Financial institutions such as banks, insurance companies and pension funds are also known as ‘Financial Intermediaries’. They dominate the financial scene all around the globe. It is virtually impossible to spend or save or lend or invest money nowadays without getting involved with some kind of financial intermediary in one way or another. Although all have similar functions, yet they are different. They are as follow…
Banks versus Non-Banks – A Brief Comparison
A sharp distinction has been drawn between the commercial banks, on one hand, and all other financial institutions on the other, such as life insurance companies, property and casualty insurance companies, savings and loans associations, credit unions, mutual saving banks, mutual funds, and other types of nonbank financial institutions.
-Banks: according to Li and Kim (1987), “Banks facilitate trade and commerce by providing:
safekeeping for cash deposited in the current, savings and fixed deposit accounts
a convenient and a safe means of making payments through the current account, or by way of bank drafts, bank transfers and bills of exchange;
Finance in the form of loans, overdrafts or discounted bills of exchange;
Advice on financial investments or on the credit-worthiness of customers, local or abroad”.
There are three types of Bank; Central Bank, Commercial Banks, and also Merchant Banks. The three will be described as the following…
The Central Bank controls the operation of the whole banking system in a country and carries out its monetary policy. Its chief functions are to issue, control and regulate the supply of money in the country; to act as a banker and financial adviser to the government; to act as banker to commercial banks; and to promote monetary stability and a sound financial structure in the country. Some examples of Central Bank are Bank Indonesia, Bank Negara (Malaysia), and while in Singapore, the Monetary Authority of Singapore.
These banks are privately-owned, profit-seeking financial institutions. According to Ritter and Silber (1989), commercial banks are the most prominent of all financial institutions. These banks are also the most widely diversified in terms of both liabilities and assets. Their major source of funds used to be demand deposits (checking accounts), but today, savings and time deposits (including certificates of deposit) have become more valuable. With these funds, such banks buy a wide variety of assets, ranging from short-term government securities to long-term business loans as well as home mortgages. The services include accepting deposits, providing a convenient means of making payments, lending to customers, as well as providing other services. Examples of Commercial Banks are Citibank, Hong Kong and Shanghai Banking Corporation, Bank Bumiputra and Malayan Banking.
Merchant banks are specialized financial institutions which complement and supplement the activities and services already offered by existing financial institutions. These banks deal mainly in medium and long-term finance for large corporations; they also provide financial services that are not provided by other existing financial institutions. Examples are Malaysian International Merchant Bankers, Merchant Bankers Malaysia, etc.
After the types of banks above, along with their descriptions, let’s now turn to individual financial institutions. These institutions functions almost the same like normal banks; they are into investments and lending. However, like other institutions, they have their own rules in doing their financing businesses.
Savings and Loan Associations (S & Ls)
Before, Savings and Loan Associations (S & Ls)’s original purpose is to encourage family thrift and home ownerships, by offering mortgage loans services. These institutions have been growing rapidly since the past few decades, especially in the 1950s and 1960s where they grew more rapidly than commercial banks. These associations, as said by Mishkin (2003), obtain funds primarily through savings deposits, also known as shares, as well as time and checkable deposits. Today, they are subject to the same requirements just like commercial banks, in terms of deposits. Also, the line that separates such associations and commercial banks has become indistinct lately, and hence, has been competitive.
Life Insurance Companies
Life insurance companies, such as Prudential or Manulife Insurance Companies, and even VIG, have been a popular choice for people to invest their money. It has been a doubled benefits way of investing or saving money, we are not only saving our money, but also have our lives insured. This is especially for those who are affordable, usually Middle to Upper classes. It’s beneficial because a life insurance guarantees the payment of the agreed sum of money during a person’s death, although that person has to pay yearly premiums for the agreed life years within specific age requirements. This is profitable because the person will get interests, which usually is high enough.
Pension and Retirement Funds
According to Kamerschen (1984), pension funds hold their assets in the form of corporate stocks, although some other long-term claims, such as real
estate, corporate bonds, government obligations, and many others are held. Such funds are usually for those into retirement and pension age, also, these retirement funds are normally chosen as a source of investment with the objective of secured and guaranteed retirement life.
Property and Casualty Insurance Company
Such insurance companies usually specialize in many kinds of insurance coverages, from wind and fire insurance, to burglary and health insurance. These companies source of funds are premiums paid by policyholders. According to McCarty (1982), property and casualty insurance companies differ from life insurance companies … they deal with smaller claims and smaller premiums than a life insurance company, they have less to invest in large, long-term mortgages … property and casualty companies invest primarily in more liquid, short-term securities”. Common examples are car insurance, fire insurance, and many others.
Sales and Consumer Finance Companies
Finance companies raise funds by “both short- and long-term borrowing. Short-term borrowing is done both through banks and by sale of open-market paper (commercial paper)”, (Cooper and Fraser, 1983). However, small finance companies tend to rely more on bank credits, but larger finance companies usually depend almost entirely on commercial papers for their short-term funds. Here, the investments are primarily in consumer credits and loans to businesses. Today, these firms have been increasingly involved in both business and consumer credits.
Credit unions, as said by Zimmerer and Scarborough (2002), nonprofit financial cooperatives that promote saving and provide loans to their members, are best known for making consumer and car loans. However, they don’t just make loans for anyone; a person, in order to qualify for a loan, must be a member. Credit unions also perform similar lending practices just like banks, but usually for small amount of loan.
These financial intermediaries obtain finances by selling shares to people and use the earnings to purchase diversified portfolios of stocks and bond. Its profitable as it allows buyers to pool their resources in order to take advantage of lower cost transactions when buying huge stocks or bonds. According to Mishkin (2003), mutual funds allow shareholders to hold more diversified portfolios. Another advantage of holding mutual funds is that the buyer is able to sell his share anytime, although the rate will be determined by the securities holdings.
Money Market Mutual Funds
According to Kamerschen (1984), these funds enable a wide variety of savers and investors to put money in money market instruments, such as Treasury bills and bank-negotiable certificates of deposit. These funds have grown out of a variety of past interest rate regulations that favored large savers”. Basically, they pool the funds of many smaller savers, and then utilize the funds to purchase higher yielding of larger denomination obligations.
Stock Brokerage Houses
Usually, the lending activities here are performed by stockbrokers. These people usually offer loans to their customers at lower interest rates than banks, or also known as margin loan. The lower rate is because these stockbrokers are being supported by collaterals, such as the stocks and bonds in the customer’s portfolio and also, such collaterals are of high quality and highly liquid.