How the Banking System Works for You

The banking system is a huge part of our everyday lives. It helps us with everything from depositing our paychecks to buying our first home or a new car. How are banks able to help us with such a wide range of our needs and goals? Part of it relates to the underlying structure of how banks work.

When you deposit money into your account, the bank uses those funds to lend to other customers for a small fee. In a way, you become a lender to the bank, which borrows money from you to lend it to other borrowers. But don't worry—your money always remains your own, and you're not on the hook if those borrowers default.

What happens to your money in a bank

This system of lending and borrowing is just one way that banks make money. When they lend out their customers' money to someone who wants a house or a personal loan, they charge interest. When the borrower repays the loan, the bank receives the money they lent out, plus the amount set by their interest rate.

In general, banks are only allowed to lend 90% of their customers' money. The other 10% must be kept in the bank's vaults or the closest Federal Reserve bank. This is known as fractional reserve banking, and it ensures banks have enough funds on hand to cover any possible withdrawals by customers.

The banking industry also acts as a financial intermediary between people. When you buy something at a store with a debit card, your bank and the store's bank make a transaction on your behalf. Even if you pay with cash, that money will eventually be deposited into the store's bank account. The bank charges a small fee to conduct that transaction, usually by charging a small monthly fee for a checking account.

The money doesn't go into the store's account right away though. Banks keep track of transactions on a ledger and settle with each other in bulk, crediting or debiting accounts that the different banks have between themselves. This keeps the transaction costs for banks down and makes the process as efficient as possible.

Securing your money

So, with all the transactions that banks conduct in a day, how does your money stay secure?

Today, banks are required to be insured by the Federal Deposit Insurance Corporation, or FDIC. The FDIC insures up to $250,000 per person, per account. This is an insurance policy for customer deposits. In the unlikely case that the bank doesn't have enough cash to pay customers, they'll still receive their money through the FDIC.

Since the 2008 financial crisis, regulators have also restricted how much money a bank can lend relative to how much they have in assets, which includes customer bank accounts. If a bank is highly leveraged, that means it has to use its own capital to make loans or investments. These guidelines reduce the chance of default if the economy has a downturn and borrowers can't pay back their loans.

Types of banking services

Borrowing and lending are just some of the services that banks provide. They also help people save and grow their money through checking and savings accounts. They provide advice on different investment options. You can also get a credit card from banks. And of course, the bank is the best place to go for a personal loan, a mortgage or a car loan.

Banks also help small businesses by offering business accounts, including debit and credit cards. They service business loans and can help a company with merchant services, like processing credit card transactions or maintaining their payroll accounts.

These days, more and more banks offer extensive digital services, too. You can deposit your checks and pay bills through your smartphone or computer. You can even opt for online bank statements instead of paper documents sent to you in the mail. Banks also offer extra layers of digital security—you can receive text messages and alerts about your accounts on your phone.

No matter what your financial goals are, or where you are in your life, the banking system is there to help you meet your target.