Depository institutions come in several different types. Anytime you give your money to someone with the expectation that the person will hold it for you and give it back when you request it, you’re either dealing with a depository institution or acting very foolishly. Depository institutions all function in the same basic manner:
They accept your money and typically pay interest over time, though some accounts will provide other services to attract depositors in lieu of interest payments.
While holding your money, they lend it out to other people or organizations in the form of mortgages or other loans and generate more interest than they pay you.
When you want your money back, they have to give it back. Fortunately, they usually have enough deposits that they can give you back what you want. That’s not always true, as everyone saw during the Great Depression, but it’s almost always the case.
Plus, safeguards are now in place to protect against another Great Depression in the future (at least one that occurs because banks lend out more money than they keep on hand to pay back to their lenders).
The three main types of depository institutions are commercial banks, savings institutions, and credit unions.
Commercial banks
Commercial banks are easily the largest type of depository institution. They’re for-profit corporations that are usually owned by private investors. They often offer a wide range of services to consumers and corporations around the world.
Often the size of the bank determines the exact scope of the services it offers. For example, smaller community or regional banks typically limit their services to consumer banking and small-business lending, which includes simple deposits, mortgage and consumer loans (such as car, home equity, and so on), small-business banking, small-business loans, and other services with a limited range of markets.
Larger national or global banks often also perform services such as money management, foreign exchange services, investing, and investment banking, for large corporations and even other banks like overnight interbank loans. Large commercial banks have the most diverse set of services of all the depository institutions.
Savings institutions
Have you ever passed by a savings bank or savings association? Those are both forms of savings institutions, which have a primary focus on consumer mortgage lending. Sometimes savings institutions are designed as corporations; other times they’re set up as mutual cooperatives, wherein depositing cash into an account buys you a share of ownership in the institution.
Corporations don’t use these institutions frequently, however, so I don’t cover them throughout the rest of the book.
Credit unions
Credit unions are mutual cooperatives, wherein making deposits into a particular credit union is similar to buying stock in that credit union. The earnings of that credit union are distributed to everyone who has an account in the form of dividends (in other words, depositors are partial owners).
Credit unions are highly focused on consumer services, so I don’t discuss them extensively here or elsewhere in this book. However, their design is important to understand because this same format is very popular among the commercial banks in Muslim nations, where sharia law forbids charging or paying traditional forms of interest.
As a result, the structure of a credit union in the U. S. is adopted by commercial banks in other parts of the world, so a basic awareness of this structure can be useful for international corporate banking.