How Banking Works: Overview, Types, Accounts & Fees

Banks can be intimidating. We know we need them, but there’s always a sense that there’s more going on there than we know about, and it’s easy to wonder if you’re using the right bank for you. If you’re thinking about getting your first bank account, if you’re wondering whether you should change banks, or if you’d just like to know more about banks and what they do, this guide to how banking works is for you.

1. What do Banks Do?

Banks provide financial services. Those services fall into two main categories.

• Banks accept deposits into checking, savings, and investment accounts. Banks may pay you interest on some of these deposits. They may also charge you fees for some services.
• Banks make loans of multiple types: mortgages, car loans, personal loans, and many more. Banks charge interest and fees on the loans that they make.

Your bank will also help you make payments, transfer money, and carry out other financial transactions.

Most banks now have online services and some banks are entirely online. In many cases, you will rarely, if ever, have to physically visit the bank’s premises.

2. There Are 4 Main Types of Banks

All banks provide similar services, but there are different types of banks with services geared toward different types of customers.

• National banks are the big players that everyone’s heard of. They have huge branch networks, sophisticated online services, and a wide range of services. They may also be oriented toward large commercial clients and may not be the best choice for small depositors.
• Local banks have fewer branches and the branches are usually concentrated in one region. They do not have the range of products and services that national banks have, but they may be more accessible and more friendly for small clients.
• Credit unions are not profit-making businesses. Depositors own credit unions, and they vote for management and policy decisions. They often offer limited products and services but they tend to pay higher interest on deposits and charge lower fees and interest rates on loans than conventional banks. While credit unions have traditionally been restricted to specific areas or groups, there are now credit unions that anyone can join.
• Online banks exist entirely online. Because they don’t have the overhead of physical branches they often charge low interest on loans, have low fees, and pay high interest on deposits. They may not be the best choice if you need or prefer the option of talking to a live person.

📕 Explore the differences between a bank and a credit union so you can make the right choice for your situation: Bank vs. Credit Union

📗 Not sure which type of bank would be best for you. Read our helpful guide on How to Choose a Bank.

3. There are Different Types of Bank Accounts

Banks offer different types of deposit products. These are some of the most common types of bank accounts.

• Checking accounts are for everyday transactions. They often have paper checks and a debit card associated with them. There are usually no transaction limits. Checking accounts usually do not pay interest, and they may charge fees for some services. These accounts are for money you will spend, not money you want to save.
• Savings accounts are for short-term savings. They pay interest, but usually at a relatively low rate. There will usually be a limit on the number of transactions you can make per month.
• Certificates of deposit let you deposit a fixed amount for a set period of time. You commit the money for that time and receive a higher interest rate in return. You may forfeit some or all of the interest if you withdraw the money before the set period is over. These accounts are a great way to save for a specific event.
• Money market accounts are similar to savings accounts but with higher interest rates. You’ll need to maintain a relatively high minimum balance. You may be able to make withdrawals, but if you fall below the minimum deposit you’ll pay a penalty.
• Individual Retirement Accounts or IRAs are a way to save for retirement. Your money is typically placed in a range of investments. You’ll receive tax benefits, which vary with the type of account. Learn more about retirement accounts here.

Before you open an account, think about the type of service you need. Many customers choose to have more than one account.

📘 Unsure wheater you need a checking or a savings account? Here are the main differences: Checking vs. Savings Accounts

4. Bank Deposits are Protected

The Federal Deposit Insurance Corporation protects bank deposits from loss if the institution fails. Insurance for credit union deposits comes from the National Credit Union Administration, state agencies, or private insurance companies.

Deposit insurance covers losses up to $250,000 per depositor. A joint account will have $500,000 in losses covered. Always verify that your bank or credit union has deposit insurance.

5. Banks Charge Fees

Banks charge various fees. It’s one of the ways they make money. Understanding bank fees and checking the fees your bank charges can help you minimize the cost of banking.

• Maintenance fees are fees a bank charges simply to hold an account. Look for a bank that does not impose maintenance fees.
• Minimum balance fees are imposed if your account balance falls below the account’s minimum required balance. Look for banks with low minimum balances, especially for checking accounts.
• Overdraft fees are charged if you write a check that your account balance won’t cover. This often happens if you write a check before a deposit you made has cleared. These fees average over $30 per overdraft.
• Overdraft protection fees come with overdraft protection. Your bank agrees to cover any overdraft, but you pay a monthly fee for that protection. If you keep a substantial balance and don’t overdraw your account, you won’t need the protection.
• Returned deposit fees hit you if you deposit a check that is returned for insufficient funds.
• Debit card transaction fees may be charged when you use your debit card in transactions. Avoid these fees if you often use your debit card for shopping.
• ATM fees are charged if you use an ATM outside your bank’s network.
• Paper statement fees are designed to encourage you to view your bank statements online. You’ll pay a fee to have a paper statement sent to you.
• Savings withdrawal fees will be imposed if you make more than the permitted number of withdrawals from a savings account in a given month.

Many other fees are possible, including cashier’s check fees, lost card fees, inactivity fees, and others.

If you’re shopping for a bank, be sure to get a clear list of the fee structure for each bank you’re considering. Note the fees that could affect you and do what you can to select the bank with the lowest fee structure. Each individual fee might not sound like a lot of money, but they can add up fast and become a significant cost.

6. Not Everyone Can Get a Bank Account

We think of opening a bank account as a simple process, but some applications are denied. This may happen because the bank was unable to verify some of your identifying information. It can also happen if you have a previous history of overdrafts or unpaid bank fees.

If a bank won’t let you open an account, ask why. You may have simply made a mistake in the application. If a bank turns you down because of an issue in your past, you should ask for details. If a bank turns down your application because of information from a reporting agency you are entitled to a copy of your file.

Some banks offer “second chance accounts” with limited functions for customers with bad records. You may be able to open an account with an online bank, and a prepaid debit card offers many features that you would normally get from a bank account.

7. You Should Always Check Your Bank Statements

Once you have an account, you will receive a monthly statement from your bank. Some banks still mail paper statements, but many banks now use online statements.

The statement is a list of all deposits, withdrawals, charges, interest payments, and fees during the statement period. Always read your statement thoroughly. Errors can happen, and unexplained entries could be a sign of fraud or identity theft. Reading your bank statement is also a great way to stay familiar with your finances and spending patterns.

8. You Can Automate Some Transactions

Many employers will pay your salary with an automatic transfer into your bank account. You can also set up automatic “pull” payments from your bank account to make recurring debt payments or pay recurring bills. Just be sure you have enough in your account to cover automated payments!

Automatic transactions can be a great way to simplify your financial life.

9. Your Banking Needs Will Change

You’ll probably start out with a simple checking account. As you get older and your financial life gets more complicated, you may need other types of accounts. You may also need to borrow money.

Remember that you can do business with more than one bank. There’s nothing wrong with keeping your checking account at a local credit union, opening a high-interest savings account at an online bank, and taking out a loan from a specialist lender. As your banking needs evolve, consider other alternatives to your current setup. Checking your options whenever you have new needs will help you get the best deals.

Knowledge is Power

Knowing the banking basics is part of understanding banks and how they work. The more you know about how banking works and the banking system, the easier it will be to choose financial institutions that fit your needs and give you the best possible deal.