Banks and Banking Services

Banks are business organizations that accept and hold deposits from the public, transfer funds on order from their depositors, and use these funds to make loans or purchase securities. Banks earn profits when the interest earned on investments exceeds both the amount of interest paid out to depositors and other business costs. The term "bank" once described only commercial banks, but now savings banks, savings and loan associations, and credit unions provide nearly the same services. These institutions differ in some respects, however. For example, savings and loan associations specialize in housing finance, while credit unions focus primarily on consumer credit. Still, every legitimate banking institution operates with a charter from either the federal government or a state government and is subject to a substantial number of regulations. These regulations include restrictions on lending and other activities; they also specify the amount of capital, or their own funds, that the owners must invest in the bank.

Commercial banks are the most prominent type of banking organization because of their numbers and size. The several thousand credit unions are quite small.

Deposit Services

Banks provide deposit services to individuals, businesses, and governments. There are two kinds of deposits:

Transaction accounts are those against which depositors may write checks. Checks are orders that go from a depositor to a bank, directing the bank to pay out a specified sum to a designated recipient. Checking accounts provide a safe, convenient means of paying bills, while canceled checks represent a legal receipt or evidence of payment. Banks provide other services for checking — account customers. Depositors may arrange to have recurring payments, such as mortgage or insurance bills, made for them automatically by the bank each month. Likewise, they can have a fixed amount transferred monthly from their checking account to a savings account, or vice versa. Banks will also certify checks to assure the payee that sufficient funds to cover the check are on deposit.

These services, however, are expensive. While banks are prohibited from paying corporations interest on their checking accounts, they do pay interest on some transaction accounts held by individuals (NOW accounts). To cover such costs, a bank must either charge its depositors a service fee or earn interest by investing the funds in the account. Service charges may take the form of a fixed monthly fee or a charge for each check. Some banks waive charges if the average balance in the account exceeds a certain amount. Time deposits include:

- savings accounts,
- money-market accounts, and
- certificates of deposit (CDs).

These accounts represent a safe way to hold assets as well as to earn interest. The interest rate these deposits earn depends on market conditions and the type of deposit. The federal deposit insurance system guarantees the safety of time deposits in an amount of up to $100,000 per depositor.

Banks usually pay the highest rate of interest on certificates of deposit because these accounts have a specific maturity date. A depositor pays a penalty if the funds are withdrawn before then. By contrast, the funds in savings accounts and money-market accounts are usually available on demand, although, technically, a bank can require notice before withdrawal. While checks usually can not be used to withdraw money from savings accounts other than NOW accounts, a limited number of checks or electronic transfers can sometimes be drawn on money-market accounts.

Credit Services

The principal business of banks is making loans, and interest on loans is their main source of income. Banks lend to all sectors of the economy — businesses, consumers, home buyers, farmers, security dealers, and governments — though most institutions specialize in certain types of loans.

Commercial banks are an important source of credit to business. Banks make loans either on a short-term basis, to finance business inventories or accounts receivable, or on a long-term basis, to finance equipment purchases or for general business purposes. Loans may be made at a fixed interest rate, though most are tied to some index of market rates (frequently, the prime rate). A loan may be a one — time transaction, but much business credit is extended through lines of credit, whereby a bank promises to lend the borrower up to a certain amount of money. Banks also lend to farmers and other small business, usually on a secured basis, but sometimes on the basis of the borrower's personal credit standing.

Finally, banks make it easier for business to access other sources of credit by issuing letters of credit that, in effect, place the credit standing of the bank behind its customer. These guarantees may come in the form of a banker's acceptance — a short-term marketable security — or may facilitate issuance of commercial paper. Savings and loan associations and savings banks emphasize mortgage lending to buyers of homes. The traditional homemortgage loan in the United States has been a long-term loan at a fixed rate and amortized, which means the fixed monthly payment includes some reduction in the principal so that the loan is completely repaid at maturity. Since the 1970s, lenders have also offered adjustable rate mortgages (ARMs) at rates that adjust as market conditions change. These loans redoce a bank's exposure to risk from swings in the market interest rate.

Bank also extend credit to developers and purchasers of commercial real estate, such as office buildings, apartments, and shopping centers. These loans are considerably riskier than homemortgage loans.

Commercial banks and credit unions are major sources of credit for consumers, and they offer credit in many forms. Banks make installment loans to finance the purchases of expensive consumer goods, such as automobiles. The borrower makes large enough montly payments to repay the loan at maturity. Banks also offer credit cards that let consumers borrow up to a fixed amount, provided consumers pay the loan back with monthly payments that include interest on the outstanding balance of the account. (The interest is usually waived if the total balance due is paid within a grace period.) Because processing many small charges is expensive, and because defaults and fraud losses are more mmon on credit card debts than on automobile or home loans, these cards carry relatively high interest rates.

There is another way in which the deposit and lending activities of banks are interrelated. Borrowers tend to make deposits at the bank they borrow from, so making loans is an important means by which banks compete for deposits. Also, when a loan is made, the bank credits the funds to the borrower's deposit account, rather than paying out currency. Making the loan thereby creates a deposit. In this way banks are said to create moneya vital role in a free market economy.

Internet Banking

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Credit Cards

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Other Services

Banks are large investors in securities — mostly government bonds — either because they have more funds available than loan demand or bacause they want the returns and liquidity these securities offer. Because a great portion of a bank's deposits mature shortly or are payable on demand, banks need to hold some assets in liquid form so that they can be converted to cash quickly. U.S. government securities are attractive because of their liquidity and safety. State and local government bonds are less attractive than they once were, mostly because they no longer pay tax — exempt interest.

Banks provide other financial services, usually for a free. Most rent safe deposit boxes and sell traveler's checks and foreign currency. Some provide trust services or a wide variety of securities services. Still, these services are ancillary to the primary banking activities of handling deposits and making loans.

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