Decoding the U.S. Banking System

Jan 27, 2025

44,000 – that's the total number of banks and credit unions around the globe today. Every day, 8 billion people around the world rely on these financial rails to exchange goods and services, making capital the most widely transferred asset of our times. Banks, being at the heart of these transactions, play a vital role in our lives. From depositing your paycheck to buying groceries, and covering school fees for our kids—each of us rely on these financial arteries that power global economies. 

Given the essential role these institutions play in our society , the ongoing debate around the shift to digital currencies, concerns over rising debts, and recent software outages in the sector, it's important to understand how these systems work. By doing so, we can better manage what is arguably one of the most vital element of our life and economy—capital.

Over the last five years, I have crossed paths with the banking and financial industry on multiple occasions. Recently, it was through providing advisory services to help banks build mission-critical software systems via our consulting arm. Each of these interactions prompted me to decode this web of financial systems that we deal with in our daily lives. 

You might wonder, what are the different pieces of this banking system that one must understand and how exactly do they work? We’ll try to simplify that in this piece.

Federal Reserve & U.S. Department of Treasury

While there are different approaches one can take to decode the banking system, we will start at the top of the pyramid—consumers. We all exchange goods and services using currency, which in the U.S. is printed by the Bureau of Engraving and Printing (BEP), a division of the U.S. Department of the Treasury. The BEP delivers this currency to the Federal Reserve, the central bank of the U.S.

You might ask: what’s the difference between the Treasury Department and the Federal Reserve in terms of roles and responsibilities?

Each country has its own central bank, the highest banking institution in the nation. In the U.S. it's the Federal Reserve. The Federal Reserve controls the money supply in the U.S. It does this by setting and adjusting the repo and reverse repo rates, which are essentially the interest rates at which commercial banks can borrow money from the central bank and vice versa. Higher interest rates reduce the money supply in the market, while lower rates increase it, thereby influencing liquidity in the economy.

In contrast, the Treasury Department oversees the money flowing into and out of the government. This includes managing taxes, infrastructure spending, budgets, and other fiscal responsibilities. Together, the Federal Reserve and the Treasury ensure a balanced and functional economy—one controlling the monetary supply, the other managing fiscal operations.

To summarize, the BEP, under the Treasury Department, prints the money, but how much money circulates in the economy is determined by the Federal Reserve through its monetary policies. Obviously, this money now enters the economy through a series of banks—commercial banks, credit unions, and digital banks.  You may ask what role do these different types of banks play in our economy? To better understand that below is a graphic I’ve put together to help you visualize the banking ecosystem.

Decoding the Banking Ecosystem in the U.S.

Looking at this graphic, you'll notice that we've already explored the role of the central bank—the Federal Reserve—in the previous section, represented by the leftmost pillar. Now, we'll try to understand how other banks, represented by the three pillars on the right in this graphic, function to meet the financial needs of individuals and businesses.

• Commercial Banks: These are the familiar names you see every day—JPMorgan Chase, Wells Fargo, Bank of America, Citibank, and U.S. Bancorp. They offer a wide range of services to individuals and businesses, including checking and savings accounts, loans, credit, and investment products. Commercial banks form the backbone of our financial system, handling large volumes of transactions and providing liquidity. While commercial banks are typically owned by large corporations, communities that prefer member-owned institutions often turn to credit unions as their preferred choice. 

  
  

• Credit Unions: Credit unions are similar to commercial banks but are member-owned institutions that often cater to specific communities, such as military veterans or employees of certain companies. They typically offer higher interest rates on deposits and lower interest rates on loans, which can make them attractive options for consumers. However, their relatively smaller scale and community-oriented structure can leave them more exposed to market risks. Prominent examples in the U.S. include the State Employees’ Credit Union (SECU), Navy Federal Credit Union, and SchoolsFirst Federal Credit Union.  For consumers who prefer an online-only banking experience, digital banks offer a convenient alternative

  
  

• Digital Banks: Digital banks, such as American Express Bank and Ally Financial, operate almost entirely online, offering a full range of financial services without the need for physical branches. By eliminating brick-and-mortar locations, they significantly reduce overhead costs and pass those savings on to consumers by offering higher interest rates on savings accounts, lower fees on checking accounts, and competitive loan products. Although digital banks operate online, they are chartered under the Federal Reserve and must obtain a banking license to function as a regulated financial institution. This ensures they comply with strict regulatory standards, including capital requirements, consumer protection laws, and risk management policies. But what about smaller banks and fintech companies that want to offer similar services but cannot afford the high costs associated with obtaining a banking license? This is where neo-banks come into play.

  
  

• Neo-banks: Neo-banks are also fully digital, but here’s the catch: they don’t hold banking charter—a license required to access liquidity directly from the central bank. So, how do they operate? They partner with licensed commercial banks and indirectly access the liquidity offered by the central banks.

To summarize this section, the Federal Reserve primarily provides liquidity to regulated financial institutions, such as commercial banks and licensed digital banks. Institutions like neo-banks or some credit unions that don’t hold banking charters i.e. license cannot directly interact with the Federal Reserve but instead rely on partnerships with licensed banks to access the liquidity.

Now that we have a basic understanding of the U.S. banking structure, you might wonder: what’s the easiest way to visualize the system architecture of a bank?  While there is no easy way to do this, I’ve tried to distill the software functions of a bank into 7 key pillars. 

System Architecture of Banks

To begin with, a bank is fundamentally a trust engine. It allows us to store, manage, and move capital in a safe and reliable manner. To do this at scale, modern banks rely on seven pillars, each serving a core purpose.

While I have outlined the details of each software pillar of a bank in the diagram above, I will now provide a brief overview of each.

1. Core Banking System: Think of this as the bank’s operating system. It keeps track of your accounts, loans, deposits, and every transaction you make, ensuring everything adds up. Without this, the bank is just a vault without a ledger, i.e., a record-keeping service.

2. Digital Banking Platform: This pillar represents how you interact with the bank—mobile apps, online banking, or ATMs. It ensures you can access your money and services anytime from any location, without stepping into a branch. The question is, how do you transfer money across accounts? That’s the function of the third pillar—PPS.

3. Payment Processing Systems (PPS): Every time you tap your card or send money abroad, this system quietly does the heavy lifting. It processes credit cards, transfers, real-time payments, and even cross-border transactions. What keeps this system secure? That’s where we need the fourth pillar.

4. Risk Management & Compliance Tools: This pillar symbolizes trust. It ensures that loans are given responsibly, fraudulent transactions are flagged and blocked, and regulations are followed. It’s the bank’s immune system, preventing risks from becoming existential threats. You might ask, "What happens if I lose access to my account? Whom do I contact?" That’s where the fifth pillar comes into play.

5. Customer Relationship Management (CRM): A bank is more than a transaction processor—it’s a business serving people. CRM is how banks manage customer relationships, offer personalized services, and address issues effectively. As the bank grows, so does its customer base. With more customers comes more data, and this data is managed by the next pillar. 

6. Data Analytics & Business Intelligence: Banks are data-rich institutions, and services mapped under this pillar help us turn raw data into actionable insights. Whether it’s predicting customer needs or optimizing operations, this is the brain that helps the bank think strategically and act decisively. You may ask, what about cyberattacks? That’s where the next software module comes into the picture.

7. Cybersecurity: Services mapped under this pillar protect the bank from external threats, encrypt data at rest and in transit, and ensure that trust—arguably the most valuable asset in banking—remains intact.

Now that we have a clear understanding of the 7 core components of banking software infrastructure, you might wonder: what are some of the core services that banks provide to individuals and businesses?

Key Functions of Banks

At their core, banks facilitate the flow of money, credit, and investments, making them the lifeblood of our economy. While banks offer a wide range of services, they generally fall into these four categories:

• Deposits: Checking and savings accounts.

• Lending: Personal loans, mortgages, and business loans.

• Payment services: Credit/debit cards, wire transfers, and auto. (ACH) payments.

• Investment services: Wealth management, brokerage, and financial advisory.

Now, the most challenging aspect of building, operating, and growing a bank is navigating regulations and managing the ledger. While ledger management warrants a separate discussion, for now, if you're building banking software, responsible for modernizing it, or a founder working with a bank, here are some key regulations you must understand when dealing with banks.

Core Regulations in Banking

Whether you're a technology partner working with banks or a consumer, understanding banking regulations is crucial for addressing the risks that fintechs and financial firms frequently encounter. While numerous regulatory bodies oversee banking operations, for the purpose of this post, I have condensed them into eight key entities, as illustrated in the diagram above. Also, to further simplify the regulations, there are three core areas that founders and technology partners working in this space should keep in mind.

Regulatory Areas

Regulations as we all know are designed to ensure financial stability, protect customers, and prevent misuse of the financial system. That being said, there are many out there and there is no easy way to condense them down.  But if we were on Mt. Everest and needed to break them down just to get our hands on an oxygen cylinder, here’s what I’d do: First, we’ll condense the regulatory ecosystem into three key components—regulatory bodies, deposit insurance, and AML (Anti-Money Laundering) and KYC (Know Your Customer) compliance protocols.

Regulatory Bodies: In the U.S., banks operate under the oversight of several key organizations. Here’s a brief overview of the core regulatory bodies:

• The FDIC (Federal Deposit Insurance Corporation) insures deposits up to $250,000, providing peace of mind to account holders.

• The Federal Reserve controls monetary policy and supervises the largest banks.

• The OCC (Office of the Comptroller of the Currency) regulates national banks.

• The CFPB (Consumer Financial Protection Bureau) safeguards consumer rights, ensuring transparency in services like loan approvals and credit cards.

• The SEC (Securities and Exchange Commission) oversees investment services and securities trading.

  
  

Insuring Deposits: This one is a slightly gray concept and is applicable in the right contexts. Let’s simplify it: imagine you deposit your hard-earned money into a bank, and something goes wrong with that bank. What happens to your money? That’s where deposit insurance comes in. In the U.S., the FDIC guarantees deposits up to $250,000 per account holder, ensuring that even if the bank fails, your money is protected. However, with the way banks and fintech companies operate today, there are additional considerations to keep in mind—but we'll save those details for another time.

AML and KYC Compliance: Have you ever wondered why banks request a lot of information when you open an account or why certain transactions trigger extra scrutiny? That’s because of AML (Anti-Money Laundering) and KYC (Know Your Customer) rules. These safeguards are there to ensure that banks can verify your identity, monitor transactions for unusual activity, and prevent fraudulent transactions.  While it's challenging to condense these concepts into a few key points, I have attempted to summarize the core principles of AML and KYC regulations in the following diagram.

For consumers, these regulations mean safer, more reliable banking services. For technology partners, understanding these regulatory frameworks is essential when building software systems to better manage operational and regulatory risks. In both cases, regulations ensure that trust—the foundation of the banking ecosystem—remains intact.

Summary

In summary, a bank is an institution built on trust. It exists because people believe their money is safe and that transactions facilitated by the bank are secure. However, banks today face significant risks. In 2024 alone, SWIFT—the global messaging system used to transmit payment details between banks—suffered a major outage, creating a ripple effect that disrupted the transaction systems of multiple banks for hours. Similarly, cyber breaches are on the rise. If that weren’t enough, poor ledger management is another critical risk, leading to liquidity crises among banks and fintechs.

When a bank fails—or when critical infrastructure like SWIFT experiences outages—the impact extends far beyond a single institution. It affects billions of consumers and millions of businesses worldwide.

This makes operational resilience non-negotiable.

Banks and fintechs are mission-critical systems since they enable the flow of capital—the very DNA of our economy. These systems must be designed with resilience and reliability at their core. To achieve this, it’s crucial to understand both the risks inherent in today’s banking and financial systems, as well as the emerging regulations that will have a profound impact on how we transfer capital on these financial rails for years to come.

Cheers,

Prathamesh

Disclaimer: This blog is for educational purposes only and does not constitute financial, business, or legal advice. The experiences shared are based on past events. All opinions expressed are those of the author and do not represent the views of any mentioned companies. Readers are solely responsible for conducting their own due diligence and should seek professional legal or financial advice tailored to their specific circumstances. The author and publisher make no representations or warranties regarding the accuracy of the content and expressly disclaim any liability for decisions made or actions taken based on this blog.