What’s Are Key Difference Between Different Types of Banks?

The main difference between banking institutions is that larger banks tend to have a more robust amount of capital. Due to the increased capital they can use a larger float and diversification within their books to make up for any short-term windfalls in cash deposits, asset depreciation or short term losses on their books.

Smaller banks on the other hand do not have that luxury and if a small bank takes a large loss it could more severely impact their bottom line. They can sometimes be more susceptible to losses due to their size. Losses can be more meaningful to smaller banks because their assets under management are lower, meaning it’ll have a more meaningful impact to their books.

Stress Tests

This is why banks undergo stress tests! The main reason is to make sure that #1 the Great Recession doesn’t repeat itself and that banks have a system of checks and balances in place to prevent banking failure in the United States of America. Stress tests are key to helping banks prevent bank failure and making sure their books are sounds and their assets are well accounted for.

Why Does the Fed and U.S. Government Have Stricter Restrictions on Smaller Banks Than the Bigger Banks?

The FED has restrictions on smaller banks because they are perceived as more of a risk due to the assets they manage. They also tend to be friendlier towards small businesses and provide them with more small business loans (or this is the theory at least). Ultimately, small businesses receiving more capital is a great thing for the economy but sometimes these lending services can backfire on themselves.

Big Banking is Big Business

Banks have continued to consolidate until this day because mergers and acquisition tend to make sense and provide a tremendous amount of synergies across different financial services and banking channels. Not so long ago, SunTrust became a part of Truist and Morgan Stanley bought Etrade. Financial services and banking services have consolidated tremendously over the years. However, there has also been many innovations by the shadow banking sector. Even with the innovations in the shadow banking sector, most of those actions performed by traditional banks is being spread across different channels.

Shadow Banking

The Shadow banking sector is anything that is not directly aligned or considered a bank. This sector was quite large but these organizations have blurred that lines since they do operate with the bounds of a bank.

Paypal, Cash App, Venmo, etc., were all at one point or another a part of the shadow banking sector. Many of these apps have taken share from Big Banks but this still remains to be seen, since shadow banking and traditional banks still tend to rely on each other.

What’s Up with Federal Credit Unions?

Federal Unions are great for what they are. They are non-profit banks that provide great savings rates for those who want one. They might not have as many branches as JPM Chase does or all the bells and whistles of JPM Chase’s app but they do have great savings rates. Federal credit unions will provide robust yields but they might fall short on a lot of other areas. However, to each his own.

Why are Small Banks Considered to Be More Risk Averse?

Small banks are required to be more risk averse by the fed due to the fact that they don’t have all the assets that bigger banks might have and therefore can’t mess around with taking too many risks. If a small bank takes too many risks and they can’t handle the situation it will usually be the FED that helps take control of the situation.

That’s the FED’s job to help keep unemployment low and inflation low while making sure nothing cataclysmic happens to the banking system. The FED has a dual mandate to help keep the unemployment rate low and keep inflation low. That’s the FEDs main objection. Since a banking failure would mean that the FED has not observed their objective, they look to improve things they can, no matter how small they might be.

The Fall of SVB

As we learned with the fall of Silicon Valley Bank, there is always a potential for banking failure, even when you least expect it. SVB shocked the financial community as nobody expected a banking failure due to from short term and long-term duration maturity risk. However, as was stated due to excessive duration risk on bonds, SVB was hit like a rock once interest rates hiked and they began to owe interest payments on their bond payments. They exposed themselves to so much duration risk that they actually became bankrupt.

Also, if something is too good to be true, it might be, so make sure you double check it.

These are the key differences between different types of banks and their functions.

This is why it’s important to always be mindful of how the banking system works in America. We work on a fractional reserve banking system and that system is really good out stretching money to its maximum. The problem here is that stretching deposits to its maximum can expose you to different types of risk. The job of banks is ultimately to maximize profit. However, since banks are profit maximizing, when consumers come ask to make withdrawals that can't be processed, chaos can sometimes ensue.

This is what fraction reserve banking is. It’s a fragile system that requires trust from customers and government backing. If there wasn’t FDIC insurance, consumers would be a lot less distrustful of banks.

No matter your bank and what terms they provide, at the end of a day a bank is a bank. They serve a purpose and hopefully yours is serving theirs.