The banking sector in North America takes up a significant portion of the stock index. Indeed, they represent some of the largest companies in the world today and that has sometimes brought about a “too big to fail” mindset wherein the failure of one major bank could have jarring system-wide repercussions. In this scenario, the government would be forced to step in and rescue them by providing liquidity in order to protect the jobs and a possible collapse of the economy. How did banks get so large in the first place though? To answer that question, it is important to know the different types of financial institutions that operate on the market today. Once that is understood, it is easy to see why banks have bloated up due to the sheer volume of services that they can offer to various types of customers. While this versatility is good for the consumer as it often offers a one-stop shop for them to conduct all their banking operations through, a situation where the bank becomes too big to fail can have implications that can eliminate the positive effects.
The first and most common type of bank is the retail bank where depositors (everyday people) deposit their money into chequing and savings accounts. The banks are also responsible for providing private investors with opportunities to invest their money as well as distributing debit and credit cards. However, most importantly, it is what they do with the deposited money that makes them valuable in an economy. Once depositors provide them with the funds, the banks go out to customers and offer them loans and mortgages. The difference between the interest rate charged on the loans and what the bank pays to the depositor for their money is what the retail bank earns. Some common examples of a retail bank include TD Canada Trust and J.P. Morgan Chase. The second type of bank is the commercial bank that largely deals with business customers. Just like individual consumers need chequing and savings accounts, businesses need it too to pay their bills and deposit their money in. However, the needs of the business are typically more complex as compared to consumers as they often need lines of credit, letters of credit and/or cash flow management advisory services. The commercial bank provides them with all of this and more. Some common examples include HSBC and BNP Paribas.
The third type of bank is called the investment bank which connects investors with financial markets. These banks offer financial advisory services to companies in matters such as capital raising, sales and trading, mergers and acquisitions, restructuring and other corporate actions. Prime examples of investment banks include Goldman Sachs and Morgan Stanley. The next type of bank is called a credit union which is owned by customers themselves. These credit unions offer services that are similar or identical to those offered by retail banks and commercial banks. However, the key difference here is that the union members share one or more characteristics in common such as where they live, work etc. A banking type that has become more prevalent over the last decade is the concept of the online bank which does not have physical branches. Due to their lower operating costs, these banks sometimes offer cheaper services such as a free chequing account. In terms of the breadth of services provided however, they are once again identical to retail banks.
While there are certainly other types of financial institutions, these form the crux of what most banks these days offer their customers in terms of services. The increasing competition between banks has led to some pursuing strategies where they offer all of the services listed above under one umbrella, creating a universal bank. This provides the banks with economies of scale and scope and allows them to cross-sell services to customers. Some of the biggest universal banks in the world today include Bank of America and Wells Fargo.