Different Types of Banking: Where Does Your CU Fit In?

“Bankers” are not a well-liked group, or so the media would lead you to believe. But, what a banker is varies greatly. For some, a banker is someone who may help you with a checking account or a car loan, and for others, a banker is someone who buys and sells stocks and bonds. So which is it? Well, like all things in life, the world of banking is far from monolithic.

Banking, at its core, is about accepting deposits from savers, and lending those deposits to borrowers. This is often a highly regulated activity, because the savers want assurance their deposits will be returned. If you want to accept deposits from anyone so that you may lend them out, you will need to obtain a charter (license) from a state government or the national government. This activity is called commercial banking.

In commercial banking, you may accept deposits and lend them out as funds so that people can obtain consumer goods; like cars, campers, furniture, etc. These types of loans are known as consumer loans. The people needing consumer loans may have a need for deposit accounts and other savings products as well. Managing these deposit accounts and consumer loans is often referred to as retail banking. Just like a retailer targets most anyone in the general public, most banks are offering “retail” deposit accounts and consumer loans to the public.

Retail banking is a volume business. To be successful, you need to do a lot of it. Often, a more efficient way to generate interest income on loans is to focus on making only big loans. Less work will go into making one $1 million loan than 50 car loans for $20,000. But, consumers will not have a need for large $1 million loans. Businesses tend to have more of a need for these types of loans, and this banking is appropriately called business banking.

When a business loan is relatively small, say to purchase some equipment or small piece of real estate, the lending need usually falls into the category of small business lending. When a company wants to borrow a large sum of money, often several million dollars, but it is not big enough to do so by issuing stocks or bonds, this is considered a middle-market request. It is middle-market, because it is not small business; but also, not large enough to justify the involvement of an investment bank.

When a large recognized company can raise funding by selling stocks or bonds to the public, an investment bank is enlisted. These banks underwrite the financial instruments sold and find buyers for them. However, investment banks often do not raise money through accepting traditional retail deposits, nor do they often fund much of what they underwrite. For these reasons, investment banks are much less regulated.

Investment banks may offer private banking services to wealthy clients, in which the private banker will assist clients (for a fee) in finding high yielding investments for their savings; however, they will not provide any protection nor guarantee to return all the money invested. For these reasons, investment banks gain a reputation for being risk takers. Investment banks are not like commercial banks that strive to connect savers with borrowers, but rather, their goal is to make as much money as possible, often by being as innovative as possible with financial instruments sold, and with clients’ money being invested.

Credit unions engage in banking; of course, they are not privately owned, but collectively shared by all those who provide deposits. Credit unions have traditionally provided retail banking products and occasionally small business products. Credit unions have an opportunity to fill in more of middle-market lending going forward, simply because there are less banks every year that engage in this due to mergers and acquisitions. Credit unions have a niche to fill, because these middle-market companies are owned by local individuals and provide good local jobs too. People should not confuse business lending with “bad” banking or investment banking when a credit union is scaling up its business lending. It doesn’t mean it is catering to wealthy clients or engaging in more risk-taking like investment banks do.