A bank is a business that takes in deposits and makes loans, and it keeps people's money safe until they want to use it. A bank does not keep each deposit in its own box: a deposited bill is mixed with other cash, the balance is recorded by computer, and much of the money is lent out. Banks combine many people's savings into one pool and lend that money to people who want to borrow. They act as go-betweens for people who save and people who want to borrow, and without savers' deposits, banks would have little or no money to lend. A bank may pay savers 3 percent and charge borrowers 8 percent, and the 5-point gap goes to the bank. Charging interest on loans is one of its main ways to make money, while banks pay depositors just enough interest to stay competitive with one another and attract savers.
If a bank lends someone 100 pounds and credits their account, new money has been created, per the Bank of England (as of October 2019). When a bank loan is repaid, the electronic money the bank created is deleted, and borrowing makes no one richer or poorer, so banks create money, not wealth (as of October 2019). Most money in the economy is created by banks when they make loans, not by printing presses at the central bank, according to the Bank of England (as of October 2019). Banks create about 80 percent of the money in the UK economy as electronic deposits, and notes and coins are only about 3 percent, per the Bank of England (as of October 2019). Banks cannot create unlimited money. They must hold capital in case borrowers default, and a bank that lends too freely risks going bust, per the Bank of England.
Loans that seem risky carry more interest, and lenders also check whether borrowers can repay before they lend. Interest rates on loans rise when many people want to borrow and banks have little money to lend, and fall when the reverse is true, and interest rates on loans may be fixed, staying the same, or variable, moving up or down over time. The money in a bank belongs to its depositors, not to the bank's owners, so bankers have a special duty not to take big risks with loans. A bank is a business, so it can fail like other businesses, and bank failures are unlikely, but they do happen. Banks fail when managers make poor choices, such as growing too fast or lending too much of one kind, and they also fail when changing economic conditions stop borrowers from repaying loans. An example in a Federal Reserve Bank booklet describes a bank closed by regulators after it lent heavily to energy companies and energy prices fell.
There are several kinds of banks: commercial banks, savings banks, savings and loan associations, cooperative banks and credit unions. The first savings banks were founded in the early 1800s to give workers with little money a secure place to save, and the savings and loan associations and cooperative banks of the 1800s helped factory workers and other wage earners become homeowners, using deposits to make home loans. Credit unions began in the 1800s as a way for people shut out of ordinary lending to borrow in emergencies, using a pool of members' savings. In the 1980s savings and loans were squeezed. Their deposit rates were capped by the government below what savers could earn elsewhere, so savers withdrew funds. Because savings and loans made long-term fixed-rate mortgages, rising interest rates cut the value of those loans and nearly wiped out the industry's net worth. For years banks could not pay interest on checking accounts, and in 1980 the savings account rate was set by law at 5.25 percent.
Before the Civil War, the nation's currency was coins and notes issued by state-chartered banks, and rules varied by state, and a note from one state was often accepted in another only at a discount, if at all. The National Banking Acts of 1863 and 1864 were wartime laws meant to help finance the Civil War and to create a stable, uniform currency. Banks rarely keep gold or silver in their vaults, and today's paper money and coins are backed by the full faith and credit of the U.S. government. Before federal deposit insurance, bank runs were common: at the first hint of trouble depositors lined up to withdraw money, and only the first few in line might get theirs, and even healthy banks sometimes failed in those days, when rumors made depositors panic and withdraw their money. Trust companies in 1907 held about 5 percent of deposits as cash reserves, against about 25 percent for national banks, and their deposits could be demanded in cash, so they were as open to runs as banks.
The Federal Reserve, called the Fed, is the central bank of the United States, a bank for other banks and a bank for the United States government, and the Federal Reserve Act was signed on December 23, 1913, and the panic of 1907 had spurred the monetary reform movement that led to it. The Federal Reserve System has 12 Federal Reserve Banks, each serving its own district. The Fed's jobs are guiding the economy's money and credit, supervising banks, keeping the financial system stable and running payment systems, and it shares the job of supervising banks with other federal and state agencies. The Federal Reserve Banks supply cash to banks: a bank that needs cash for customers orders it from the Reserve Bank in its district. The Fed does not print paper money, and the Bureau of Engraving and Printing, part of the Treasury Department, prints it and ships it to the Federal Reserve Banks. The Federal Reserve does not lend money to private borrowers, but it sometimes lends to banks when the need arises.
The Federal Reserve discount window lets banks borrow from Federal Reserve Banks after signing legal agreements and pledging collateral. Clearing-house loan certificates of 1907 were the predecessor to discount window loans from the Federal Reserve and gave banks a temporary rise in liquidity. Since March 2020 the discount window's primary credit rate has been the top of the FOMC's federal funds target range, and loans last overnight up to 90 days (as of November 2026). Before 2020, Federal Reserve rules required banks to hold reserves: 0 percent on a small slice of checking-type balances, 3 percent on the next band and 10 percent above that. Reserve requirements were cut to zero on March 26, 2020, ending any Federal Reserve rule that banks hold a set share of deposits in reserve (as of November 2026). The federal funds rate is the rate at which banks lend reserve balances to other banks overnight, and the Federal Reserve Banks pay interest on reserve balances, and that rate is an important tool of monetary policy.
In the 1920s hundreds of banks a year were suspended, and in 1930 about 1,350, and bank trouble came well before the 1929 stock market crash. Bank suspensions totaled under 1,000 a year in 1921-1928, began rising in 1929, peaked in 1933 and fell near zero after the banking holiday, and a bank in trouble in 1930 needed cash from a correspondent bank, which might itself face many requests or runs. This reserve pyramid limited small banks' access to cash in a crisis. In the 1920s checks in the mail were counted as cash reserves by two banks at once, though the cash was only in one, a practice that bankers called fictitious reserves. When the Great Depression crises began in 1930, over 8,000 commercial banks belonged to the Federal Reserve System, but nearly 16,000 did not. The U.S. had 12,427 commercial banks in 1900, 30,291 in 1920 and 23,769 at the end of 1930.
In November 1930 a series of bank crises turned a typical recession into the beginning of the Great Depression. On March 4, 1933 all twelve Federal Reserve Banks kept their doors locked, and banks in 37 states closed or limited withdrawals. The crisis began to ease on March 9, 1933, when Congress passed the Emergency Banking Act, and member banks in Federal Reserve cities could reopen on March 13. In 1933 banks reopened in stages: Class A banks were solvent, Class B were weakened and could reopen after reorganization, and Class C were insolvent and were not allowed to reopen. The Banking Act of 1933, also called the Glass-Steagall Act, was signed on June 16, 1933, to reform a banking system hurt by the Depression. The act separated commercial banking from investment banking, and commercial banks that took deposits and made loans could no longer underwrite or deal in securities. In 1999 the Gramm-Leach-Bliley Act repealed the 1933 rules that restricted ties between banks and securities firms.
After thousands of banks closed in the Great Depression, Congress created the FDIC in the Banking Act of 1933. Bank failures fell from about 4,000 in 1933 to 62 in 1934, after Congress set up the FDIC. The deposit insurance part of the 1933 act was the most controversial at the time, and it was included at the insistence of a congressman who had the interests of small rural banks in mind. The chairman of the House Banking and Currency Committee agreed to back the 1933 banking bill only after an amendment was added to permit bank deposit insurance. The 1933 deposit insurance law set a basic coverage of $2,500, effective January 1, 1934, in a Temporary Fund paid for by bank assessments. In 1934 the basic coverage rose from $2,500 to $5,000. The deposit insurance limit then rose to $20,000 in 1969, $40,000 in 1974 and $100,000 in 1980, and in October 2008 the limit was temporarily raised to $250,000. A 2010 law made $250,000 permanent, retroactive to January 1, 2008 (as of November 2026).
As of November 2026, FDIC insurance covers $250,000 per depositor, per insured bank, for each ownership category, and deposits in one category at one bank are added together. It covers deposit accounts such as checking, savings, money market deposit accounts and certificates of deposit, but not investments such as stocks, bonds, mutual funds or annuities, even if a bank sells them. The NCUA insures credit union accounts up to $250,000 through the Share Insurance Fund, backed by the full faith and credit of the United States (as of November 2026). The FDIC usually pays insured depositors within days of a bank closing, often the next business day, with a new account at another bank or a check. If a failed bank's depositors have funds over the insured limit, they may recover part of it as the FDIC sells the bank's assets, but that can take several years. As of November 2026, no depositor has lost a penny of FDIC-insured funds since the FDIC was founded in 1933.
Words to know
- liquidity: cash on hand
- correspondent: partner bank
- collateral: pledged property
- insolvent: unable to pay
- default: fail to repay
- retroactive: counting backward
