A banker's bank is a financial institution that exists to serve smaller banks. Generally, these are community banks that need access to the functions of larger institutions. In other words, this is a bank for bankers. They also may deal with credit unions.

How does this work, and what are the potential benefits to big and smaller banks that are involved with it? You should be aware of these three aspects of a banker's bank and its purpose.

Limited Scope of Customers

When the concept of a bank for bankers is expressed, it means that the entire scope of the operation is inherently limited. A banker's bank does not deal with everyday retail or even commercial customers outside of the financial world. It won't even do business with many larger banks and financial institutions because working with those parties is outside its scope.

Risk and Economies of Scale

Many smaller banks lack sufficient economies of scale to offer major services. For example, a community bank operating on its own probably doesn't have a large enough risk pool to safely handle many types of investment trades. It would also be hard for the community banks in smaller towns and cities to underwrite municipal bonds. Accessing federal funds is sometimes harder for small banks, too.

Suppose these institutions pooled their resources with a bank for bankers. The bigger bank has a larger risk pool, economies of scale, and flat-out access to bigger amounts of cash. It also will have an easier time getting funds from federal institutions, and it can distribute funds to the smaller members.

Lower Costs and Faster Services

Establishing an economy of scale ultimately drives down costs. If a small bank wants to offer second mortgages, for example, they face concerns about what happens if a few too many of them default. Consequently, such a bank operating in isolation would have to raise rates to ensure it's collecting a sufficient risk premium to make up for that possibility. This makes it harder to offer mortgages, and the ones the community bank does sell are going to be more expensive.

By pooling resources and risks with a banker's bank, smaller institutions can cut the cost of borrowing. Not only does this make things better for their customers, but it provides greater liquidity for the bank. That means the banks can clear transactions, including large ones, faster because there isn't as much risk attached to expediting the process.