Banks are a place for us to handle our checking, savings, and possibly a loan. Beyond that, for many of us, banking is a black hole. Why banks do what they do and how they do it is little understood outside of the banking community.

The more information you have, the better consumer you can be.

So, let’s get started...

Being a Smart Banking Consumer

(Part 1): An Introduction to Banking

How Do Banks Earn Money?

Every dollar that you put into the bank needs to earn money for the bank. Cash in the vault does not earn money, so banks will keep as little as is needed for daily transactions with customers over the counter. A small percentage will be kept in an account at the Federal Reserve. This is required to conduct certain types of transactions each day between banks. For our purposes right now, there’s no need to go into detail here. First, let’s talk about how banks earn money.

At any point in time, the bank may have less than 5 to 10% of all the money in checking and savings accounts on hand in their vault. Banks take the money in your checking or savings account and lend it out. They pay you a small amount of interest and lend it out by charging the borrowers a higher rate of interest.

The difference between the interest they charge to borrowers and the interest they pay customers is what is needed for banks to be profitable. This is how the bank earns money to pay employees, bills, and investors. If the bank does not have enough borrowers, the bank will often invest your money into government bonds.

Government bonds come from different federal, state and city government agencies that need to borrow money. For example, when your local school district or utility needs to borrow money, it will create a legal document called a bond and sell that bond to the banks. This is, in effect, a loan that pays interest to the bank. As a result, the bank will earn money on the amount it has not lent to borrowers.

What will I need to open a checking account?

When a new customer walks into the bank to open a checking account, his or her history with other banks will be checked. All banks are members of a checking account tracking company. Banks will report forced closed accounts and that information is available to all members. In order to open a checking account at a bank, it’s best if you have not had a previous checking account forced to close because of bounced checks at another bank in the past. Some banks will allow you to open an account if you’ve had trouble with a previous bank, but they are few. Moral of the story here: treat your account and your bank in a nice way.

You will need to have a current driver’s license or official picture ID for identification. Some banks will allow you to open an account with zero money, others will want a minimum deposit. The bank will check your name against an official possible terrorist list (banks don’t want to do business with those guys). You will also be asked a series of questions to determine if you are a risk for money laundering (banks don’t want to do business with possible money launderers, either).

What is a money launderer?

A money launderer is a person that has money received through illegal means and wants to put that money in his or her checking account. From there, the money can go in many different directions, like paying bills and other “normal” transactions. Once this happens, that money has now become normal money and has been laundered, in the words of the government. This makes it hard to trace. 

What are my rights as an account holder?

You have many rights under federal and state law. Here, the government steps in to prevent the bank from taking advantage of you and your money. When you open a new account, you will receive many documents to sign and/or initial. Signing and initialing these documents means that you agree that you have read and understood the contents of those documents. Of course, very few people read these things fully (if at all) or even understand the basics of what they say… unless you’re a banking lawyer, maybe. However, these documents are extremely important because they set up the rights and responsibilities of both you and the bank.

Stay tuned for part 2, where we will go into more detail on rights and responsibilities.

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