Commercial banks take deposits from people and businesses, then lend that money out at higher interest rates

A commercial bank is a for-profit business that accepts deposits (money you put in), pays you interest on some of those deposits, and lends money to other customers at higher interest rates. The difference between what they pay depositors and what they charge borrowers is how they make money. Banks also charge fees for services like checking accounts, wire transfers, and overdraft protection.

The core transaction is simple: you deposit $1,000 in a savings account earning 0.5% interest per year. The bank lends that $1,000 (or a portion of it) to a small business at 8% interest. The bank keeps the difference. This spread—the gap between deposit rates and loan rates—is the primary source of bank profit.

Commercial banks are different from investment banks (which trade securities and advise on mergers), credit unions (which are member-owned nonprofits), and central banks like the Federal Reserve (which regulate the money supply and other banks). A commercial bank is the kind you walk into on Main Street or access online.

Key Takeaways

  • Commercial banks profit by paying lower interest on deposits than they charge on loans, plus collecting fees for services.
  • Banks must keep a portion of deposits on hand as reserves, set by federal regulation, so they cannot lend out every dollar deposited.
  • The Federal Deposit Insurance Corporation (FDIC) insures deposits up to $250,000 per account holder per bank, protecting your money if the bank fails.
  • Banks make loans to individuals (mortgages, car loans, personal loans) and to businesses (lines of credit, equipment financing, working capital loans).
  • Banks are regulated by federal and state authorities that set rules on capital levels, lending practices, and consumer protections.

How banks use your deposits

When you deposit money into a checking or savings account, the bank does not lock it away in a vault with your name on it. Instead, the bank pools deposits from thousands of customers and uses that pool to fund loans. The bank keeps a percentage in reserve—money it must hold without lending—as required by federal law and its own risk management.

The reserve requirement varies depending on the type of account and the bank's size. As of 2023, the Federal Reserve eliminated the reserve requirement for most banks, but banks still hold reserves voluntarily to cover withdrawals and meet regulatory capital standards. If many customers withdraw money at once, the bank must have enough cash on hand to pay them.

This is why banks can fail: if too many customers demand their money back at the same time (called a "run" on the bank), and the bank has lent out most of the deposits, it cannot pay everyone. This is also why the FDIC insures deposits up to $250,000 per depositor per bank—to prevent panic withdrawals and protect people's savings.

The types of loans banks make

Commercial banks lend to two main groups: consumers and businesses. Consumer loans include mortgages (home loans), auto loans, personal loans, and credit cards. Business loans include lines of credit (short-term borrowing for operating expenses), term loans (money for equipment or expansion), and commercial mortgages (loans to buy or refinance business property).

Banks assess risk before lending. They pull your credit report, check your income, and look at your debt-to-income ratio. A borrower with a high credit score and stable income gets a lower interest rate because the bank sees less risk. A borrower with poor credit or unstable income either gets rejected or pays a higher rate to compensate the bank for the risk.

Banks also make money from fees on these loans: origination fees (charged when you take out the loan), prepayment penalties (charged if you pay off early), and late fees (charged if you miss a payment). These fees are separate from interest and add to the bank's revenue.

Fees and services that generate bank revenue

Beyond interest on loans, banks charge fees for dozens of services. A monthly maintenance fee on a checking account, overdraft fees (charged when you spend more than you have), wire transfer fees, ATM fees (if you use another bank's machine), and stop-payment fees (if you ask the bank to block a check) all add up. Some banks waive these fees if you maintain a minimum balance or set up direct deposit.

Banks also offer investment services—brokerage accounts, mutual funds, financial advisory—and charge commissions or advisory fees. They offer credit cards and earn a percentage of every transaction (called an interchange fee, paid by the merchant's bank). They offer wealth management to high-net-worth customers and charge a percentage of assets under management.

The fee structure varies widely between banks. Online banks often charge fewer fees because they have lower overhead costs. Large national banks charge more fees but offer more services and branch locations. Credit unions typically charge lower fees because they are member-owned and return profits to members rather than shareholders.

How the Federal Reserve and regulators oversee commercial banks

Commercial banks operate under a framework of federal and state regulation. The Federal Reserve (the central bank of the United States) sets the discount rate—the interest rate at which banks can borrow from the Fed—and uses this to influence the broader economy. The Fed also sets reserve requirements, conducts bank examinations, and enforces consumer protection rules.

The Office of the Comptroller of the Currency (OCC) charters and regulates national banks. The Federal Deposit Insurance Corporation (FDIC) insures deposits and closes failed banks. State banking regulators oversee state-chartered banks. These agencies work together to ensure banks have enough capital, do not take excessive risks, and follow consumer protection laws like the Truth in Lending Act and the Fair Credit Reporting Act.

Banks must also comply with anti-money-laundering rules, know-your-customer requirements, and fair lending laws that prohibit discrimination. Violations can result in fines, restrictions on operations, or loss of charter. This regulatory structure exists to protect depositors, prevent systemic financial crises, and maintain public confidence in the banking system.

Why banks fail and what happens to your money

A bank fails when it runs out of capital—the money it has set aside to absorb losses. This can happen if too many borrowers default on loans, if the bank makes bad investments, or if economic conditions deteriorate rapidly. When a bank fails, the FDIC steps in, takes control of the bank's assets, and pays off insured deposits up to $250,000 per depositor per account type.

If you have $250,000 in a checking account and $250,000 in a savings account at the same bank, both are fully insured because they are different account types. If you have $500,000 in a single checking account, only $250,000 is insured; the rest is at risk. If you have accounts at multiple banks, each bank's insurance is separate, so you can protect more money by spreading deposits across institutions.

The FDIC maintains a fund (paid by bank premiums, not taxpayers) to cover insured deposits when banks fail. In the 2008 financial crisis, the FDIC paid out billions to depositors of failed banks. The process is usually quick—most depositors have access to their insured funds within a few business days.

The difference between commercial banks and other financial institutions

A credit union is member-owned and nonprofit, so it returns profits to members as lower fees and better rates. Credit unions are smaller and more local than commercial banks, but they offer similar services: checking, savings, loans, and credit cards. You must be a member to use a credit union, usually by working in a certain industry or living in a certain area.

An investment bank does not take deposits or make consumer loans. Instead, it trades securities (stocks and bonds), advises companies on mergers and acquisitions, and underwrites new stock offerings. Investment banks make money from trading commissions, advisory fees, and underwriting fees. They are riskier than commercial banks because they trade with their own capital and are exposed to market swings.

A savings bank or thrift historically focused on mortgages and savings accounts but now operates much like a commercial bank. The distinction has blurred over time, and many savings banks are now chartered as commercial banks.

Frequently Asked Questions

What happens if a bank goes out of business?

The FDIC takes over the bank and pays off insured deposits (up to $250,000 per depositor per account type) from its insurance fund. Uninsured deposits may recover some money if the bank's assets are sold, but there is no may provide. The process usually takes a few business days for insured funds to reach your account.

Why do banks charge overdraft fees if I spend more than I have?

Banks charge overdraft fees because they are covering the cost of lending you money on the spot to prevent a transaction from being rejected. The fee compensates the bank for the risk and the administrative cost. Some banks offer overdraft protection (linking your account to savings or a line of credit) to avoid the fee.

Can a bank refuse to give me my money?

A bank can place a hold on your deposit (delaying access for a few business days) to verify funds, but it cannot refuse to give you your money if it is insured and the bank is solvent. If the bank is insolvent, the FDIC takes over and pays insured deposits. If your deposit exceeds $250,000, the uninsured portion is at risk.

How do banks decide what interest rate to offer me?

Banks set rates based on the Federal Reserve's benchmark rate, their own cost of funds, the risk of lending to you (your credit score and income), and competition from other banks. A borrower with excellent credit gets a lower rate than one with poor credit. Rates also vary by loan type and term.

Is my money safer in a bank or under my mattress?

Your money is safer in a bank because it is insured by the FDIC up to $250,000 and you earn interest. Under a mattress, your money earns nothing and is at risk of theft or loss. The only reason to keep cash at home is for immediate emergency access or if you distrust banks, but FDIC insurance makes bank deposits extremely safe.