American Banking

Non-Bank Financial Institutions

A non-bank financial institution offers customers bank-related services such as payday lending, cashier’s checks, and check cashing.

Learning Objectives

Describe the services offered by non-bank financial institutions

Key Takeaways

Key Points

  • Non-bank financial institutions such as payday lenders will offer consumers relatively small-dollar, short-term, cash loans at a high interest rate.
  • While the nature of the loans offered by non-bank financial institutions are not ideal for financing a major purchase like a home or an automobile, they serve as a crucial last resort for those facing an emergency.
  • Financial services are equally important in protecting against the unforeseen consequences of natural disasters, war, illness, incapacity or death of a breadwinner, and other crises.

Key Terms

  • currency: Money or other items used to facilitate transactions.
  • non-bank financial institution: A financial institution that does not have a full banking license or one that is not supervised by a national or international banking regulatory agency.

Services from Non-Bank Financial Institutions

A non-bank financial institution (NBFI) is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFIs facilitate bank-related financial services, such as investments, risk pooling, contractual savings, and market brokering. Examples of these include insurance firms, pawn shops, cashier’s check issuers, check cashing locations, payday lending, currency exchanges, and microloan organizations. Alan Greenspan has identified the role of NBFIs in strengthening an economy, as they provide “multiple alternatives to transform an economy’s savings into capital investment which act as backup facilities should the primary form of intermediation fail. ”

Financial services are equally important in protecting against the unforeseen consequences of natural disasters, war, illness, incapacity or death of a breadwinner, and other crises. With financial services, poor families can send their children to school, buy medicine, and get through lean times when cash and food are scarce. Despite the importance of financial services for both poverty reduction and equitable economic growth, experts estimate that only five percent of low-income households around the world have access to such services. The international development community, with a vision it calls “financial sector deepening,” is promoting the extension of diverse financial services by a wide range of bank and non-bank financial institutions to ever larger numbers of low-income and middle-class households around the world.

High-Cost Loans

You have probably seen ads for check-cashing stores, payday loans, and rent-to-own stores. You may be intrigued by the services they offer. But these short-term financial fixes can cost you big bucks because they are ostensibly high-cost loans. Make sure you understand what you’re agreeing to and can afford to pay back your loan before you sign any documents. Consider your options to taking a high-cost loan and use loans wisely.

Check-Cashing Establishments

If you don’t have a checking or savings account, you might think check-cashing stores are a convenient alternative. Understand, however, check-cashing stores charge you for that convenience. Many check-cashing stores charge a fee of $4 for every $100 on a payroll check. That means if you have a $700 payroll check, you’re paying $28 just to cash it. For $28 you might be able to fill your car with gas or buy groceries. For personal checks, these establishments charge even more.

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Mural: Checks Cashed: Check-cashing institution on Haight Street, San Francisco, California

Payday Lenders

Many check-cashing stores also make payday loans. A payday loan is a small, high-interest, short-term cash loan. In most cases, you write a post-dated, personal check for the advance amount, plus a fee. The payday lender holds the check for the loan period and then deposits it, or you return with cash to reclaim the check. Although a payday loan may be a convenient short-term solution, it is not a good idea for long-term cash needs. You run the risk of getting into a payday loan cycle of debt by taking out loan after loan

Commercial Banks

Commercial banks enable business by providing access to resources and risk-mitigating exchanges.

Learning Objectives

Perceive the role of commercial banks from the business sense, and recognize the variety of risks banks encounter as a result

Key Takeaways

Key Points

  • Commercial banks offer consumers the ability to conduct most of their financial business through a single institution.
  • Recently, the U.S. banking industry has become more commercial. Commercial banks generally deal with mid-sized to larger businesses, though due to high consolidation in the industry, they also offer various retail services.
  • By enabling the exchange of capital and currency on a global scale via various investment mediums, commercial banks enable businesses with valuable resources.
  • While banks offer a wide range of services, the primary service a bank offers revolves around exchanging various capital assets to access funding and mitigate risks.
  • Banks themselves must combat a variety of risks themselves, as they are essentially in the business of taking strategic risks. These risks come in a variety of forms.
  • The 2008 economic collapse is a strong example of how commercial banks impact the broader economy, and the potential repercussions of failing to manage risk.

Key Terms

  • Risk management: Offsetting potential financial exposures through strategic investments.

Commercial banks are financial institutions that focus on enabling the exchange of capital and currency via a variety of services. For the most part, the term commercial bank refers to divisions of banks that deal primarily with mid-sized to large businesses.

Banking Commercially

When considering commercial banks, it’s useful to understand that they act as an outlet for strategic financial decisions for businesses to offset certain risks, procure resources, invest, and store assets. These services generally include the following:

  • Enabling bank accounts, used to store, exchange, send, and receive capital electronically (generally via the internet)
  • Providing loans and other lending services, at established rates of interest
  • Safekeeping of documents and valuables via safe deposit boxes
  • Enabling the purchase of a wide variety of investment options
  • Risk management (i.e. foreign exchange risks, interest rates, hedging commodities, derivatives)
  • Project financing
  • Raising capital (i.e. IPOs and other forms of commercial capital raising)

While banks offer other services in addition to these, the primary function of commercial banks is to act as a critical resource for businesses to access capital, enable investments, and mitigate risks.

Banking Risks and Economic Issues

Banking is, in many ways, in the business of risk. It is in measuring these risks that banks determine their interest rates and fees. There are a few types of risks banks encounter, which are useful in understanding how banks function:

  • Credit Risk – Risk that a borrower may not return the entirety of the payment owed.
  • Liquidity Risk – Risk that an acquired asset cannot be traded quickly enough to capture profit.
  • Market Risk – Virtually any capital asset has a market, and is therefore subjected to the risks of it’s respective market.
  • Operational Risk – Risk that an operational issue will diminish returns.
  • Reputation Risk – Risk that a company’s trustworthiness will decline.
  • Macroeconomic Risk – Risk that the broader economy will decline.

The economic collapse in 2008, partly as a result of banks failing to accurately identify and ethically respond to risk, is a strong example of the consequences of banking failures.

This image shows the continued consolidation of the banking industry, by illustrating the overall concentration of the entire market held by the biggest 5 banks.

Percent of Industry Assets Owned by the Largest 5 Banks: This image demonstrated the ongoing consolidation of the banking industry, through displaying the overall assets owned by the largest 5 banks.

Savings and Loan Associations (S&Ls)

A savings and loan association is a special kind of deposit institution that only participates in a subsection of financial activities.

Learning Objectives

Define a savings and loan association, and its role in the American banking system

Key Takeaways

Key Points

  • A savings and loan association primarily earns income by lending the deposits held at their institution by other members.
  • Savings and loan associations tend to be smaller and less complex than commercial banks.
  • Savings and loan associations and cooperative banks were established during the 1800s to help factory workers and other wage earners become homeowners.

Key Terms

  • credit union: A financial cooperative similar to a bank but owned and controlled by its members, often restricted to a local area or sometimes to a single profession.
  • savings and loan association: A financial institution that specializes in accepting savings deposits and making mortgage and other loans.

A savings and loan association (or S&L), also known as a thrift, is a financial institution that specializes in accepting savings deposits and making mortgage and other loans. The terms “S&L” or “thrift” are mainly used in the United States; similar institutions in the United Kingdom, Ireland, and some Commonwealth countries include building societies and trustee savings banks. They are often mutually held (often called mutual savings banks), meaning that the depositors and borrowers are members with voting rights, and have the ability to direct the financial and managerial goals of the organization like the members of a credit union or the policyholders of a mutual insurance company. While it is possible for an S&L to be a joint stock company, and even publicly traded, in such instances it is no longer truly a mutual association, and depositors and borrowers no longer have membership rights and managerial control. By law, thrifts must have at least 65% of their lending in mortgages and other consumer loans, making them particularly vulnerable to housing downturns, such as the deep one the United States has experienced since 2007.

Savings and loan associations and cooperative banks were established during the 1800s to help factory workers and other wage earners become homeowners. S&Ls accepted savings deposits and used the money to make loans to home buyers. Most of the loans went to people who did not make enough money to be welcomed at traditional banks.

The savings and loan association became a strong force in the early twentieth century through assisting people with home ownership, through mortgage lending, and further assisting their members with basic saving and investing outlets, typically through passbook savings accounts and term certificates of deposit.

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Banking district in China: All three note-issuing banks are in this shot: Bank of China, HSBC (Hongkong and Shanghai Banking Corporation), and Standard Chartered Bank.

Credit Unions

Credit unions offer local communities unique banking benefits by empowering local ownership and reinvesting in the community.

Learning Objectives

Assess the value of credit unions, particularly compared to big banks and an understanding of risk

Key Takeaways

Key Points

  • Credit unions act as a substitute to traditional larger banks, focusing on providing local communities full ownership, voting rights, and funding through their emphasis on people rather than profits.
  • There are a variety of benefits when choosing a credit union instead of a bank, primarily revolving around supporting the community, minimizing risk, and achieving lower rates.
  • Credit unions also come with their fair share of downsides, most notably easy global accessibility, the benefits of scale, and access to riskier investment options.
  • When making a banking decision, consumers must carefully consider the pros and cons of credit unions before making a decision.

Key Terms

  • mitigating risk: Reducing the potential for losing capital, as well as gaining larger returns, through investing in more volatile options.
  • Credit unions: Cooperative banking institutions focused more on people and community, as opposed to profitability and global scale.

Not A Bank

Credit unions are substitutes and competitors of banks, owned by members as a financial cooperative. As a result, credit unions tend to be smaller forms of cooperative banks that avoid borrowing, and operate solely upon the funding and liquidity enabled by the resources deposited by members.

The primary difference between a credit union and a bank from an operational perspective is best described via the decision-making system. The board of directors for a credit union is traditionally elected through a vote of all existing members, where each member gets one vote (regardless of the amount of capital one has invested). Credit unions pride themselves on being community-oriented, deliberately mitigating risk and serving people as opposed to pursuing profit.

The Pros and Cons

There are a variety of valid reasons to support credit unions, as well as a few downsides consumers should also be aware of:

The Good

  • Credit unions commit resources to the local community.
  • Credit unions usually offer better rates on deposits and lower costs for loans
  • Credit unions offer access to borrowing options not always available at traditional banks
  • Credit unions provide more personalized service
  • Credit unions increase competition (big banks tend to be oligopolies, while credit unions are intrinsically smaller in scale, thus high in quantity)

The Risks

  • Credit unions are usually region specific, so traveling can have some complexities in terms of support
  • Credit unions are smaller, and therefore more likely to go out of business
  • Credit unions are more vulnerable to risk, and thus may not be as willing as larger banks to lend money without confidence in repayment

While there are many considerations to be made when deciding on a banking option, credit unions are uniquely positioned to offset the downsides of big banks through avoiding risk while focusing on local needs. Big banks add advantage through scale (along with risk), providing more investment opportunities and global access to capital.