What are the different retail bank types?
Broadly speaking, there are three main retail bank types. These are commercial banks, credit unions and certain investment funds that offer retail banking services. Broadly speaking, all three banks work towards providing similar banking services such as checking accounts, savings accounts, mortgages, debit cards, credit cards and personal loans.
One of the retail bank types is commercial banks, which offer a wide range of consumer banking services such as certificates of deposit (CDs), savings and checking accounts, credit and debit cards, etc. Commercial banks are for-profit institutions and generate income through interest rate spreads and transaction fees.
The interest rate spread refers to the difference in interest rates that banks charge on personal loans and interest rates that banks pay on deposits in savings accounts. The spread fluctuates greatly across various economic cycles. For instance, in prosperous economic times, commercial banks are able to get away with paying out lower interest rates on savings accounts and charging higher interest rates on loans. The widened spread allows these institutions to generate more income.
Conversely, during times of economic recession, banks may need to incentivize consumer spending by lowering interest rates on loans, which will compress margins. However, offering higher interest rates on savings accounts may incentivize consumers to hold more money in these accounts, which will reduce consumer participation in the capital markets.
Transaction fees also make up a substantial amount of revenue for banks. These fees include usually recurring charges on credit cards, special fees for certain transfers or most other financial services offered by the institution. Since commercial banks essentially have a monopoly on this market, they are able to charge above-equilibrium prices without seeing excessive erosion in the demand for those products.
Credit Unions and Cooperatives
The other retail bank types are credit unions (or similar cooperative institutions). They offer very similar services to commercial banks, except that they operate at a much smaller scale. Credit unions are also usually not-for-profit institutions, where its depositors are its shareholders. As a result, credit unions face smaller pressures to generate profits. This, in turn, means that such credit unions typically charge lower interest rates on loans and may even offer higher rates on savings accounts. Transaction fees are also quite low since credit unions do not perceive them as revenue drivers, but merely services that can be offered at cost.
Nonetheless, there are some disadvantages to credit unions. Due to being much smaller institutions, credit unions lack a big brick-and-mortar presence, which is likely to dissuade consumers that prefer banking services being delivered in-person. Credit unions also employ less advanced technology than banks, making their online banking services less secure and susceptible to cyber attacks. Credit unions also employ far fewer employees, and as a result, are open for shorter periods of time than commercial banks.
What is the role of retail banks?
From an economic standpoint, all three types of banking institutions exist to:
- Provide more liquidity by influencing the money supply in an economy. This is usually done by adjusting interest rates and periodically reviewing creditworthiness protocols
- Reduce the probability of default on loans by pooling together the risks of lending money. Doing so will also place these institutions in better positions to cope with defaults due to federally-mandated reserve ratios. The ratio ensures that banks always have a minimum amount of cash on hand, and is a function of total consumer deposits
- Lower the cost of borrowing by offering competitive interest rates. Economies that follow the Keynesian monetary policy will profit take during economic booms by increasing interest rates on loans and build cash reserves. Then, during a recession, banks are expected to lower interest rates in order to spur consumer spending and stimulate economic growth.
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