Banking and How It Works

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When a bank complicates your life, you can lose money and time. This cuts into your freedom.

So let’s look at the basics of banking so you’ll know what to expect and where to find the best deals.

How Does Banking Work?

A bank or a credit union should serve as a pantry for your financial life:

  • You store up money through deposits: your direct deposits from work, the cash you earn side hustling, the money you clear when you sell something you no longer need.
  • Then, little by little, you use some of your stored money: for groceries, at online retailers, through your favorite mobile pay app, or when you need to pay a friend back.

It’s really that simple. So why does it get so much more complicated? What’s up with all the fees, rates, terms, and transfer fees?

We’ll have to dig a little deeper to find out, starting with a quick look at types of accounts.

Checking Accounts

Your checking account is the eye-level shelf in your pantry: The money in this account should be easy to access because you may use it several times a day.

We use the term checking accounts because account holders used to write checks. You can still write checks, but it’s easier to use an ATM or your debit card or to connect your checking account to PayPal, or an app like Venmo.

Most banks offer free checking accounts, though even free accounts will typically charge you overdraft fees or ATM use fees.

Traditionally, your checking account balance would not gain interest, though now you can find exceptions, especially if you keep a high balance.

Pro Tip: Check this post out to find the best places to cash checks with no fees.

Savings Accounts

Your savings account is where you store up and save money, but this is where our analogy about the kitchen pantry runs out of steam.

Unlike the household supplies in your pantry, your money in savings can grow while it’s stored. Your saved money grows because your bank will pay interest on your balance.

Paying interest means the bank pays a percentage of your balance to you on a regular basis.

How much interest you’ll earn depends on what kind of account you have:

  • Low Rates: Your neighborhood branch of a large national or regional bank will typically pay a lower interest rate. In fact, you may not notice your money grow if you have a small balance.
  • Better Rates: Money market accounts tend to pay higher interest rates but you can only access your money six times a month.
  • Best Rates: An online-only bank can usually give you the best interest rates. Some online banks pay 2 or more percentage points higher than a traditional bank.

You can find free savings accounts at most banks. Some banks charge fees if your balance falls below a pre-set level. You can also open multiple savings accounts at different banks, you are not just limited to one.

Certificates of Deposit (CDs)

Savers who want to optimize their interest payouts tend to like certificates of deposit, or CDs.

With a CD you agree to leave your saved money alone for a specific period of time — 3 months, 18 months, 60 months, for example. In exchange, you get a higher savings rate.

If you access the money early, expect to pay a fee or lose earned interest. CDs work well when you know you can leave the money alone for a while.

Borrowing Money

You earn interest on the balance in your savings account because you’re letting the bank use your money. On the other hand, when you borrow the bank’s money, you pay the bank interest.

Another term for using the bank’s money is getting a loan.

Banks loan money in several different ways:

  • Mortgages: Mortgage is the term you’ll see when shopping for a home loan.
  • Auto Loans: As you would expect, customers use auto loans to buy a car.
  • Personal Loans: Personal loans could help you pay larger personal expenses such as higher-than-expected income taxes an unexpected dental procedure or to consolidate debt into one loan.
  • Overdraft Protection: Customers can avoid overdraft fees in their checking accounts by covering temporary overdrafts with borrowed money.
  • Credit Cards: Banks typically back credit cards that customers can use to make purchases.

Any time you borrow money, find out the interest rate you’ll be paying both now and down the road. Credit cards, for example, charge incredibly high rates which can hobble your financial freedom.

Ideally, you should borrow money only when you have a really good reason and a plan for getting out of debt. Owing money cuts into your freedom.

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Types of Banks

In most towns, banks line the retail strips and downtown business districts. To choose the best bank, it helps to know about the different kinds of institutions:

Retail Banks

These are the banks with branches in busy shopping centers and Interstate exits.

They offer basic checking and savings accounts along with credit cards and other personal loans. Most retail banks now have a strong presence online, and some have excellent bonus cash promotions for signing up.


  • The convenience of having branch offices nearby.
  • Typically large networks of ATMs.
  • Wide variety of banking products.


  • Low savings rates.
  • Fees can be punitive

Credit Unions

These institutions work a lot like retail banks but without the goal of making a profit.

They’re owned by their customers, and they’ve also embraced online banking in most cases.


  • Strong customer service.
  • Pretty good rates on loans and savings.


  • Fewer locations and ATMs.
  • Online tools sometimes lacking.

Online Banks

Online banks are essentially retail banks which interact with customers exclusively (or almost exclusively) online.

Because they have fewer employees and locations, they can usually extend higher interest rates to account holders.


  • Great savings rates.
  • Not limited by geography.
  • Can connect to retail bank through online banking.


  • Few or no branches.
  • Fewer options for accounts and loans.

Commercial Banks

Commercial banks usually focus on serving businesses. They offer lines of credit and other business tools. See my list of best of business checking accounts for 2021.

Savings and Loans

These institutions aren’t as numerous as they once were, but they’re still out there. They focus on real estate development by using savings accounts to finance mortgages.

Investment Banks

Investment banks help connect investors with securities to make the economy more fluid.

Central Banks

Most of us will have little direct interaction with a central bank which helps set monetary policy for a nation.

Most people starting a relationship with a bank will opt for a retail bank, credit union, or online bank.

Bank Reviews

It can be hard to know the ins and outs of banks, their features and what makes one stand out over another. I’ve taken the time to write some in-depth bank reviews so you can get an unbiased look at where each bank excels and maybe could use a little improvement.

A Brief History of Banking

When you tap your mobile banking app or stop by an ATM you’re taking part in a relationship that spans several millennia of human history.

Historical records and archaeological digs show banking and money have always been intertwined. As economies grew more diverse, thousands of years ago, ancient banking systems evolved to meet the new economic needs.

Then, the new banking tools helped fuel more economic growth which, in turn, called for yet more elaborate banking systems. And on and on.

This evolution hasn’t been particularly smooth. Most of us are old enough to remember the Great Recession back in 2008 and 2009. Failures in the banking system sparked that huge global financial collapse that we still talk about today.

These sorts of calamities were almost regular events in the late 18th, 19th, and early 20th centuries as banking strained to serve the industrializing world economy.

Learn more:

Banks and Regulation

Banking failures have introduced a new player in the financial system: governments, which set rules for private banks and, in some countries, directly run the banking system. In the U.S., the Federal Reserve sets monetary policy and regulates private banks.

Often, after a recession or depression, governments ramp up the regulations, attempting to prevent more failures in the future. During the Great Depression of the 1930s, for example, Congress created the Federal Deposit Insurance Corp., or FDIC.

The FDIC guarantees Americans won’t lose their bank deposits. We still rely on the FDIC to protect our deposits of up to $250,000 per bank.

Always a Push and Pull

Banks resist regulations. Over time — especially during times of financial stability — governments face pressure to relax regulations on banks. Relaxed regulations can allow more growth in the financial system. But they can also lead to more disorder.

For example, some economists blame the 2008 banking collapse on the deregulations in the late 1990s.

Compared to the 1800s and early 1900s we live in a time of stability for banks in developed nations. International agencies such as the World Bank and the International Monetary Fund have helped developing nations access reliable banking services.

When you go to an ATM or deposit a check on your app, you have consumer protections through the federal Consumer Financial Protection Bureau and the FDIC.

The way you access your money, your knowledge about what the bank does with your money, and even the fees you’re charged — for all these issues and more your bank has rules to follow.

You can better protect yourself and find out what to expect from a bank by getting more familiar with the rules of banking.

Additional Disclosures: Millennial Money has partnered with CardRatings and for our coverage of credit card products. Millennial Money, CardRatings and may receive a commission from card issuers. This site does not include all financial companies or financial offers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities.

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