Why Do Banks Exist? How They Work & Services Explained

Imagine you want to borrow money to start a business and plan to repay it over the next ten years. Finding an individual who has the exact amount you need and is willing to lend it for a decade is unlikely. 

Whether you’re looking to take out a loan, pay bills, save for the future, or even transfer money, you typically turn to a bank.

Although banks have served as the backbone of the financial system for centuries, they remain mysterious to many. What are banks really, and why do we need them?

This article will explain what a bank is, the core functions and services that banks provide, and why they play such a vital role in the broader economy. 

Before we get into why banks exist, let’s understand what a bank is. A bank is a financial institution licensed and regulated by a government agency to perform key banking functions, including accepting deposits, providing loans, and offering financial services such as insurance products, currency exchange, and financial advice.

In essence, banks serve as essential intermediaries in the economy, acting as a bridge between savers and borrowers.

Banks collect deposits from individuals and businesses, forming a pool of funds. They retain a portion of these funds as reserves to cover withdrawals, while the remainder is used for investments or lent out as loans and credit to various borrowers. 

This process creates new money in circulation, helps individuals save, and enables businesses to invest in expansion, thereby creating jobs and economic growth.

Banks then make money by charging fees such as transaction fees and monthly fees. In addition, they pay interest to depositors and collect interest from borrowers. The difference between the interest rates banks pay on deposits and the rates they charge on loans, along with returns from investments and other fees collected for providing banking services, makes up the bank's profit.

This profit covers bank expenses and allows them to continue operating.

There are various types of banks, each with slightly different objectives or focuses. Here's a breakdown of common ones:

• Retail Bank: Retail banks serve individuals and small businesses, offering basic services like checking and savings accounts, debit and credit cards, loans, and more.
• Commercial Bank: These banks focus on helping mid-sized and large businesses. Commercial banking services often include business loans, cash management, and support for international trade.
• Investment Bank: They work with corporations and governments to raise capital through stocks and bonds, manage mergers and acquisitions, and handle investment portfolios.
• Central Bank: Central banks differ from other types of banks in that they are government entities responsible for managing monetary policy, controlling the money supply, and overseeing the banking system. Their primary goal is to maintain the stability and overall health of the financial system rather than generating profit.

There are also other financial institutions, such as loan associations and credit unions, that offer services similar to banks. 

Considering the diverse types of banks, it can be concluded that banks exist to:

• Provide secure storage for individuals and businesses: Banks offer a safe place to store money. Most banks participate in government deposit insurance programs.
• Boost the country’s economy: Banks connect people with surplus funds (depositors) to those in need of money (borrowers), allowing depositors to earn interest and helping borrowers finance significant purchases, which stimulates economic activity. They also enable fast and secure transfers of money between parties, further supporting commerce.
• Manage monetary policy: Central banks issue and manage the country's currency, implement monetary policy, control inflation, and ensure an adequate money supply to maintain economic stability and value integrity.

Banks have multiple features and perform multiple functions. The main functions include: 

The bank relies on the public's deposits to function.

Banks provide a secure location for individuals and businesses to keep their money by accepting deposits into different types of bank accounts, mainly savings and checking accounts. Depositors then earn interest in exchange for keeping their money in the bank.

The common types of deposit accounts are:

• A current account or a checking account: used for everyday financial transactions.
• A savings account: used to store extra funds, enabling savings accumulation. Anyone with a fixed monthly income can open this account to save.
• A fixed deposit account: allows a customer to deposit a certain amount of money that cannot be withdrawn before a certain period. The customer earns interest during the holding period. The longer the period, the greater the amount. This type of bank account encourages long-term saving. 

Banks extend loans and credit to suit individuals and businesses borrowing needs, whether for short-term or long-term. Although both involve borrowing money, they differ in terms of how funds are disbursed and repaid.

• Loans:  A loan provides you with a sizable amount of money upfront, which you repay in fixed repayment schedules. Interest is charged on the entire loan amount from the outset. Loans are well-suited for substantial expenses such as purchasing a home or acquiring initial capital for building a business. 
• Lines of Credit: With a line of credit, the bank sets a maximum borrowing limit, and you can withdraw funds as needed up to that limit. You only pay interest on the amount you actually borrow. Lines of credit are ideal for managing ongoing expenses or covering unexpected costs.

Banks facilitate the transfer of money through check cashing, wire transfers, and electronic payments. 

Today, it is also much easier to operate globally than before since banks also offer international transfer services such as Telegraphic Transfers (TT) and SWIFT transfers. 

This has provided more capacity for a lot of people and businesses to operate.

For instance, many students leave their home country to study abroad, and their families back home use banks to transfer money and pay for expenses, such as rent and tuition fees. 

For businesses, using banks for money transfers offers security and reliable record-keeping. Additionally, banks simplify the process of making international payments and managing finances for businesses with overseas suppliers or branches.

Banks offer other financial services beyond deposits, loans, and transfers. These services may include

• Safe deposit boxes to store valuables and important documents.
• Currency exchange service for travelers or businesses.
• Investment products, such as mutual funds, stocks and bonds.
• Wealth management services, such as specialized consulting on personal finance, particularly for high-net-worth individuals.

The earliest form of banking can be traced back to ancient temples. Temples stored valuables and grain, lending them to local farmers and merchants when needed and keeping records of these transactions, pioneering the concept of bookkeeping. 

Likewise, there were concepts of private depositories and moneylenders in medieval Europe. By the 14th and 15th centuries, moneylenders transformed into what we now recognize as banks. The first and oldest surviving bank is Banca Monte Dei Paschi di Siena (BMPS), founded in 1472 in Tuscany, Italy, to support the underprivileged.

Banks spread across Europe and reached America in the 17th and 18th centuries, along with the establishment of state-chartered banks. In the 19th century, many important central banks were established for financial stability. By 1913, the US has created the Federal Reserve System, acting as the central bank. Technological advances, like telegraphic networks, also enabled innovations such as wire transfers to gain prominence in the early 20th century. 

Today, banks are more profit-focused than in the past, offering an expanded range of services thanks to advanced technology. They manage larger transactions, ensure enhanced security, operate ATMs, and provide diverse services such as investments and money management. Many banks now operate globally as multinational corporations.

Online banking has been developed to deliver both convenience and security through features like banking apps and transaction monitoring.

Moreover, banks have become more vigilant about transactions, the origins of funds, and ensuring privacy and confidentiality.

While banks continue to be essential in our lives,  technology surrounding banking, the options, and user preferences change over time. 

In September 2023, nearly half (48%) of U.S. bank customers primarily managed their accounts through mobile banking apps and only 9% through bank branches. 

The popularity of online banking results in the prevalence of digital-only choices like digital banks and online banks. This shift has also influenced the rise of other financial institutions like neobanks, virtual banks, and fintech companies.

These entities lack traditional banking licenses, but they have financial service licenses that allow them to offer financial products with lower fees and simpler eligibility requirements, appealing to international users and small businesses.

While they're not banks, they have gained significant traction. For instance, the number of neobank users is forecasted to reach 386.30 million by 2028.

However, traditional banks still play vital roles. Many still trust them for large deposits and complex financial services like mortgages and wealth management. 

Traditional banks are also adapting by enhancing convenience, digitizing, and automating to compete. Therefore, whether it's traditional banks or their digital versions, transferring money globally will stay smooth and might get even easier. 

Today, there is a growing number of alternatives to traditional banks, especially for cross-border transactions and small businesses. 

Statrys is not a bank but a licensed financial service provider that offers multi-currency business accounts that allow businesses to make cross-border transactions and hedge against FX rates, all 100% online. 

Here’s a summary of Statrys’ services.