Plain-English Guide to How Banks Work: Accounts, Interest, Security, and Smart Choices

Most of us use banks every day without thinking much about how they work. From payday direct deposits to tapping a card at the grocery store, banks quietly move money, offer safety for savings, and power the economy. This guide explains banking in plain English: what banks do, how they make money, how accounts and interest work, how deposits are protected, how to avoid fees and fraud, and the future of banking. If you want a clear, practical map of modern banking—start here.

What is a bank and what do banks do?

A bank is a licensed financial institution that accepts deposits, safeguards money, provides payment services, and lends funds. Think of a bank as a service hub for money: it stores cash securely, lets you move funds, helps you get loans, and provides tools to manage finances.

Core functions of banks

There are a few core functions every bank performs:

• Accepting deposits: Checking accounts, savings accounts, and certificates of deposit (CDs) let customers store money with the bank.
• Payment services: Banks process checks, electronic transfers (ACH), wire transfers, debit and credit card transactions, and newer peer-to-peer services like Zelle or mobile wallets.
• Lending: Banks make loans to individuals, businesses, and governments. Mortgages, auto loans, personal loans, and business lines of credit are examples.
• Wealth and cash management: Many banks offer investment accounts, financial advice, and merchant services for businesses.
• Risk management and liquidity provision: Banks manage liquidity so they can meet withdrawals and maintain stability.

How banks make money, explained simply

Understanding how banks earn income clears up a lot of myths. Their revenue mainly comes from two streams: interest income and fee income.

Interest margin: the classic model

Banks take deposits (which usually pay a low interest rate) and lend that money out at higher rates. The difference between the interest they earn on loans and investments and the interest they pay depositors is called the net interest margin. For example, if a bank pays 0.5% on savings but charges 4% on a mortgage, that spread funds their operations and profits.

Fees and other income

Banks also charge fees: account maintenance fees, overdraft fees, ATM fees, wire transfer fees, and merchant processing fees. They earn service fees for wealth management, safekeeping, and business services. Investment income, trading, and income from selling insurance or other financial products also contribute.

Modern revenue sources

Digital banks and fintech partners also monetize user data in compliant ways, offer subscription services, and earn interchange fees from card transactions. Understanding a bank’s fee schedule is one of the best ways to predict how much it will cost you to bank with them.

Types of banks and how they differ

Not all banks are the same. Knowing the differences helps you choose the right provider for your needs.

Retail banks

Retail banks serve individual consumers. They offer checking and savings accounts, debit and credit cards, mortgages, and personal loans. Branches, ATMs, and customer service centers are typical retail bank features.

Commercial banks

Commercial banks focus on businesses and will provide business checking, merchant accounts, loans, and treasury services. They handle payroll deposits, business lending, and payment processing.

Investment banks

Investment banks help companies raise capital, advise on mergers and acquisitions, and trade securities. They don’t typically offer retail deposits or consumer checking accounts.

Credit unions

Credit unions are member-owned, non-profit financial cooperatives. They often offer better rates on loans and savings but may have fewer branches. The main difference is governance: members elect leaders and may benefit from lower fees and higher yields.

Digital banks and neobanks

Digital banks operate primarily online and through apps, often with fewer or no branches. They typically offer streamlined services, user-friendly interfaces, and lower fees. Some are fully licensed banks, while others partner with traditional banks to provide FDIC-insured accounts.

How bank accounts work: checking, savings, CDs, and money market accounts

Banks offer several types of deposit accounts, each for different needs.

Checking accounts explained simply

Checking accounts are for everyday spending and bill payments. They provide easy access to funds through debit cards, check writing, and electronic payments. Interest is usually minimal or none. Look for accounts with low or no maintenance fees and convenient access to ATMs and branches.

Savings accounts explained for beginners

Savings accounts are meant for storing money you don’t need immediately. They typically pay interest (APY) and may limit monthly withdrawals. They’re a safe place for emergency funds and short-term goals.

Money market accounts (MMA)

Money market accounts combine features of checking and savings: they often pay higher interest than regular savings and may allow limited check writing or debit card access. Minimum balance requirements and tiered rates are common.

Certificates of deposit (CDs) explained simply

CDs are time deposits. You agree to lock money in for a fixed term (e.g., 6 months to 5 years) in exchange for a fixed interest rate. Withdrawals before maturity often incur penalties. CDs are useful when you don’t need immediate access and want a guaranteed return.

Checking vs savings vs CD: how to decide

Use a checking account for daily spending and automatic bill payments, a savings account for an emergency fund and short-term goals, and a CD when you can lock money away for a higher fixed return. Money market accounts can be a hybrid choice.

Interest, APY, APR, and compound interest

Interest terms confuse many people, but they are straightforward once you know the basics.

Interest vs APY vs APR

Interest is the cost of borrowing money or the reward for saving. APY (annual percentage yield) shows how much you earn on a deposit in a year, including compound interest. APR (annual percentage rate) represents the yearly cost of borrowing without compounding. For savings look at APY; for loans look at APR.

Compound interest explained

Compound interest means you earn interest on the interest you already earned. The more frequently interest compounds (daily, monthly, quarterly), the higher your effective yield. Compound interest is powerful for long-term savings and investments.

How banks calculate interest

Banks calculate interest using the account’s balance and the interest rate, applying the compounding frequency. For loans, interest may accrue daily on the outstanding principal. Always check whether a rate is annual and whether it’s compounded daily or monthly—small differences add up over time.

Why bank interest rates are often low and how central banks affect rates

Why do savings rates often feel tiny? Several reasons explain low rates and how central banks influence them.

Supply and demand for capital

Banks set deposit and loan rates based on market conditions. When the economy is weak, central banks lower policy rates to stimulate borrowing; banks follow by lowering deposit rates. Low inflation and high savings can also push rates down.

Role of central banks and monetary policy

Central banks, like the Federal Reserve in the U.S., influence short-term interest rates to meet macroeconomic goals (inflation and employment). When they change the policy rate, it affects how expensive it is for banks to borrow money and, in turn, the rates banks offer to customers.

How banks protect your money: FDIC, SIPC, and other safeguards

Security and insurance are crucial parts of banking. Knowing protections helps you feel confident about where to keep your money.

FDIC insurance explained for beginners

The Federal Deposit Insurance Corporation (FDIC) insures deposits in most U.S. banks up to $250,000 per depositor, per insured bank, per ownership category. That insurance covers checking, savings, CDs, and money market deposit accounts if the bank fails.

SIPC and investment accounts

SIPC protects brokerage accounts if a firm fails, but it does not protect investment losses from market declines. Cash in a brokerage’s cash sweep may be insured, but check how the program works. Always verify the exact protections on investment products versus bank deposits.

How deposits are protected in other countries

Many countries have similar deposit insurance schemes, but coverage amounts and rules vary. If you bank internationally, check the local deposit insurance program.

How banks create money and fractional reserve banking

It’s surprising to many that banks help create money through lending. This is central to modern monetary systems.

Fractional reserve banking explained simply

Under fractional reserve banking, banks keep a fraction of deposits as reserves and lend out the rest. When a bank makes a loan, it credits the borrower’s account, increasing deposit balances in the economy. That process effectively expands the money supply beyond physical cash.

Reserve requirements and central bank tools

Reserve requirements are rules that determine how much cash banks must keep on hand. Central banks also use tools like open market operations and the discount window to control liquidity and influence lending.

Opening, managing, and closing bank accounts

Everything from the documents you need to how account holds work is important practical knowledge.

Opening a bank account: step by step

To open an account you typically need identification (passport or driver’s license), proof of address (utility bill or lease), and a social security number or tax ID if required. For businesses you’ll need additional documents like incorporation papers and an EIN. Many banks now let you open accounts online with digital ID verification.

Pending transactions, available balance vs current balance

Current balance shows total funds in the account; available balance excludes pending holds (recent debit card purchases, deposits on hold) and is what you can spend immediately. Always check available balance before making transactions to avoid overdrafts.

Closing a bank account and avoiding problems

To close an account, withdraw or transfer funds, cancel automatic payments, and request written confirmation. Leaving negative balances or uncompleted payments can cause fees and harm your banking history. If you switch banks, update employers for direct deposit and creditors for autopayments.

Bank fees, overdrafts, and how to avoid costs

Fees can quietly erode your savings. Know the common fees and practical strategies to avoid them.

Common bank fees explained

Common fees include monthly maintenance fees, ATM fees for out-of-network withdrawals, overdraft fees, wire transfer fees, and foreign transaction fees. Look for free checking options, student accounts, or accounts that waive fees if you meet direct deposit or minimum balance requirements.

Overdrafts and overdraft protection

Overdraft happens when you spend more than your available balance. Overdraft protection links another account or a line of credit to cover shortfalls. You can often opt out of overdraft programs to avoid surprise fees—choose carefully based on your cash flow habits.

How to avoid ATM and maintenance fees

Use in-network ATMs, qualify for fee waivers with direct deposit or minimum balances, use fee-reimbursement accounts, or choose banks with large ATM networks. Many online banks refund ATM fees up to a monthly limit.

Bank transfers: ACH, wires, P2P, and international transfers

Moving money is one of banking’s most common tasks. Different transfer types serve different needs.

ACH transfers explained simply

Automated Clearing House (ACH) transfers are electronic, low-cost or free domestic transfers for payroll, bill payments, and account transfers. ACH payments settle in one to several business days.

Wire transfers explained for beginners

Wires are faster, often same-day transfers for domestic or international payments, but they are more expensive than ACH. Wires are commonly used for real estate closings and urgent payments.

Zelle and peer-to-peer payments

Zelle, Venmo, and similar services move money fast between users. Zelle transfers are typically instant and send money directly between participating banks, while other apps may hold funds in a wallet that can be transferred to a bank.

International transfers, SWIFT, and IBAN

International transfers often use the SWIFT network and require IBAN or account numbers depending on the destination country. International transfers involve fees, intermediary banks, and exchange rate spreads. Plan ahead, compare providers, and consider transfer time and total cost.

Foreign exchange, exchange rate spreads, and how banks profit

When you send or receive money across currencies, banks and providers make money on the exchange rate as well as fees.

How currency exchange works in banks

Banks convert currency using a wholesale rate and add a spread—a margin—on top of that rate. The spread and explicit fees are how banks and forex providers earn from currency conversions.

How to minimize FX costs

Compare providers, use specialist money transfer services for large remittances, and request transparent fees and rates. Sometimes banks offer better rates for customers with large balances or business accounts.

Bank safety, fraud, and how to protect yourself

Banking safety is a partnership: banks invest heavily in security, and customers can reduce risk with good habits.

Common banking scams and how to avoid them

Phishing emails, fake bank calls, ROMANCE scams, and account takeover attempts are common. Never share passwords or one-time codes, verify communications by contacting your bank directly, and be skeptical of urgent requests for transfers or gift cards.

Identity theft and banking

Monitor accounts and credit reports, enable transaction alerts, use strong, unique passwords, and enable two-factor authentication (2FA). Freeze your credit if you suspect identity theft and contact your bank immediately to block accounts.

Two-factor authentication and biometrics

2FA requires a second verification factor—SMS code, authenticator app, or hardware token—when logging in. Biometric checks like fingerprint or face recognition add convenience and security for mobile banking, though you should use secure devices and software.

Reading bank statements and reconciling accounts

Understanding statements helps you spot errors, unauthorized charges, and reconcile your records.

How to read a bank statement

Statements list opening and closing balances, transactions (debits and credits), fees, interest paid or earned, and any holds. Check dates, verify merchant names, and confirm any recurring charges or transfers.

Reconciling bank accounts for beginners

Reconciling means matching your records (checks, receipts, and accounting ledger) to the bank statement. Adjust for pending transactions and outstanding checks. Reconciliation helps catch errors and prevent overdrafts.

Loans, creditworthiness, and how banks approve loans

Banks evaluate borrowers using credit scores, income, debt levels, and collateral. Understanding the process helps you prepare and improve approval chances.

Secured vs unsecured loans

Secured loans require collateral (e.g., car for an auto loan, home for a mortgage), which reduces risk for the lender and often lowers interest rates. Unsecured loans rely on creditworthiness and usually carry higher rates.

What banks look for when approving loans

Banks check credit history, debt-to-income ratio, employment and income stability, and in business loans they review cash flow and collateral. Strong documentation and a good credit profile increase approval odds and get better rates.

Business banking basics and merchant services

Business accounts differ from personal accounts: they often require additional documentation and provide services tailored to companies.

Business checking vs personal checking

Business checking accounts handle higher transaction volumes and integrate with payroll and payment processors. Fees and minimum balance rules differ, so compare offerings carefully.

Merchant accounts and payment processing

Merchant accounts let businesses accept card payments. Processing fees, payment gateways, and POS systems determine costs. Understanding interchange, assessment, and merchant markups helps manage expenses.

Bank regulation, capital, and stability

Banks are heavily regulated to reduce systemic risk and protect depositors. These rules may feel technical, but they underpin financial stability.

Capital adequacy and Basel regulations

Banks must hold capital to absorb losses and protect depositors. Basel standards set international rules for capital ratios, risk weights, and liquidity to keep banks resilient during stress.

Why banks hold capital and liquidity

Capital cushions against loan losses; liquidity ensures banks can meet withdrawals. Regulators require stress testing and recovery planning so banks can survive economic shocks.

Open banking, APIs, and the future of banking

The banking landscape is changing: open banking, digital wallets, CBDCs, and AI are reshaping how we interact with money.

Open banking and API banking explained simply

Open banking allows third-party apps to access banking data (with your consent) via APIs. This enables better personal finance tools, faster payments, and more competition in financial services.

AI, automation, and digital identity in banking

AI helps detect fraud, personalize product offers, and automate customer service with chatbots. Digital identity systems and biometrics make onboarding faster and more secure while reducing fraud risk.

CBDCs and crypto

Central bank digital currencies (CBDCs) are government-backed digital money under exploration globally. Banks are also adapting to cryptocurrencies—some custody crypto, others provide restricted access. Regulation, volatility, and interoperability remain major considerations.

How to choose the right bank and practical banking habits

Choosing a bank is personal. Match a provider to your priorities: low fees, high APY, branch access, or digital tools.

Questions to ask when choosing a bank

• Are deposits FDIC insured and what is the coverage?
• What are the fees and how can I avoid them?
• Is the mobile app well-rated and secure?
• Does the bank offer the accounts and services I need (mortgages, business services, international transfers)?
• How easy is it to access cash via ATMs or branches?

Banking habits for everyday life

Set up direct deposit where possible, automate savings, review statements monthly, use alerts for low balances, and keep emergency funds in a liquid account. Use budgeting tools—many banks offer built-in categorization—to stay on top of spending.

Banking is a blend of tradition and rapid change. At its core, a bank connects savers and borrowers, processes payments, and safeguards money. Understanding account types, how interest and fees work, how deposits are protected, and basic transaction mechanics will make you a smarter banking customer. Protect your accounts with strong passwords and two-factor authentication, choose accounts that match your needs, and be mindful of fees and exchange costs. As digital innovations like open banking, APIs, and AI continue to reshape financial services, your most powerful tool is knowledge: informed choices keep your money working for you while reducing risk.