How Banking Works, Types of Banks, and How To Choose the Best Bank for You

Banking is about managing money—yours and everyone else’s. Banks act as intermediaries, taking in deposits from customers, safeguarding that money, and lending it out to others while offering a range of financial services. Let’s break it down step by step.

1. Deposits: Where It All Begins

When you open a bank account—whether it’s a savings account, checking account, or certificate of deposit (CD)—you’re essentially entrusting your money to the bank. These deposits are the lifeblood of the banking system. Banks don’t just let this money sit idle; they use it to fuel other activities, like lending. In return, they promise to keep your funds safe and accessible (within the terms of your account) and, in some cases, pay you interest.

For example, a savings account might earn a small percentage of interest annually, while a checking account typically doesn’t. The bank can offer this interest because it’s using your money elsewhere—more on that in a moment.

2. Lending: The Engine of Profit

Banks make most of their money by lending out the deposits they receive. When you deposit $1,000, the bank doesn’t keep all $1,000 locked away. Instead, it’s required to hold a small fraction—say, 10%—in reserve (this is called the reserve requirement, set by regulators like the Federal Reserve in the U.S.). The rest, $900, can be loaned to other customers or businesses.

These loans come in many forms: mortgages for homebuyers, auto loans, personal loans, or credit lines for businesses. Borrowers pay interest on these loans, typically at a higher rate than what the bank pays depositors. This difference, known as the net interest margin, is a primary source of profit for banks. For instance, if a bank pays you 1% interest on your savings but charges 5% on a loan, it pockets the 4% difference.

3. Services: Beyond Deposits and Loans

Banks aren’t just about holding and lending money. They offer a suite of services to make financial life easier:

Payment Systems: Debit cards, credit cards, wire transfers, and online bill pay help you move money around.
Investment Products: Some banks provide access to mutual funds, retirement accounts, or brokerage services.
Safety Nets: Features like FDIC insurance (in the U.S.) protect your deposits up to $250,000 per account if the bank fails.
Digital Tools: Mobile apps and online banking let you manage accounts, transfer funds, or even deposit checks from your phone.

4. Regulation: Keeping It Safe

Banks operate under strict oversight to protect customers and the economy. In the U.S., agencies like the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Consumer Financial Protection Bureau (CFPB) set rules on everything from reserve requirements to lending practices. This ensures banks don’t take excessive risks with your money and can weather economic downturns.

In short, banking works by creating a cycle: you deposit money, the bank lends it out, borrowers repay with interest, and the bank uses those profits to pay you interest, cover costs, and grow. It’s a delicate balance of trust, risk, and regulation.

Types of Banks

Not all banks are the same. Depending on your needs—personal savings, business loans, or investment options—different types of institutions might suit you better. Here’s a rundown of the main categories.

1. Commercial Banks

These are the most common banks, serving both individuals and businesses. Think of giants like JPMorgan Chase, Bank of America, or Wells Fargo. They offer checking and savings accounts, loans, credit cards, and more. Commercial banks are for-profit entities, aiming to maximize shareholder value while meeting customer needs.

Pros: Wide range of services, extensive ATM/branch networks, advanced digital tools.
Cons: Fees can be high, and customer service may feel impersonal at larger institutions.

2. Credit Unions

Credit unions are member-owned, not-for-profit institutions. To join, you typically need to meet a membership criterion—like working for a specific employer or living in a certain area. They pool members’ deposits to offer loans and other services, often at lower rates than commercial banks.

Pros: Lower fees, higher savings rates, community focus.
Cons: Smaller branch/ATM networks, limited product offerings.

3. Online-Only Banks

Digital-first banks like Ally, Chime, or SoFi operate entirely online, with no physical branches. They save on overhead costs and often pass those savings to customers through higher interest rates on savings accounts and fewer fees.

Pros: Competitive rates, low/no fees, 24/7 access via apps.
Cons: No in-person support, cash deposits can be tricky.

4. Investment Banks

Unlike retail banks, investment banks (e.g., Goldman Sachs, Morgan Stanley) focus on helping businesses and governments raise capital. They underwrite stock and bond offerings, advise on mergers, and manage large-scale investments. They’re less relevant for everyday consumers but critical for the broader economy.

Pros: Expertise in complex financial deals.
Cons: Not designed for personal banking needs.

5. Community Banks

These smaller, local banks prioritize serving their immediate region. They often cater to small businesses and individuals, offering personalized service that bigger banks might not.

Pros: Strong customer relationships, local focus.
Cons: Limited resources, fewer digital tools.

6. Central Banks

Central banks, like the Federal Reserve or the European Central Bank, don’t serve individuals. They manage a country’s monetary policy, control money supply, and stabilize the economy. They’re the banks’ bank, lending to commercial banks when needed.

Each type of bank has a unique role, and your choice depends on what you value—convenience, cost, or community ties.

How To Choose the Best Bank for You

With so many options, picking the right bank can feel overwhelming. The best choice hinges on your financial goals, lifestyle, and preferences. Here’s a step-by-step guide to narrow it down.

Step 1: Define Your Needs

Start by asking yourself what you need from a bank:

Daily Banking: Do you want a checking account with a debit card and easy bill pay?
Saving: Are you looking for high interest rates on savings or a CD?
Borrowing: Will you need a mortgage, auto loan, or credit card?
Business: Do you run a small business requiring merchant services or payroll support?
Tech: How important are mobile apps and online banking to you?

Your priorities will shape your decision. A student saving pocket money might lean toward an online bank with no fees, while a business owner might prefer a community bank with tailored loans.

Step 2: Compare Fees

Fees can eat into your money over time. Look out for:

Monthly Maintenance Fees: Some banks charge unless you maintain a minimum balance or set up direct deposit.
ATM Fees: Will you pay extra for using out-of-network ATMs?
Overdraft Fees: How much does it cost if you overspend?
Transaction Fees: Are there limits on free transfers or withdrawals?

Credit unions and online banks often have lower fees than big commercial banks, but always read the fine print.

Step 3: Check Interest Rates

If you’re saving, interest rates matter. Online banks frequently offer higher yields on savings accounts (e.g., 4-5% APY as of 2025) compared to traditional banks (often below 1%). For loans, compare APRs (annual percentage rates) to find the cheapest borrowing option.

Step 4: Evaluate Accessibility

Branches and ATMs: If you prefer face-to-face service or need cash often, choose a bank with a strong physical presence. National banks excel here, while online banks rely on ATM networks (e.g., Allpoint) to offset this.
Digital Tools: Test the bank’s app or website. Can you deposit checks, transfer money, or contact support easily?

Step 5: Assess Customer Service

Read reviews or ask friends about their experiences. Smaller banks and credit unions often shine in personalized service, while big banks might offer 24/7 phone support but longer wait times.

Step 6: Look at Perks and Products

Some banks sweeten the deal with extras:

Sign-Up Bonuses: Cash rewards for opening an account or depositing a certain amount.
Rewards Programs: Cashback on debit/credit card purchases.
Specialized Accounts: Student accounts, high-yield CDs, or business tools.

Step 7: Verify Safety

Ensure the bank is insured (e.g., FDIC for banks, NCUA for credit unions in the U.S.). This guarantees your money’s safety up to a limit if the institution fails.

Step 8: Test the Waters

You don’t have to commit to one bank forever. Open a basic account, try it for a few months, and switch if it doesn’t meet your expectations. Many people use multiple banks—one for checking, another for high-yield savings.

Practical Tips and Examples

Let’s put this into context with a few scenarios:

Scenario 1: The Tech-Savvy Saver
Jane, a 28-year-old freelancer, wants to maximize savings with minimal fees. She chooses Ally Bank (online-only) for its 4.5% APY savings account, no maintenance fees, and robust app. She uses a separate credit union for cash deposits.
Scenario 2: The Small Business Owner
Carlos runs a local bakery and needs loans and in-person support. He picks a community bank with a nearby branch, low-cost business accounts, and a relationship manager who understands his needs.
Scenario 3: The Everyday User
Sarah, a busy mom, values convenience. She opts for Chase Bank, with its widespread ATMs, solid mobile app, and a $200 sign-up bonus for direct deposit.

Conclusion

Banking is more than just a place to stash your cash—it’s a system that keeps money flowing through deposits, loans, and services, all under careful regulation. From commercial giants to local credit unions, each type of bank offers distinct advantages. Coosing the best one boils down to aligning their offerings with your needs: low fees, high rates, accessibility, or personalized care.