LECTURE 4
FINANCIAL INSTITUTIONS
Banks[1]
A bank is a financial institution licensed to receive deposits and make loans. Banks may also provide financial services such as wealth management, currency exchange, and safe deposit boxes. There are several different kinds of banks, including retail banks, commercial or corporate banks, and investment banks. In most countries, banks are regulated by the national government or central bank.
Banks are essential to the economy because they provide vital services for consumers and businesses. As financial services providers, they give you a safe place to store your cash. Through various account types, such as checking and savings accounts and certificates of deposit (CDs), you can conduct routine banking transactions like deposits, withdrawals, check writing, and bill payments. You can also save your money and earn interest on your investment.
Banks also provide credit opportunities for people and corporations. The bank lends the money you deposit at the bank—short-term cash—to others for long-term debt such as car loans, credit cards, mortgages, and other debt vehicles. This process helps create liquidity in the market—which makes money and keeps the supply going.
Like any other business, the goal of a bank is to earn a profit for its owners. For most banks, the owners are their shareholders. Banks do this by charging more interest on the loans and other debt they issue to borrowers than what they pay to people who use their savings vehicles. For example, a bank that pays 1% interest on savings accounts and charges 6% interest for loans earns a gross profit of 5% for its owners.
Non-Banking Financial Institutions[2]
A non-banking financial institution (NBFI) is a financial institution that does not have a full banking license and cannot accept deposits from the public. However, NBFIs facilitate alternative financial services, such as investment (collective and individual), risk pooling, financial consulting, brokering, money transmission, and check cashing. NBFIs are a source of consumer credit (along with licensed banks). Examples of non-bank financial institutions include insurance firms, venture capitalists, currency exchanges, some microloan organizations, and pawn shops. These non-bank financial institutions provide services that are not necessarily suited to banks, serve as competition to banks, and specialize in sectors or groups.
INSURANCE COMPANIES[3]
The insurance sector is made up of companies that offer risk management in the form of insurance contracts. The basic concept of insurance is that one party, the insurer, will guarantee payment for an uncertain future event. Meanwhile, another party, the insured or the policyholder, pays a smaller premium to the insurer in exchange for that protection on that uncertain future occurrence.
Types of Insurance Companies
Not all insurance companies offer the same products or cater to the same customer base. Among the largest categories of insurance companies are accident and health insurers, property and casualty insurers, and financial guarantors. The most common personal insurance policies are auto, health, homeowners, and life.
Life insurance companies mainly issue policies that pay a death benefit as a lump sum upon the death of the insured to their beneficiaries. Life insurance policies may be sold as term life, which is less expensive and expires at the end of the term, or permanent (typically whole life or universal life), which is more expensive but lasts a lifetime and carries a cash accumulation component. Life insurers may also sell long-term disability policies that replace the insured’s income if they become sick or disabled.
Businesses require special insurance policies that insure against specific risks faced by a particular business. For example, a fast-food restaurant needs a policy that covers damage or injury resulting from cooking with a deep fryer. An auto dealer is not subject to this type of risk but does require coverage for damage or injury that could occur during test drives.
Some companies engage in reinsurance to reduce risk. Reinsurance is insurance that insurance companies buy to protect themselves from excessive losses due to high exposure. Reinsurance is an integral component of insurance companies’ efforts to keep themselves solvent and avoid default due to payouts, and regulators mandate it for companies of a specific size and type.
For example, an insurance company may write too much hurricane insurance based on models that show low chances of a hurricane inflicting a geographic area. If the inconceivable did happen with a hurricane hitting that region, considerable losses for the insurance company could ensue. Without reinsurance taking some of the risks off the table, insurance companies could go out of business whenever a natural disaster hit.
Types of Insurance Companies in India
1. Life insurance companies: Life insurance is a contract between an insurer and a policy owner. A life insurance policy guarantees the insurer pays a sum of money to named beneficiaries when the insured dies in exchange for the premiums paid by the policyholder during their lifetime. To enforce the contract, the life insurance application must accurately disclose the insured’s past and current health conditions and high-risk activities.[4]
2. General insurance companies:
Definition: Insurance contracts that do not come under life insurance are called general insurance. The different forms of general insurance are fire, marine, motor, accident and other miscellaneous non-life insurance.
Description: The tangible assets are susceptible to damages, and a need to protect the economic value of the assets is needed. For this purpose, general insurance products are bought as they provide protection against unforeseeable contingencies like damage and loss of the asset. Like life insurance, general insurance products come at a price in the form of a premium.
[1] https://www.investopedia.com/terms/b/bank.asp
[2] https://www.worldbank.org/en/publication/gfdr/gfdr-2016/background/nonbank-financial-institution
[3] https://www.investopedia.com/ask/answers/051915/how-does-insurance-sector-work.asp
Academician 