Non-bank financial institution

7 July 2016

a) What are the categories of non bank financial institutions? b) Give similarities and differences between non banking financial institutions and commercial banks. INTRODUCTION A non-bank financial institution (NBFI) is a financial institution that does not have a full banking license. It can also be defined as a financial institution that is not supervised by a national or international banking regulatory agency. such institutions facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering.

NBFI can add to the health and stability of a financial system by making it complete, balanced and sophiscated. NBFIs supplement the role of commercial banks in providing financial services in the economy by serving the section of population generally not covered by banks, help improve the operational efficiency through enhanced competition in the market and improve the resilience of the financial system. NBFI also play a complementary role. They often borrow funds from banks and extend them as loans to their customers.

They also increase competition in the financial system. They compete with banks in deposit collection and loan advancements. NBFI play an important role in strengthening the economy of a country by providing many alternatives to transform an economy’s savings into capital investment. These institutions also introduce competition in the provision of financial service. Categories of non bank financial institutions. Depending upon their nature of activities, non- banking finance companies can be categorized into the following categories; a). Asset Finance Company (AFC):

An AFC is a company which is a financial institution that holds the principal in business of financing physical assets supporting productive/economic activity, such as automobiles, tractors, lathe machines, generator sets, earth moving and material handling equipments, moving on own power and general purpose industrial machines. b). Loan Company (LC): LC means any company which is a financial institution that has its main principal in business as provision of finance whether by making loans or advances or otherwise for any activity other than its own but does not include an Asset Finance Company.

c). Investment Company (IC): IC means any company involved in the business of shares, stocks, bonds, debentures issued by government and local authority that are marketable in nature. Example stock brokering companies like Nairobi stock exchange (NSE). d). Contractual savings institutions (CIV) Contractual savings institutions (also called institutional investors) give individuals the opportunity to invest in collective investment vehicles (CIV) as a fiduciary rather than a principal role.

Collective investment vehicles pool resources from individuals and firms into various financial instruments including equity, debt, and derivatives. Note that the individual holds equity in the CIV itself rather what the CIV invests in specifically. The two most popular examples of contractual savings institutions are pension funds and mutual funds. e). Risk-pooling institutions Insurance companies underwrite economic risks associated with illness, death, damage and other risks of loss. In return to collecting an insurance premium, insurance companies provide a contingent promise of economic protection in the case of loss.

There are two main types of insurance companies: general insurance and life insurance. General insurance tends to be short term, while life insurance is a longer-term contract, which terminates at the death of the insured. Both types of insurance, life and general, are available to all sectors of the community. f). Financial service providers Financial service providers include brokers (both securities and mortgage), management consultants, and financial advisors, and they operate on a fee-for-service basis.

Their services include: improving informational efficiency for the investors and, in the case of brokers, offering a transactions service by which an investor can liquidate existing assets. g). Market makers Market makers are broker-dealer institutions that quote a buy and sell price and facilitate transactions for financial assets. Such assets include equities, government and corporate debt, derivatives, and foreign currencies. After receiving an order, the market maker immediately sells from its inventory or makes a purchase to offset the loss in inventory.

The differential between the buying and selling quotes, or the bid–offer spread, is how the market-maker makes profit. A major contribution of the market makers is improving the liquidity of financial assets in the market. Similarities between non bank financial institutions and commercial banks The key similarity 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 (including cash deposits) but are not entitled to offer a savings 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.

Differences between non bank financial institutions and commercial banks . (i) Banks generally deals with short-term loans in the money market, whereas the nonbank intermediaries mostly deal with all types of loans i. e short-term, medium-term and long-term loans. (ii) The credit creation activities of the commercial banks are determined by the excess reserves and the cash-reserve ratio of the banks. The activities of the non-bank intermediaries (i. e. , saving mobilization, lending activities, etc. ) are largely governed by the structure of interest rates.

(iii) Commercial banks raise funds costless because no interest is paid on demand deposits. Nonbank intermediaries, on the other hand, have to pay higher interest to attract more funds. (iv) The credit creation activities of the commercial banks are regulated and controlled by the central bank. The nonbank intermediaries are not generally under the control of central bank, and thus, then1 activities may create hurdles in the way of effective implementation of monetary policy. (v) Banks are financial institution whose liabilities (i. e.

, deposits) are widely accepted as a means of payment in the settlement of debt. Non-bank financial intermediaries, on the other hand, are those institutions whose liabilities are not accepted as means of payment for the settlement of debt. (vi) People deposit money in the banks for safety, convenience and liquidity considerations. However, they invest their savings in the nonbank intermediaries with the motive of earning extra income. (vii) Commercial banks have the ability to generate multiple expansion of credit. The non-bank inter­mediaries do not have such ability.

They simply mobilize savings for investment (viii) Nonbank intermediaries can influence liquidity and create economic destabilization in the economy. Destabilization occurs when the financial claims on the nonbank intermediaries increase at the cost of demand deposits of the banks. (ix) Credit creation activities of the banks involve lesser time, while the lending activities of the non-bank intermediaries involve longer time. (x) Banks form a homogeneous group, while nonbank intermediaries form a heterogeneous group in the financial structure of the economy.

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