“Discuss the banking and non-banking companies or financial institutions;”
INTRODUCTION
All banks are financial institutions; yet, all financial institutions are not considered to be banks. After thorough research, which shall be reflected in the following work, the title statement can be accepted as correct. However, to deeply realize why, it is important to understand what financial institutions are considered to be. A financial institution is any organization in the business of moving, investing or lending money, dealing in financial instruments or providing financial services. It includes commercial banks, thrifts, federal and state savings banks, savings and loan associations and credit unions. It refers to any bank, credit unions or any other entity that distribute cash. Financial institutions are divided into two categories – depository and non-depository. Depository institutions are those that offer deposit accounts, such as commercial banks, savings associations and mutual savings banks, and credit unions. Non-depository institutions include life insurance companies, finance companies, and mutual funds.
FINANCIAL INSTITUTIONS
“Banking is a financial institution but all financial institutions are not banks” A financial institute is an establishment that focuses on dealing with financial transactions, such as investments, loans and deposits. Conventionally, financial institutions are composed of organizations such as banks, trust companies, insurance companies and investment dealers. Everything from depositing money to taking out loans and exchange currencies must be done through financial institutions. Financial institutions provide service as intermediaries of financial markets. They are responsible for transferring funds from investors to companies in need of those funds. Financial institutions facilitate the flow of money through the economy. To do so, savings are brought to provide funds for loans.
BANKS
We have determined, in the introductory part of this paper, that “Banking is a financial institution” – rather, a depository financial institution. To understand banking in its simplest form, it is important to understand how different types of banks work worldwide. A bank is a financial institution licensed as a receiver of deposits. There are two types of banks: commercial/retail banks and investment banks. In most countries, banks are regulated by the national government or central bank. Commercial banks are mainly concerned with managing withdrawals and deposits as well as supplying short-term loans to individuals and small businesses.
Consumers primarily use these banks for basic checking and savings accounts, certificates of deposit and sometimes for home mortgages. Investment banks focus on providing services such as underwriting and corporate reorganization to institutional clients. While many banks have both brick-and-mortar and online presence, some banks have only an online presence. Online-only banks often offer consumers higher interest rates and lower fees. Convenience, interest rates and fees are the driving factors in consumers’ decisions of which bank to do business with. As an alternative to banks, consumers can opt to use a credit union.
The primary source of funds to a bank is customer deposits. Deposits can be categorized as demand deposits (checking accounts), time deposits (certificates), or savings deposits. Banks obtain a relatively large amount of funding from demand deposits because of their business customers. Banks also use borrowed funds to supplement their deposit base to a larger degree than credit unions. Bank loan portfolios contain consumer loans but also typically contain a great deal of business lending. The types of business loans made by banks vary by the size and location of the bank, with some more prominent in agricultural loans, others in real estate development or commercial property loans, and others in operating loans for businesses.
OTHER FINANCIAL INSTITUTIONS:
Definitely banks are a major subset of the universe of financial institutions. We have acknowledged that banks are deposit-taking institutions that accept and manage deposits and make loans. However there are other institutions that do the same. For example,
- Building societies
- Savings and loan associations
- Mutual savings bank
- Credit unions
- Trust companies
Among the non-depository financial institutions, the major ones are
- Insurance companies
- Pension funds
- Finance companies
Just for a clear conception, these financial institutions are discussed briefly here.
BUILDING SOCIETY
Building society is a cooperative whose members pool their resources in order to offer financial and lending services, such as mortgages. It is similar to a bank or credit union. Building societies emerged in the U.K. during the 19th century, and are similar to savings and loans institutions in the United States.
In the United Kingdom, a depository institution that is primarily involved in accepting retail deposits and granting residential mortgages; deregulation during the 1980s broadened the scope of permissible activities to include commercial banking business and derivatives dealing, but many continue to focus on the core mortgage credit sector. While most building societies were originally formed as mutual organizations, many have gone through demutualization and converted to public corporations.
SAVING AND LOAN ASSOCIATION
Saving and loan association is a deposit-gathering financial institution that is primarily engaged in making loans on real estate. Although many Savings and loan associations are owned by their depositors, some are organized as profit-making institutions with stock that is publicly traded.
Members of a savings and loan association are stockholders of the corporation. The members must have the capacity to enter into a valid contract, and as stockholders they are entitled to participate in management and share in the profits. Members have the same liability as stockholders of other corporations, which mean that they are liable only for the amount of their stock interest and are not personally liable for the association’s negligence or debts.
MUTUAL SAVING BANK
Mutual saving bank is a type of thrift institution, originally designed to serve low-income individuals that historically invested in long-term, fixed-rate assets such as mortgages. These are the savings institutions that issue no stock and are mutually owned by their investors who are paid dividends on earnings and profit. Savings Bank organized under state charter for the ownership and benefit of its depositors. A local board of trustees makes major decisions as fiduciaries, independently of the legal owners. Traditionally, income is distributed to depositors after expenses are deducted and reserve funds are set aside as required. In recent times, many mutual savings banks have begun to issue stock and offer consumer services such as credit cards and checking accounts, as well as commercial services such as corporate checking accounts and commercial real estate loans.
CREDIT UNIONS
A non-profit financial institution is owned and operated entirely by its members. Credit unions provide financial services for their members, including savings and lending. Large organizations and companies may organize credit unions for their members and employees, respectively. To join a credit union, a person must ordinarily belong to a participating organization, such as a college alumni association or labor union. When a person deposits money in a credit union, he/she becomes a member of the union because the deposit is considered partial ownership in the credit union.
TRUST COMPANIES
Trust companies are business organized specifically for entering into fiduciary relationships with individuals and organization to as act as an executor, guardian, or trustee in administration of custodial arrangements, estates, and trust funds. Trust companies also act as fiscal agents and paying agents for corporations and governments who have issued bonds and provide services such as estate planning, stock registration, share transfer, etc. A trust company does not own the assets its customers assign to its management, but it may assume some legal obligation to take care of assets on behalf of other parties. It is called Trust Corporation in the UK.
INSURANCE COMPANY
To know about insurance companies we must have a clear idea of what insurance is. Insurance is a promise of compensation for specific potential future losses in exchange for a periodic payment. Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Some forms of insurance are required by law, while others are optional. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event. A company that offers insurance policies to the public, either by selling directly to an individual or through another source such as an employee’s benefit plan. An insurance company is usually comprised of multiple insurance agents. An insurance company can specialize in one type of insurance, such as life insurance, health insurance, or auto insurance, or offer multiple types of insurance.[1]
PENSION FUNDS
A pension fund is an entity set up to collect money from employer(s) and workers, invest the proceeds in securities and other assets, and pay benefits to retirees from the fund’s accumulated resources. A pension fund ordinarily has an investment policy statement that describes the nature of the assets in which the pension fund can invest. Traditionally, the investment plan of a pension fund has been quite conservative, sometimes limiting its investment vehicles to government bonds or life insurance annuities. In recent decades, the average pension fund has assumed a more aggressive investment posture to achieve the higher returns required by its obligations. The pension fund is a common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years and commence retirement.
FINANCE COMPANIES
Finance company is an organization that originates loans for both businesses and consumers. Much like a bank, a typical finance company acts as a lending entity by extending credit. However, the main difference between a bank and a finance company is that, unlike a bank, a finance company does not accept deposits from the public. Instead, a finance company may draw funding from banks and various other money market resources. A finance company may extend credit to individuals for various consumer purchases, as well as to corporations for commercial use. A finance company may also specialize in providing financing for a variety of installment plan sales. A finance company may also be affiliated with a manufacturing firm or a holding company.
Generally, finance companies fall into three categories:
(1) Consumer finance companies, also known as small loan or direct loan companies, lend money to individuals under the small loan laws of the individual U.S. states.
(2) Sales finance companies, also called acceptance companies, purchase retail and wholesale paper from automobile and other consumer and capital goods dealers.
(3) Commercial finance companies, also called commercial credit companies, make loans to manufacturers and wholesalers; these loans are secured by accounts receivable, inventories, and equipment.
Finance companies typically enjoy high credit ratings and are thus able to borrow at the lowest market rates, enabling them to make loans at rates not much higher than banks.
CONCLUSION
Financial institutes play an important role in any economy because all the financial dealings and matters are handled and monitored by such institutes.
Though all the financial institutes (Bank or Non-bank) have a common role to play in the country’s economy, there is a significant difference between the banking and non-banking sectors. The banking sectors include commercial banks including private banks, public sector banks, and foreign banks that are mainly responsible for ensuring fiscal stability in the country. On the other hand, the non-banking sector includes all the other components like credit card agencies, investment companies, and insurance companies that are responsible to regulate and monitor lending as well as borrowing of funds.
The key difference between banks and other financial institutes is the facility of cash deposits. This unique facility is provided by the banking sector to all its customers through means of saving accounts and current accounts. This is an easy and effective way of handling all the personal as well as business finances. Apart from this, banks also serve as financial intermediaries offering a host of financial services to all customers.
Non-banking financial institutes do provide various types of financial services but are not entitled to offer a saving account. These institutes mainly serve as investment tools or to fulfill the financial needs of individuals and companies. However, in the present day, banks are gradually expanding their operations and are offering all financial services including investment, loan, credit, and bonds under one shelter.
Therefore, we can come to a clear conclusion that a bank has all the specifications that are needed to be a financial institution hence banking is a financial institution but financial intuitions are not confined to banks only rather there is a lot more that financial institutions perform in the economy.
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[1] This discussion is adapted from Mehr and Camack “Principles of Insurance”, 6th edition, 1976, pp 34 – 37.