Banks take deposits, lend money, and move payments between accounts

A bank's core job is to hold your money safely, lend it out to borrowers, and process the payments you make to other people. When you deposit a paycheck, the bank credits your account and holds that cash (or invests it). When you write a check or use a debit card, the bank moves money from your account to someone else's. When you borrow for a car or house, the bank lends you money at interest and collects monthly payments. These three functions—deposit-taking, lending, and payment processing—are what make a bank a bank.

Banks make money on the difference between what they pay you in interest on savings and what they charge borrowers in interest on loans. They also charge fees for services like overdraft protection, wire transfers, and account maintenance. The money you deposit is not locked in a vault with your name on it; the bank uses deposits to fund loans to other customers, to invest, and to keep operating. Federal insurance through the FDIC protects your deposits up to $250,000 per account type at each bank, so even if the bank fails, you get your money back.

Key Takeaways

  • Banks accept deposits from customers and pay interest on savings accounts, while using those deposits to fund loans to other borrowers.
  • Banks lend money for mortgages, car loans, personal loans, and business loans, and earn money by charging interest higher than what they pay depositors.
  • Banks process payments—checks, wire transfers, debit card transactions, and ACH transfers—between accounts and institutions.
  • The FDIC insures deposits up to $250,000 per account type, so your money is protected even if the bank fails.
  • Banks also offer services like credit cards, investment accounts, and safe deposit boxes, and charge fees for many of these services.

Taking deposits and paying interest on savings

When you open a checking or savings account, you are depositing money with the bank. The bank promises to hold it, let you withdraw it, and in the case of a savings account, pay you interest. The interest rate on savings accounts is set by the bank and varies based on how much money you keep there and what the Federal Reserve's interest rates are. A bank might pay 0.01% on a basic savings account and 4% or 5% on a high-yield savings account, depending on market conditions.

The bank does not keep your physical cash in a separate box. Instead, it uses the money you and other depositors put in to fund its lending operations and investments. This is why banks can fail—if too many depositors withdraw money at once, or if loans go bad, the bank can run out of cash. The FDIC (Federal Deposit Insurance Corporation) protects you by insuring deposits up to $250,000 per account type at each bank, so even if the bank collapses, you get your money back up to that limit.

Lending money and collecting interest payments

Banks lend money to individuals and businesses, and that lending is where most of their profit comes from. A mortgage is a loan to buy a house. An auto loan finances a car. A personal loan can be used for almost anything. A business loan funds a company's operations or expansion. In each case, the borrower signs a contract agreeing to repay the loan plus interest over a set period—usually 15 to 30 years for a mortgage, 3 to 7 years for a car, and 2 to 5 years for a personal loan.

The interest rate a bank charges depends on the borrower's credit score, the size of the loan, how long the loan lasts, and what the bank's own cost of borrowing is. A borrower with excellent credit might get a mortgage at 6%, while someone with poor credit might pay 8% or higher. The bank pays depositors 4% on savings, charges the mortgage borrower 6%, and keeps the 2% difference as profit (minus the cost of running the bank). If a borrower stops paying, the bank can seize the collateral—the house, the car—and sell it to recover the money.

Processing payments and transfers

Every time you write a check, swipe a debit card, or set up an automatic bill payment, the bank is processing a payment. When you write a check to your landlord, your bank deducts the amount from your account and sends it to your landlord's bank. When you use a debit card at a store, the bank instantly moves money from your account to the store's account. When you set up an ACH transfer (automatic clearing house), the bank schedules a payment to another account on a date you choose.

Banks also process wire transfers, which move money between banks quickly—usually within hours. Wire transfers cost more than ACH transfers because they are faster and more direct. Banks also clear checks, which means they verify the check is real, the account has enough money, and the signature is valid. All of this payment processing is a service banks provide, and many of these services come with a fee.

Offering credit cards and lines of credit

Banks issue credit cards, which are a form of short-term borrowing. When you use a credit card, you are borrowing money from the bank. You receive a bill at the end of the month and can pay it in full or make a minimum payment. If you pay in full, you owe no interest. If you carry a balance, the bank charges interest—often 15% to 25% annually, depending on your credit score and the card's terms. The bank makes money from the interest you pay and from fees merchants pay when you use the card.

Banks also offer lines of credit, which work like a credit card but are usually tied to your home or business. A home equity line of credit (HELOC) lets you borrow against the value of your house. A business line of credit lets a company borrow up to a set amount whenever it needs cash. These are riskier for the bank than deposits, so the bank charges higher interest and requires collateral or a strong credit history.

Providing investment and wealth management services

Many banks offer investment accounts where you can buy stocks, bonds, and mutual funds. The bank does not own these investments; you do. The bank holds them in an account and charges you a fee—either a flat fee, a percentage of the money you invest, or a commission on each trade. Some banks offer financial planning services where an advisor helps you decide how to invest your money for retirement or other goals.

Banks also offer safe deposit boxes, where you can store important documents, jewelry, or other valuables. The bank provides the box and security; you pay an annual rental fee. The bank does not insure what is inside the box—that is your responsibility—but the FDIC does not cover items in safe deposit boxes anyway.

Charging fees for services and account maintenance

Banks charge fees for many services. An overdraft fee is charged when you spend more money than you have in your account. A monthly maintenance fee is charged just for having an account, though many banks waive this if you keep a minimum balance or set up direct deposit. A wire transfer fee covers the cost of moving money between banks. An ATM fee is charged when you use an ATM that is not owned by your bank. A returned check fee is charged if a check bounces.

These fees vary widely between banks. Some banks charge $35 for an overdraft; others charge $25. Some charge $15 a month for a basic checking account; others charge nothing. Shopping around for a bank that matches your habits—whether you overdraft often, use ATMs frequently, or maintain a high balance—can save you hundreds of dollars a year.

Frequently Asked Questions

What happens to my money when I deposit it in a bank?

The bank holds your money in an account and uses it to fund loans to other customers and to invest. You can withdraw your money anytime (in a checking account) or on a schedule (in a savings account). The FDIC insures deposits up to $250,000 per account type, so your money is protected even if the bank fails.

How do banks make money if they pay me interest on my savings?

Banks pay you a lower interest rate on savings than they charge borrowers on loans. If a bank pays you 4% on savings and charges a borrower 6% on a mortgage, the bank keeps the 2% difference as profit. Banks also earn money from fees and from investing deposits in stocks and bonds.

Can a bank take my money if I have a loan with them?

A bank cannot take money from your deposit account to pay off a loan unless you miss payments and the bank sues you and wins a judgment. Even then, the bank must follow legal procedures. If you have a loan and a deposit account at the same bank, the bank can sometimes "set off" the loan against the deposit, but this varies by state and account type.

Why do banks charge overdraft fees?

An overdraft fee covers the cost of processing a transaction when you do not have enough money in your account. The bank is lending you money temporarily and charging a fee for that service. You can often avoid overdraft fees by linking a savings account to your checking account or by opting out of overdraft protection.

Is my money safe in a bank?

Your deposits are insured by the FDIC up to $250,000 per account type at each bank. This means if the bank fails, the FDIC will return your money. However, investments you hold through the bank (stocks, mutual funds) are not FDIC-insured; they are protected by SIPC (Securities Investor Protection Corporation) up to $500,000 if the brokerage fails.