Types of Banking

Types of Banking

When we talk about banks, we are talking about several different types of financial institutions, conducting different kinds of business. Some banks are very large and carry out many different functions, others are more specialised. Some have operated for hundreds of years and some have taken on new kinds of business quite recently.

Not all banks carry out the same range of activities. Banking activities can be generally divided into the following types:

Central Banking
The duty of central banks is to maintain financial stability, otherwise a country's economy will not operate properly. Central banks act as regulators of their country's interest rates by controlling the amount of money in circulation and buying and selling currencies. They amass reserves and act as lenders of last resort, should another bank get into trouble. They exist as a separate entity from all the other banks.
Retail Banking
Retail banks are the high street banks we are all familiar with. They take deposits from individuals, provide saving facilities and pay interest on these accounts. They also lend money to individuals, in the form of loans and overdrafts, and charge interest on the money they lend. They provide a range of other financial services.
Commercial Banking
Commercial banks, or divisions of banks, provide banking services to businesses, from small companies through to corporate banking directed at large corporations. They help companies raise finance to expand their businesses and to maintain their cashflow by lending them money. They provide a wide range of other financial services.
Investment Banking
Investment banks distribute and underwrite (guarantee the sale of) share and bond issues; they trade securities on the financial markets and advise corporations on capital market activities such as mergers and acquisitions. Investment banks originally developed in the USA and these banks have now taken over many roles that were previously carried out by UK merchant banks.

Universal Banks

Although some investment banks exist as separate institutions (in the United States between 1933 and 1999 investment banking and commercial banking had to be kept apart by law) in the United Kingdom, most larger commercial/retail banks also have an investment section in the company. The divisions work separately, as the work and knowledge required for each division is very different. These very large banks are known as universal or conglomerate banks.

However, there is now pressure from many governments to keep investment banking separate from commercial and retail banking. If an investment bank gets it wrong and buys the wrong commodities, they can lose vast amounts of money and even go bust. Investment banking, if it goes well, can make huge amounts of money. Unlike retail and commercial banking, investment banking is a very high risk form of banking.

Another type of banking that was important in the past was merchant banking. Barings was a merchant bank. Merchant banks performed activities that helped companies trade internationally. They would issue letters of credit, transfer funds internationally and co-invest in projects involving trade. In practice, the fine lines that separate the functions of merchant banks and investment banks have now blurred and now the terms are sometimes used to mean the same thing. You can find out more about merchant banking in the section on the Story of Barings.