they buy and sell securities on behalf of customers (many of them institutional clients), as well as for the bank’s own account.
In the United States, the primary regulator for investment banks is the SEC, but some investment banking activities fall under other regulators, such as the Federal Reserve System. Some investment banks also hold commercial banking charters, so they are subject to those regulations as well.
Other types of banks
Many nonfinancial organizations that connect people with a surplus and people with a need call themselves banks, such as food banks and blood banks. But there are two more categories of organizations that use the word “bank” and operate in the financial system:
- Savings banks. Savings banks, or thrift institutions, focus on promoting savings and homeownership. They usually concentrate on a particular community and have few branches. From a regulatory perspective, they are virtually the same as commercial banks.
- Land banks. These are government entities or public-private partnerships that acquire vacant, abandoned, or tax-delinquent properties within a community. They work to make the properties safer and salable through demolition, rehab, and redevelopment.
The bottom line
On a simple level, banks connect people who have assets to lend with people who need to borrow assets to fund purchases—from mortgages and auto loans to multibillion-dollar strategic acquisitions. In the United States, commercial banks collect deposits and issue loans, while investment banks facilitate capital formation and other financial transactions.
Both are critical to the growth and functioning of a market-based economy.