Non-bank financial institutions provide financial services, but they don’t hold the same license or charter as a bank. Also referred to as non-bank financial companies or NBFCs, these entities can extend credit, provide investment services, cash checks, and exchange currencies. However, they generally can’t accept deposits from customers.
There are different types of non-bank financial institutions, and the way they’re structured can determine what services they provide. An NBFC can serve as a complement to traditional banking services or act as a competitor to licensed banks.
Here, you’ll learn more about these businesses, how they compare to banks, and their pros and cons.
What Are Non-Bank Financial Institutions?
Nonbanking financial institutions (NBFI) are institutions that don’t have a banking license but are able to facilitate certain types of financial services. They’re different from depository institutions, which can offer deposit accounts such as checking accounts, savings accounts, or money market accounts. An NBFI or NBFC is not licensed or equipped to accept deposits.
Non-bank financial institutions can specialize in niche financial services, including:
• Financial consulting
• Money transfers
• Risk pooling.
They can target a broad or narrow range of customers, which can include consumers, business owners, and corporate entities. Because they’re not licensed the same way that banks are, NBFCs are not subject to the same degree of government regulation and oversight.
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How Do NBFCs Work?
Now that you know NBFCs’ meaning, consider how these institutions work. In general, NBFCs work by providing financial services that are outside the scope of what traditional banking typically entails. There are different types of organizations that can bear the NBFC (or NBFI) label. The type of organization can determine how it works and what services it offers.
Here are some of the most common types of NBFCs:
• Investment companies
• Loan companies
• Companies that offer asset-based financing
• Micro-lending companies
• Risk pooling institutions.
In terms of regulation, NBFCs generally operate within the framework of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. However, the scope of regulation that extends to NBFCs and NBFIs is limited. For that reason, they’re sometimes referred to as “shadow banks” since they operate within the shadows of traditional banking institutions.
Pros and Cons of NBFCs
Non-bank financial institutions have both advantages and disadvantages. On one hand, they can play an important role in providing financial services outside the confines of traditional banking.
However, questions have been raised about the lack of oversight for NBFCs and what implications that might have for the individuals and businesses that use them.
Here are some of the main pros and cons of NBFCs at a glance.
|Pros of NBFCs||Cons of NBFCs|
|NBFCs can provide easier access to credit for individuals and businesses who need to borrow money.||NBFCs cannot provide certain banking services, including offering deposit accounts.|
|Investors may be able to find higher-yield through an NBFC or NBFI that isn’t offered at a bank.||Financial experts have argued that NBFCs and NBFIs can pose a systemic risk to the financial system as a whole.|
|NBFCs can offer alternative services to customers, such as check cashing, that may otherwise be inaccessible.||Operations are largely unregulated and there may be less transparency around NBFCs vs. traditional banks.|
Accountability is more of a question mark with non-bank financial companies since there’s less oversight overall. The increase in popularity of NBFCs has raised questions about the need for greater regulation of this section of the financial services industry.
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NBFCs vs Banks vs Fintech
You may wonder how NBFCs and NBFIs compare to banks and fintech companies. Here are some points to consider:
• Non-bank financial companies are not the same as banks, and they can also be differentiated from fintech. Again, a bank is a financial institution that holds a license or charter which allows it to accept deposits from its customers. Some banks may fall within the category of Community Development Financial Institutions (CDFIs), which help to promote access to capital and financial services in underserved areas.
• Fintech or financial technology is a term that describes the use of innovation to improve financial services and products. Fintech generally encompasses tools, apps, and other tech that can make managing money or borrowing it easier. There can be some overlap between NBFCs and fintech or between fintech and banks.
Which is better, an NBFC vs. a bank vs. fintech? There is no single answer as each one can fulfill different needs. Comparing them side by side can make it easier to distinguish between them.
|What It Is||An NBFC or non-bank financial company provides alternative financial services but does not hold a banking license.||Banks are financial institutions that hold a federal or state license or charter which allows them to accept deposits.||Fintech is a broad term that can refer to technological innovations that are applied within the financial services industry.|
|How It Works||NBFCs work by offering financial services (other than accepting deposits) to their customers, such as check cashing, investment services, or insurance.||Banks work by accepting deposits, lending money, and facilitating financial transactions. Some of the benefits of local banking include being able to open a checking account, apply for a mortgage, or pay bills online.||How fintech works can depend on its application. For example, budgeting apps can link to your checking account to track spending automatically. Robo-advisors make it easy to invest using an algorithm.|
|Whom It’s For||NBFCs may be right for individuals or businesses who are seeking services outside of traditional banking.||Banks are suited to people who want to be able to deposit funds, withdraw them on demand, or borrow money.||Fintech may appeal to people who want easier access to their finances online or via mobile apps.|
Examples of NBFCs
As mentioned, there are different types of NBFCs and NBFIs. If you’re looking for a specific non-banking financial institution example, the list may include:
• Life insurance companies
• Insurance companies that underwrite disability insurance policies
• Property insurance companies
• Mutual funds
• Pension funds
• Hedge funds
• Financial advisors and investment advisors
• Securities traders
• Mortgage companies
• Peer-to-peer lending companies
• Payday lenders
• Leasing or financing companies
• Companies that provide money transfer services
• Check cashing companies.
If you invest money, send money to friends and family via an app, or own a home, then chances are you’ve encountered an NBFC somewhere along the way. Examples of companies that may be classified as NBFC include LendingClub, Prosper, and Quicken Loans.
At the same time, you may also use traditional banking services if you have a checking account or savings account at a brick-and-mortar bank or an online bank.
NBFCs and the 2008 Financial Crash
The 2008 financial crash was fueled by a number of factors, including risky lending and investment practices. The resulting fallout included bank failures, banking bailouts, and a housing market crisis. Many of the companies that were engaging in these risky behaviors were NBFCs.
In 2010, the Dodd-Frank Act was passed to address some of the conditions that led to the crisis, including the lack of regulation and oversight as it pertained to NBFCs. The legislation made it possible for non-banking financial institutions to flourish, rather than whither away in the wake of the crisis.
Why? Simply because NBFCs continued to lend money at a time when traditional banks were placing greater restrictions on lending. While questions linger about the degree of regulation needed for NBFCs, their popularity has only increased since the financial crisis.
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Non-bank financial institutions can play a part in how you manage your money. For some people, they may provide financial services that make their lives easier. However, they are not regulated in the same way that licensed or chartered banks are. Also, if you want to be able to deposit money into your checking or savings account, then you can do that through a bank.
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How are NBFCs different banks?
NBFCs are different from banks because they do not hold a banking license or charter. While they can provide some of the same financial services as banks, they’re not equipped to accept deposits from customers.
What is the difference between fintech and NBFCs?
Fintech refers to the use of innovation and technology to improve financial products and expand access to financial services. An NBFC can use fintech in order to offer its products and services to its customers. For example, an investment company may offer robo-advisor services that operate on a fintech platform.
What are the disadvantages of NBFCs?
The main disadvantages of NBFCs include lack of government regulation and oversight, as well as their inability to offer deposit accounts. However, NBFCs can offer numerous advantages, including convenient access to credit and the potential to earn higher returns on investments.
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