Introduction to Principles of Banking

Accessible to professionals and students alike, The Principles of Banking covers issues of practical importance to bank practitioners, including asset-liability management, liquidity risk, internal transfer pricing, capital management, stress testing, and more.

What is the bank?
A bank is a financial institution licensed to take deposits and grant loans. Banks may also provide financial services such as wealth management, currency exchange, and safe deposit boxes. There are several different types of banks including retail banks, commercial or corporate banks, and investment banks. In most countries, banks are regulated by the national government or central bank.

Understanding the banks
Banks are a very important part of the economy because they provide vital services to both consumers and businesses. As financial service providers, they provide you with a safe place to store your money. With a variety of account types such as checking accounts, savings accounts, and certificates of deposit (CD), you can perform routine banking transactions such as deposits and withdrawals, write checks, and pay bills. You can also save your money and earn interest on your investment. Funds stored in most bank accounts are federally insured by the Federal Deposit Insurance Corporation (FDIC), with a maximum of $250,000 for individual depositors and $500,000 for joint deposits.

Banks also provide credit opportunities to individuals and businesses. The money you deposit in the bank — short-term cash — is used to lend to others for long-term debt such as car loans, credit cards, mortgages, and other debt vehicles. This process helps create liquidity in the market – which creates money and keeps the supply going.

Just like any other business, the aim of the bank is to make a profit for its owners. For most banks, the owners are their shareholders. Banks do this by charging more interest on loans and other debts they issue to borrowers than they pay people who use their savings cars. Using a simple example, a bank that pays 1% interest on savings accounts and charges 6% interest on loans makes a total profit of 5% for its owners.

Banks vary in size depending on where they are located and who they serve — from small community enterprises to large commercial banks. According to the FDIC, there were just over 4,500 FDIC-insured commercial banks in the United States as of 2019.2 This number includes national banks, state-chartered banks, commercial banks, and other financial institutions. While traditional banks offer both a physical location and an online presence, a new trend in online-only banks emerged in the early 2010s. These banks often offer consumers higher interest rates and lower fees. Convenience, interest rates and fees are some of the factors that help consumers determine their preferred banks.

Special Considerations
US banks were subjected to intense scrutiny after the global financial crisis that occurred in 2007 and 2008. Since then, the regulatory environment for banks has been tightened considerably as a result. US banks are regulated at the state or national level. Depending on the structure, they may be organized at both levels. State banks are regulated by a state banking department or department of financial institutions. This agency is generally responsible for regulating issues such as what practices are allowed, how much interest a bank can charge, and the review and inspection of banks.

National banks are regulated by the Office of the Comptroller of the Currency (OCC). OCC regulations mainly cover banking capital levels, asset quality, and liquidity. As mentioned above, banks with FDIC insurance are additionally regulated by the FDIC.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010 with the goal of reducing risk in the US financial system in the wake of the financial crisis. Under this law, large banks are evaluated on the basis that they have sufficient capital to continue operating under difficult economic conditions. This annual assessment is referred to as the stress test.

Bank types
Retail banks deal specifically with retail consumers, although some global financial services firms have both commercial and retail banking divisions. These banks provide services to the general public and are also called personal or public banking institutions. Retail banks offer services such as checking and savings accounts, loan and mortgage services, auto financing, and short-term loans such as overdraft protection. Many major retail banks also provide credit card services to their customers, and may also provide their customers with foreign currencies. Larger retail banks often cater to high net worth individuals, giving them specialized services such as private banking and wealth management. Examples of retail banks include TD Bank and Citibank.

Commercial banks or corporations provide specialized services to their commercial clients from small business owners to large corporate entities. Besides day-to-day business banking, these banks also provide their customers with other things like credit services, cash management, commercial real estate services, employer services, and trade finance. JPMorgan Chase and Bank of America are two common examples of commercial banks, although both have large retail banking divisions as well.

Investment banks focus on providing corporate clients with complex services and financial transactions such as underwriting and assistance in merger and acquisition (M&A) activity. As such, they are primarily known as the financial intermediaries in most of these transactions. Clients typically range from large corporations, other financial institutions, pension funds, governments and hedge funds. Morgan Stanley and Goldman Sachs are examples of US investment banks.

Unlike the above-mentioned banks, central banks do not depend on the market and do not deal directly with the general public. Instead, they are primarily responsible for currency stability, control of inflation and monetary policy, and supervision of a country’s money supply. It also regulates the capital and reserve requirements of member banks. Some of the world’s major central banks include the US Federal Reserve, the European Central Bank, the Bank of England, the Bank of Japan, the Swiss National Bank, and the People’s Bank of China.
Bank vs Credit Union
Credit unions vary in size from small, community-based entities to larger entities with thousands of branches across the country. Just like banks, credit unions provide routine financial services to their customers who are generally called members. These services include basic deposit, withdrawal and credit services.

But there are some inherent differences between the two. While a bank is a profit-driven entity, a credit union is a nonprofit organization that is traditionally run by volunteers. Created, owned and operated by participants, it is generally tax deductible. Members buy shares in the barn, and these funds are pooled together to provide credit services to a credit union. Since they are smaller entities, they tend to offer a limited range of services compared to banks. They also have fewer locations and Automated Teller Machines (ATMs).

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