A bank is a financial institution that typically accepts deposits, extends credit, and provides payment services. Banks connect households, businesses, and public bodies within the financial system, while their deposit liabilities constitute an important form of money. The precise legal definition varies by jurisdiction: deposit-taking banks generally require specific authorization, whereas some institutions called banks specialize in investment or development finance without accepting ordinary customer deposits.
Historical development
Banking developed from practices of safekeeping, lending, money changing, and transferring claims. Records from Mesopotamia document loans of grain and silver, while money changers and deposit-taking activities existed in ancient Greece. These arrangements resembled particular banking functions rather than the complete organization of a modern bank.
The expansion of medieval European trade encouraged merchant finance and bills of exchange, which enabled payments across distances without transporting equivalent amounts of coin. Italian commercial centers became prominent in banking during the late Middle Ages and Renaissance. The Medici family operated a banking network closely connected to international commerce.
Public banks, note-issuing institutions, and joint-stock banks subsequently developed in different countries. During the Industrial Revolution, banks helped finance commerce and expanding production, although their importance relative to securities markets varied. Banking failures during the Great Depression contributed to major changes in supervision and depositor protection.
Functions and services
Banks perform financial intermediation by assessing borrowers, extending credit, and managing financial claims. They help address information asymmetry: borrowers usually know more about their circumstances than potential lenders do. Credit assessment, monitoring, and specialized knowledge can reduce the cost of evaluating and administering loans.
Deposit accounts provide customers with balances usable for saving and payments. Banks process transfers, standing orders, card transactions, and other payment instructions, reducing transaction costs. Depending on their authorization, they may also provide custody, foreign-exchange services, investment products, and financial advice.
Lending includes business credit, mortgages, overdrafts, and consumer loans. Banks earn income from fees and from the difference between interest received on assets and interest paid on funding. Profitability also depends on operating expenses, loan losses, and changes in interest rates.
A central function is maturity transformation: banks commonly fund longer-term assets with deposits or other liabilities that can be withdrawn or mature sooner. This supplies borrowers with longer-term finance while offering depositors liquidity, but creates a need to manage potential funding shortfalls. International banking also supports trade finance through instruments such as letters of credit and guarantees.
Types of banks
Commercial banks generally combine deposit-taking, lending, and payments. Retail banking serves individuals and smaller businesses; corporate banking serves larger organizations. These are business segments rather than necessarily separate legal categories.
Investment banks specialize in securities issuance, mergers and acquisitions, trading, and related activities in the financial markets. Universal banking groups combine commercial and investment services where permitted. Cooperative banks and credit unions have member-based ownership structures, although their legal classification differs between countries. Development banks provide financing associated with development objectives.
A central bank has a different role from an ordinary commercial bank. It typically conducts monetary policy and provides settlement accounts for eligible financial institutions; its responsibilities may also include currency issuance, supervision, and financial-stability functions.
Balance sheets and money creation
A bank’s assets include loans, securities, cash, and reserves held at the central bank. Its liabilities include customer deposits and borrowed funds. Capital, broadly the difference between assets and liabilities in accounting terms, absorbs losses; regulatory capital is defined through more specific eligibility rules.
When a commercial bank grants a loan and credits the borrower’s account, it generally creates both a loan asset and a deposit liability. This increases deposit money rather than merely transferring an existing depositor’s balance. Repayment of loan principal reverses the corresponding entries.
Banks cannot expand lending without constraints. Capital and liquidity requirements, funding costs, borrower demand, expected profitability, and creditworthiness all matter. Payments to another bank require settlement assets or access to funding. Consequently, the relationship between reserves and the money supply is not adequately described by an automatic, fixed lending multiplier. Monetary policy influences lending through interest rates, financial conditions, and other channels.
Risk and regulation
Banks face credit risk when borrowers fail to repay, market risk when asset prices change, and operational risk from failures of systems, processes, or controls. Liquidity risk concerns meeting obligations when due; solvency concerns whether assets and capital are sufficient to cover liabilities and losses.
A bank run occurs when many depositors seek withdrawals at once. Even a bank with sound longer-term assets can encounter difficulty if it cannot obtain cash quickly enough. Interconnections between institutions can transmit financial stress.
Regulation commonly includes licensing, supervisory examinations, capital requirements, liquidity standards, and restrictions on particular activities. Deposit insurance protects eligible deposits within specified limits. Central banks may provide emergency liquidity under applicable conditions, while resolution frameworks govern failing banks. The Basel Accords establish international supervisory standards, whose implementation occurs through national or regional rules.
Digital banking and access
Banking increasingly operates through the internet, mobile applications, and automated payment systems. Digital-only banks may hold banking licenses, while many financial-technology providers rely on licensed partner banks. Their legal responsibilities depend on the service and jurisdiction.
Digital distribution can lower some service costs, but introduces dependence on software, telecommunications, and external providers. Cybersecurity, identity verification, and data protection are therefore important operational concerns. Financial inclusion concerns access to and use of appropriate financial services; affordability, documentation requirements, physical access, and digital connectivity influence who can obtain banking services.