Oct 12, 2021
What the Financial Services Sector is All About
The sector facilitates the movement of money between people and businesses.
You go to the bank to put money in your savings account, to make a withdrawal, to apply for a loan, and more. But banks aren’t just places where you store your cash. They’re also businesses, and part of a large sector of the economy.
The economy couldn’t function without a solid banking system, but the financial services sector is much more than just banking. The sector also includes alternative lenders, credit card companies, financial service providers, and increasingly, fintech and cryptocurrency businesses, and more.
However, banks are the backbone, holding and providing the money that consumers spend to keep businesses open. Banks also help people invest money, and potentially build wealth. Additionally, banks provide loans and financial services to businesses which can help them grow and stay in business.
This sector, which employs over 8.5 million people in the U.S. as of September 2021, keeps money flowing between businesses and people. Financial services contribute about 8% to the gross domestic product of the U.S. And as of the second quarter of 2021, finance and insurance businesses accounted for almost $3.6 trillion of GDP.
As of 2020, there were 4,377 commercial banks insured by the Federal Deposit Insurance Corporation (FDIC) in the U.S., with almost 75,000 branches across the country. And total assets held by U.S. banks totaled almost $22.6 trillion. In 2020, the four biggest banks in the country—JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo—held a record $10 trillion in total assets.
|Bank of America
Source: Federal Reserve, June 2021
How do banks earn money?
Banks earn money in a variety of ways. You may not know it, but when banks take your money as a deposit, they also lend it out to others and make money from the interest they charge on the loan.
That interest can be for loans such as mortgages and credit cards. But banks can also charge fees on checking and savings accounts, such as overdraft or under limit charges.
Banks that issue credit cards also collect a portion of interchange, which is a fee charged to merchants for accepting cards for payment.
And many of the largest banks, known as Wall Street banks, have prominent investment divisions, which charge for stock and bond trading, as well as for their services involved in bringing companies public, through a process called an initial public offering (IPO).
A changing landscape for financial services
Since the financial sector is so essential to the economy, it tends to be heavily regulated, both at the state and federal level. Those regulations ensure that banks meet capital requirements that ensure they have enough cash on hand to meet their obligations to consumers and businesses. They also help to diminish some of the risk they might otherwise take in their investments. Yet other regulations also lay out principles that ensure they behave ethically toward consumers, for example by lending fairly.
The two main overseeing bodies for commercial banks are the Federal Deposit Insurance Corp.(FDIC), which insures consumer deposits, and the Office of the Comptroller of the Currency (OCC)which tests the solvency of banks.
Following the financial crisis of 2009, regulators put in place a new set of requirements called the Dodd-Frank Act that protect consumers from abusive lending practices, and that prevent banks from getting “too big to fail.” In 2018, however, Congress voted to roll back some of the restrictions outlined in Dodd-Frank for banks with less than $250 billion in assets, easing their reporting requirements and capital restrictions.
Role of the central bank
There’s another component to the financial sector in the U.S. that’s important to know about.
It’s called the Federal Reserve System.
The Federal Reserve, also known as the Fed, is the central bank of the U.S. It comprises 12 district banks located throughout the country, which together are responsible for the monetary policy of the U.S.
The Fed’s mission is to oversee the health of the nation’s financial system. It attempts to keep the economy strong and growing by enacting policies to maintain low inflation and healthy employment levels. It does this primarily by adjusting interest rates and lending money to the nation’s banks.
The Fed sets something called the overnight funds rate, which is also known as the federal funds rate. This rate dictates how much it costs for banks to lend their money to other banks, specifically the central bank. The Fed can manipulate the rate in certain ways, which can have effects throughout the economy.
For example, at the start of the pandemic, the Fed lowered the federal funds rate to almost zero percent to stimulate the economy with so-called cheap money in the form of low-interest loans. The Fed has kept the rate there, and has been hesitant to increase it, since the economy is still recovering. But that influx of cash has push inflation up, and maybe keeping inflation higher than normal.
The future of banking
While commercial banks and the Federal Reserve make up the traditional banking sector, new technology is shaking up the banking industry. And new financial services companies (such as Stash), known as FinTech companies, are disrupting the market.
Today, there are hundreds of such companies changing the way we bank, spend, lend money, accept payments, finance our businesses, apply for mortgages, and more.
Perhaps the oldest and best-known is Paypal, which in the early days of the Internet allowed people to pay for things online in a secure manner, using either a credit card or a bank account.
Paypal is a multibillion-dollar company. It’s also facing disruption by a host of startups including Stripe, Venmo, Dwolla, and Square.
In short, the financial services industry is moving beyond handing hand-written checks to your local bank teller. Banking is becoming global and mobile, giving more people the ability to access their money from wherever they are in the world.
Cryptocurrency and financial services
Cryptocurrency, a digital asset that doesn’t rely on physical currency, is also changing the financial services sector. Cryptocurrency uses something called blockchain, or distributed ledger, software. That means code produces an encrypted record of the value of each virtual coin and the transactions it’s involved in, distributing that record across numerous networks on the Internet. Distributed ledger is different from the way your bank keeps track of your dollars, in a centralized database that only it controls, cryptocurrency experts say. Since its introduction in 2009, more than 2,000 types of cryptocurrency have emerged, including Bitcoin, Ethereum, Stellar, and Binance Coin.
Cryptocurrency has also opened the door for something called decentralized finance, or DeFi. DeFi is an economy that’s entirely online and based on cryptocurrency, typically Ethereum. Businesses in the DeFi industry, often called DeFi apps or dapps, operate by taking out the middleman: traditional banks. Rather than requiring the many steps banks use, DeFi uses the technology behind cryptocurrency to securely and automatically carry out financial transitions, such as loans, peer-to-peer transactions, and more.
It’s important to remember, however, that cryptocurrency isn’t recognized as an official currency, and it has a tendency to be highly volatile. So you should keep that in mind if you’re interested in cryptocurrency or participating in DeFi.
Investing in financial services
Banks aren’t just places that hold and move your money. They’re businesses, and you can invest in them. You can invest in individual stocks of financial services. Stash also offers exchange-traded funds (ETFs) within this sector.
If you do decide to invest in financial services, you should know that investments in this sector tend to be cyclical, meaning that they respond to changes in the economy. When the economy is doing well, financial services also tend to perform well, and vice versa.
Following the Stash Way can help protect you from market volatility. You can follow the Stash Way by investing regularly in a diversified portfolio that includes stocks, bonds, and ETFs across a variety of sectors.
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