Top 10 Functions of Non Banking Financial Institutions
As per Alan Greenspan, NBFIs have an important role in any economy as they provide alternative means to transform savings into capital investment. Non Banking Financial Institutions act as backup facilities in case banking intermediaries fail to support the people within economy.
Let us learn about non banking financial intermediaries in detail.
Table of Contents
- What is a Non-Banking Financial Institution?
- Types of Non Banking Financial Institutions
- Characteristics of Non-Banking Financial Institutions
- Functions of Non Banking Financial Intermediaries
What is a Non-Banking Financial Institution?
A non-banking financial institution (NBFI) is also known as non banking financial company or Non Banking Financial Corporation (NBFC). It is a financial entity that operates without a complete banking license. It is not supervised by any national or international banking regulatory agency.
These financial institutions offer bank-related financial services including risk pooling, investing, contractual savings, and market brokering. Examples include hedge funds, insurance firms, pawn shops, cashier's cheque issuers, check cashing locations, payday lending, currency exchanges, and microloan organizations.
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Types of Non Banking Financial Institutions
Different types of Non Banking Financial Intermediaries have distinct and unique contribution to the financial ecosystem. Non Banking Financial Institutions offer specialized services as well as traditional banking services.
1. Investment Banks
Investment banks are important in the financial markets, serving as intermediaries between issuers of securities and the investing public. They assist corporations, governments, and other entities in raising capital through debt and equity offerings. Investment banks also provide strategic advisory services for mergers and acquisitions as well as other types of financial transactions. Investment banks do not take deposits. Morgan Stanley and Goldman Sachs are popular investment banks.
2. Mortgage Lenders
Mortgage lenders specialize in issuing loans used for purchasing real estate. While some mortgage lenders are banks that also accept deposits, many are dedicated institutions focused solely on mortgage lending. These lenders evaluate, authorize, or recommend approval of loan applications for individuals and businesses. Quicken Loans is an example of a non-bank mortgage lender that has significantly impacted the housing finance market.
3. Money Market Funds
Money market funds are types of Non Banking financial institutions that invest in highly liquid, near-term instruments like treasury bills and commercial paper. They aim to offer high liquidity with a very low level of risk, making them an attractive option for investors seeking a safe place to park cash. These funds are essential for providing short-term financing for governments, banks, and corporations. Vanguard Prime Money Market Fund is an example of this type of fund.
4. Insurance Companies
Insurance companies mitigate risk for individuals and businesses by offering various insurance products, including life, health, property, and casualty insurance. These companies collect premiums from policyholders, forming large pools of funds they invest in markets to pay out claims as they arise. State Farm and Allianz are examples of large insurance companies that play a critical role in the financial system.
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5. Hedge Funds
Hedge funds are private investment funds that employ diverse strategies to earn active returns for their investors. They can invest in a wide array of assets and often use leverage and derivatives to amplify their bets. Hedge funds are known for their aggressive investment strategies aimed at achieving high returns. Bridgewater Associates and Renaissance Technologies are notable hedge funds.
Read Later6. Private Equity Funds
Private equity funds gather capital to invest in companies that are not listed on public stock exchanges. They aim to restructure, improve, and sell these companies at a profit. Private equity is involved in various activities, including leveraged buyouts, venture capital, and growth capital. Blackstone Group and KKR are leading players in the private equity space.
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7. Peer-to-Peer (P2P) Lenders
P2P lending platforms enable individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman. These platforms use technology to match borrowers with lenders efficiently. P2P lending can offer more favourable terms compared to traditional bank loans due to lower overhead costs. LendingClub and Prosper Marketplace are some of the companies active in the P2P lending industry.
Characteristics of Non-Banking Financial Institutions
Non-Banking Financial Institutions (NBFIs) have the following characteristics that differentiate them from traditional banking institutions:
- Lack of Banking License: NBFIs do not hold a banking license and are not allowed to accept demand deposits from the public.
- Regulatory Framework: They operate under a different regulatory framework, which is often less stringent than that governing traditional banks.
- Specialized Financial Services: NBFIs typically offer specialized financial services, including investment, risk pooling, contractual savings, and market brokering, among others.
- Credit Provision: They provide credit and loans to individuals and businesses, often catering to sectors or clients not served by traditional banks.
- Investment Opportunities: NBFIs offer various investment products and opportunities, such as mutual funds, hedge funds, and private equity funds.
- Risk Management: Through products like insurance, NBFIs offer risk management solutions to individuals and businesses.
- Innovation and Flexibility: Non Banking Financial Intermediaries are more flexible and innovative in their product offerings. These institutions adapt quickly to changes in demands of the market or consumers.
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Functions of Non Banking Financial Intermediaries
NBFIs help in making the economy more stable and efficient. They offer a various financial services across different areas of the economy, meeting the needs of various groups of people. The following are the key functions of Non-Banking Financial Institutions:
- Credit Provision: They extend credit to individuals and businesses that might not meet the stringent criteria of traditional banks, thereby filling a critical gap in the credit market. This includes loans for real estate, personal loans, and business financing.
- Investment Services: Offering investment opportunities to individuals and institutions through the management of various funds such as hedge funds, private equity funds as well as mutual funds. These services help investors with diversifying their portfolios beyond traditional bank products.
- Risk Management: Through insurance products, NBFIs provide risk management solutions to individuals and businesses, covering several risks related to life, health, property, and casualty.
- Savings and Retirement Planning: They offer products like annuities and mutual funds that help individuals save for retirement and other long-term goals, often providing higher returns compared to traditional savings accounts.
- Payment and Settlement Systems: Some NBFIs offer payment processing and settlement services, facilitating transactions between buyers and sellers in various markets.
- Financial Advisory Services: Providing expert advice on mergers, acquisitions, restructuring, and other financial transactions to businesses and individual investors.
- Market Making and Liquidity Provision: By acting as market makers, some NBFIs contribute to the liquidity and efficiency of financial markets, facilitating trading in stocks, bonds, and other securities.
- Peer-to-Peer Lending: Connecting borrowers directly with lenders through online platforms, bypassing traditional banking channels, and often offering more competitive rates and terms.
- Innovation and Financial Inclusion: NBFIs are often at the forefront of financial innovation, developing new financial products and services that fulfil the requirements of consumers and businesses. They promote financial inclusion by reaching potential customers who do not have any banking experience.
- Capital Market Access: NBFIs facilitate access to the capital markets for both individuals and corporate entities by offering investment banking services, including underwriting and acting as intermediaries in the issuance of stocks and bonds.
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FAQs
What is the difference between balance sheet of banking and non-banking financial companies?
The balance sheets of banking and non-banking financial companies (NBFCs) differ primarily in their structure and the nature of their assets and liabilities:
- Deposits: Banks' balance sheets typically include a significant portion of demand deposits from the public, which form a major part of their liabilities. NBFCs, on the other hand, do not accept demand deposits.
- Loans and Advances: Both banks and NBFCs have loans and advances as assets. However, the nature and segmentation of these loans can differ, with NBFCs often focusing on specific sectors or types of loans.
- Regulatory Capital: Banks are required to maintain certain regulatory capital ratios, influencing the composition of their balance sheets. NBFCs are subject to different capital adequacy requirements.
- Investment Portfolio: NBFCs might have a more diversified investment portfolio, including investments in stocks, bonds, and other financial instruments, compared to traditional banks.
What do you mean by the term 'underbanked'?
The term "underbanked" means an individual or busines with a limited access to banking services as well as products. These entities might have a bank account but depend on alternative financial services, such as money orders, payday loans and check-cashing services, for their financial needs. The underbanked population often faces challenges in accessing credit, investment products, and other comprehensive banking services due to various barriers, including financial, geographical, or socio-economic factors.
What are banking financial services?
Banking financial services encompass a broad range of products and services offered by banks to assist individuals, businesses, and governments in managing their financial transactions and needs. These services include:
- Deposit Accounts:Checking accounts, savings accounts, and time deposits.
- Credit Services: Including personal loans, credit cards, mortgages, and lines of credit.
- Payment and Transaction Services: Such as wire transfers, online banking, and payment processing services.
- Wealth Management: Including investment advice, asset management, and brokerage services.
- Insurance Products: Some banks offer insurance products, either directly or through partnerships with insurance companies.
- Foreign Exchange and International Banking Services: For customers engaging in international trade or travel.
- Corporate and Investment Banking: Services for businesses and institutional clients, including underwriting, mergers and acquisitions advice, and corporate finance.
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