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Understanding the role and functions of banks in the financial system
What is a Bank?
A bank is a financial institution that accepts deposits from customers, provides loans, and offers various financial services. Banks act as intermediaries between people who have money and people who need money.
Banks take money from depositors (people who save) and lend it to borrowers (people who need money). They make money from the difference between interest paid to depositors and interest charged to borrowers.
Banks provide a safe place to store money, facilitate payments, enable borrowing, and help the economy function by moving money from savers to borrowers who can use it productively.
How Banks Work
Customers deposit money into bank accounts (checking, savings). The bank promises to keep this money safe and return it when requested.
Banks keep a small portion of deposits as reserves (required by law). The rest can be lent out to borrowers. This is called "fractional reserve banking."
Banks lend the deposited money to borrowers (for homes, cars, businesses). They charge interest on these loans, which is how banks make profit.
Banks pay low interest to depositors (e.g., 0.01% on savings) and charge higher interest to borrowers (e.g., 5% on loans). The difference is profit.
When banks make loans, they create new money. A $100 deposit can become $90 in loans, which gets deposited elsewhere, creating more money. This multiplies the money supply.
Main Functions of Banks
Banks provide safe storage for money. Customers deposit cash into checking, savings, or other accounts. Banks promise to return the money on demand.
Banks lend money to individuals and businesses. Borrowers pay back the loan plus interest over time. This is how banks make most of their profit.
Banks enable money transfers between accounts, process checks, handle wire transfers, and provide payment infrastructure for commerce.
Banks offer various financial products and services beyond basic deposits and loans.
Banks provide security for money through insurance, fraud protection, and secure storage.
Banks create credit by lending money that doesn't exist yet. This expands the money supply and enables economic growth.
Types of Banks
Large banks that serve individuals and businesses. They offer checking, savings, loans, and other services. Examples: Chase, Bank of America, Wells Fargo.
Smaller, local banks that focus on serving their communities. Often more personal service and local decision-making.
Member-owned financial cooperatives. They're not-for-profit and often offer better rates to members. Examples: Navy Federal, State Employees Credit Union.
Banks that operate primarily online with no physical branches. Often offer higher interest rates and lower fees. Examples: Ally Bank, Capital One 360.
Banks that help companies raise capital, facilitate mergers, and provide investment services. They don't typically serve individual consumers. Examples: Goldman Sachs, Morgan Stanley.
Government banks that control monetary policy, regulate other banks, and manage the money supply. Examples: Federal Reserve (US), European Central Bank.
Credit Unions
A credit union is a member-owned, not-for-profit financial cooperative. Unlike traditional banks that are owned by shareholders and exist to make profits, credit unions are owned by their members and exist to serve their members' financial needs.
Credit unions are owned by their members. When you join a credit union, you become a member-owner with voting rights. Members elect the board of directors, who make decisions in the members' best interests.
Credit unions are not-for-profit organizations. Any profits are returned to members in the form of better interest rates on savings, lower interest rates on loans, and reduced fees. They don't pay dividends to outside shareholders.
Credit unions focus on serving their members rather than maximizing profits. They often offer better rates, lower fees, and more personalized service than traditional banks.
Credit unions have membership requirements based on common bonds such as:
Centralized Banks
A centralized bank (also called a traditional bank or commercial bank) is a for-profit financial institution owned by shareholders. These banks operate with a centralized structure where decisions are made by management and a board of directors accountable to shareholders, not customers.
Centralized banks are owned by shareholders who invest capital expecting returns. The bank's primary goal is to maximize profits for shareholders, not necessarily to serve customers' best interests.
These banks exist to generate profits. They make money from interest rate spreads, fees, and other services. Profits are distributed to shareholders as dividends or reinvested to grow the business.
Decisions are made by a centralized management structure and board of directors. Customers have no voting rights or say in how the bank operates. The bank controls all policies, fees, and terms.
Centralized banks are often large institutions with many branches, extensive ATM networks, and comprehensive service offerings. They serve millions of customers nationwide or globally.
Centralized banks represent the traditional financial system with central control and intermediaries. This contrasts with decentralized systems like cryptocurrency, where there's no central authority and users have direct control over their assets.
How Banks Make Money
The main way banks make money. They pay low interest on deposits and charge higher interest on loans. The difference is profit.
Banks charge various fees for services, which generate significant revenue.
Banks invest customer deposits in securities, bonds, and other financial instruments to generate returns.
Banks earn fees and commissions from offering financial products and services.
Fractional Reserve Banking
Fractional reserve banking means banks only keep a fraction of deposits as reserves. They lend out the rest. This allows banks to create money and multiply the money supply.
You deposit $1,000 in Bank A
Bank A keeps $100 as reserves (10% reserve requirement)
Bank A lends $900 to a borrower
Borrower deposits $900 in Bank B
Bank B keeps $90, lends $810 to another borrower
Result: Your $1,000 deposit created $1,710+ in the economy!
Banks don't just store your money - they create new money by lending. This is why banks are so powerful in the economy. They control the money supply through lending.
Bank vs Cryptocurrency
Pros and Cons of Banks
Key Takeaways
Banks are financial intermediaries that take deposits, make loans, and facilitate payments. They're central to the traditional financial system.
Banks make money from interest rate spreads (charging more on loans than paying on deposits), fees, and investment income.
Banks only keep a fraction of deposits as reserves. They lend out the rest, creating new money and multiplying the money supply.
Banks are central to the economy - they facilitate payments, create credit, and control much of the money supply. They're powerful institutions.
Cryptocurrency offers an alternative to banks - decentralized, peer-to-peer, with no central control. You become your own bank.
Banks offer security and convenience but with fees, restrictions, and central control. Crypto offers freedom but requires self-custody and responsibility.
🎮 WHAT IS A BANK ADVENTURE GAME
Navigate through banking scenarios and make critical decisions! Learn about banks as intermediaries, money creation, payment services, regulation, and the essential role banks play in the financial system.
You have $10,000 you want to save. A friend suggests keeping it under your mattress. A bank offers to hold it safely and pay you interest.
Should you use a bank to store your money?
Press Y for YES or N for NO