How the Banking Sector Impacts Our Economy (2024)

What Is the Banking Sector?

The banking sector is a major segment of the U.S. and world economies. While some might define it more broadly, the U.S. Department of Commerce considers it a subsector of the larger financial services industry, which also includes subsectors focusing on asset management, insurance, venture capital, and private equity.

The U.S. banking system alone had $23.60 trillion in assets and a net income of $263 billion at the end of 2022.

The principal economic functions of the banking sector are to take deposits and make loans.

Key Takeaways

  • The banking sector is vital to the U.S. and world economies.
  • Its primary function is to safeguard depositors’ assets and make loans to individuals and businesses.
  • Banks are regulated by the federal government, and sometimes state governments, to try to keep them from taking on too much risk and imperiling the economy.

How Banking Works

Holding financial assets is at the core of all banking, and where it began in ancient times—though it has expanded far beyond the days of storing gold coins for wealthy patrons.

At the most basic level, a bank takes deposits from individuals or businesses, with the promise that the money can be withdrawn when the depositor wants it (though sometimes with a penalty for early withdrawal). Depending on the type of account, the bank also may pay interest on the depositor’s money.

The bank then lends the money it has on deposit to other individuals and businesses and receives interest payments from the borrower in return. Banks make a profit on the difference between the interest rate that they pay depositors for the use of their money and the higher interest rate that they charge borrowers.

By law, banks cannot lend out all of the money in their possession, but are required by regulators to keep a certain amount of capital in reserve to cover withdrawals and other needs. The rules change from time to time and vary by the size of the bank, but many large U.S. banks recently were required to keep 8% of their capital in reserve.

In addition to making loans, banks can invest their own money in other kinds of assets, such as government securities.

How Do Banks Drive the Economy?

The banking sector is crucial to the modern economy. As the primary supplier of credit, it provides money for people to buy cars and homes and for businesses to buy equipment, expand their operations, and meet their payrolls.

Banks also provide depositors with a safe place to keep their money (particularly since the advent of the Federal Deposit Insurance Corp. (FDIC), which insures many accounts up to certain limits) as well as to earn some interest on it.

The credit cards, debit cards, and checking accounts that banks make available facilitate all kinds of everyday transactions. They also help drive ecommerce, where cash is of little use.

The banking sector is also a major employer. In 2022, for example, FDIC-insured commercial banks alone employed nearly 2 million people in the United States.

On the negative side, the banking sector also has the capability of doing enormous harm to the economy. In the subprime mortgage meltdown that began in 2007, for example, reckless lending on the part of some banks sent the economy into a tailspin and triggered the Great Recession of 2007–2009. Regulatory reforms enacted since that time may help avert a similar crisis in the future.

How the Banking Sector Impacts Our Economy (1)

How Banks Are Regulated

Because of the vital role that banks play in the economy, governments around the world have laws in place to try to prevent them from engaging in excessively risky behavior. In the United States, for example, banks are regulated by an assortment of federal and state agencies, depending on the type of bank. The sector also self-regulates through actions of organizations such as the Financial Services Forum and the Financial Services Roundtable.

The federal regulators include the Federal Reserve System, the Office of the Comptroller of the Currency, and the FDIC. Credit unions, which also may be considered part of the banking sector, are regulated by the National Credit Union Administration.

State-chartered banks fall under the jurisdiction of state banking regulators and supervisors. Some banks are regulated on both state and federal levels.

Major Companies in the Banking Sector

Banks range dramatically in size, from the small-town corner bank to international behemoths, sometimes referred to “global systemically important banks” or banks considered “too big to fail” because of the havoc that their failure could supposedly cause to the world economy.

In the United States today, the five largest banks are JPMorgan Chase, Bank of America, Wells Fargo, Citibank, and US Bank. All but the last hold assets in excess of $1 trillion.

Why Are Banks Called Banks?

Some believe the word “bank” comes from banca, the Italian word for bench. Merriam-Webster says banca also referred to “the benchlike counter at which an early money changer transacted business.”

What Are the Different Types of Banks?

The common types of banks include central banks, commercial banks, and investment banks. Central banks are government institutions, like the U.S. Federal Reserve, whose role is to regulate their nation’s money supply. Commercial banks are what most of us think of as banks, taking in deposits and issuing loans. Investment banks generally work with companies to help them issue stock or find financing. Large banks often have divisions for both commercial and investment banking.

How Many Banks Are There In the United States?

There were 4,706 Federal Deposit Insurance Corp. (FDIC)-insured commercial banks in the United States as of December 2022. That number is dramatically down from previous decades, due to mergers, consolidations, and bank failures. In 1984, the U.S. had more than 14,000 commercial banks.

The Bottom Line

The banking sector has been important to nations’ economies since ancient times, particularly in safeguarding wealth and providing credit to individuals and businesses. Countries, including the United States, have regulations aimed at keeping banks from getting into financial trouble and dragging down the entire economy. Those regulations have met with mixed success over the years but continue to be refined.

How the Banking Sector Impacts Our Economy (2024)


How does banking have an impact on the economy? ›

How Do Banks Drive the Economy? The banking sector is crucial to the modern economy. As the primary supplier of credit, it provides money for people to buy cars and homes and for businesses to buy equipment, expand their operations, and meet their payrolls.

How does banking drive our economy? ›

Capital Allocation: Banks are instrumental in allocating capital efficiently by moving funds from savers to borrowers. They play a vital role in connecting those who have surplus funds with those in need of capital to invest in businesses, innovation, and infrastructure projects.

What are the benefits of a banking system in an economy? ›

The banking system, a vital part of every economy, offers a range of valuable financial services. These include safeguarding deposits, facilitating transactions, providing loans, and contributing to economic stability.

How does the banking crisis affect the economy? ›

Effects on Output and Unemployment

The estimates show that banking distress, on average, leads to a reduction in output of 1.3 percent one year after its onset and a peak increase in the unemployment rate of 1.0 percentage point two years after the onset.

What are the five most important banking services? ›

The 5 most important banking services are checking and savings accounts, loan and mortgage services, wealth management, providing Credit and Debit Cards, Overdraft services. You can read about the Types of Banks in India – Category and Functions of Banks in India in the given link.

How do banks have a role in the market economy quizlet? ›

Banks play a significant role in the overall economy. Banks take peoples deposits and keep money safe so individuals feel comfortable spending their money when they can. Banks also loan money out to people and businesses to start new projects or investments.

What would happen if banking did not exist? ›

Without banking, people would have to rely on cash for every transaction, making it more difficult to purchase things online or make large purchases.In conclusion, banking plays a crucial role in our daily lives, and its absence would have a significant impact on how we manage our money and conduct transactions.

What is the banking sector? ›

What is the banking industry? The banking industry includes systems of financial institutions called banks that help people store and use their money. Banks offer clients the opportunity to open accounts for different purposes, like saving or investing their money.

Do banks invest your money? ›

Only a small portion of your deposits at a bank are actually held as cash at the bank. The rest of your money (the majority of the bank's assets) is invested by the bank into vehicles such as consumer or business loans, government bonds and credit cards. Borrowers have to pay the bank back with interest.

What are 3 advantages of banking? ›

Benefits of a Bank Account
  • Bank accounts offer convenience. For example, if you have a checking account, you can easily pay by check or through online bill pay. ...
  • Bank accounts are safe. ...
  • It's an easy way to save money. ...
  • Bank accounts are cheaper. ...
  • Bank accounts can help you access credit.

What is the backbone of the economy? ›

Agriculture is the backbone of Indian economy.

Who benefits from the banking system? ›

Savings and Investment: Banks act as intermediaries between savers and borrowers. They provide a secure place for individuals and businesses to deposit their savings while lending this capital to others.

Do banks affect the money supply in the economy? ›

The bank will keep some of it on hand as required reserves, but it will loan the excess reserves out. When that loan is made, it increases the money supply. This is how banks “create” money and increase the money supply. When a bank makes loans out of excess reserves, the money supply increases.

How did banks contribute to the financial crisis? ›

Increased borrowing by banks and investors

Borrowing money to purchase an asset (known as an increase in leverage) magnifies potential profits but also magnifies potential losses. As a result, when house prices began to fall, banks and investors incurred large losses because they had borrowed so much.

How does the banking crisis affect inflation? ›

Higher interest rates make it more expensive for companies and households to borrow, constraining access to cash and restricting their ability to spend, reducing pressure on prices. On Wall Street, and in the corridors of the Fed, this is called tightening financial conditions.

Which example best describes how a bank injects money into the economy? ›

Explanation: Injecting money into the economy means increasing money supply in the economy. It means more money is in the circulation. So when a bank approves a mortgage for a customer, it means bank is releasing money which will be in circulation and becomes a part of the economy.

How do banks make money off of the credit they issue? ›

The primary way that banks make money is interest from credit card accounts. When a cardholder fails to repay their entire balance in a given month, interest fees are charged to the account.

What are the primary functions of banks? ›

Functions of Commercial Banks: - Primary functions include accepting deposits, granting loans, advances, cash, credit, overdraft and discounting of bills. - Secondary functions include issuing letter of credit, undertaking safe custody of valuables, providing consumer finance, educational loans, etc.

Why do banks have so much debt? ›

Banks carry higher amounts of debt because they own substantial fixed assets in the form of branch networks.

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