Question

Describe the main types of non-bank Financial Institutions (FI). Are there any non-bank FI’s that are allowed to accept deposits?

Answer 1

Nonbank financial companies (NBFCs), also known as nonbank financial institutions (NBFIs) are financial institutions that offer various banking services but do not have a banking license. Generally, these institutions are not allowed to take traditional demand deposits—readily available funds, such as those in checking or savings accounts—from the public. This limitation keeps them outside the scope of conventional oversight from federal and state financial regulators.

Nonbank financial companies fall under the oversight of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which describes them as companies "predominantly engaged in a financial activity" when more than 85% of their consolidated annual gross revenues or consolidated assets are financial in nature. Examples of NBFCs include investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds, and P2P lenders.

Many financial institutions have evolved into institutional conglomerates that provide an array of services from investment advisory work to banking. There are, however, some non-banking financial institutions that focus on a single business line or are simply more dedicated to other financial services beyond banking. Non-banking institutions are not legally permitted to accept deposits from customers. They can, however, advise on how to invest assets, execute buy and sell orders on behalf of investors, or provide research on the financial markets, the economy, or individual investments. Some non-banking financial entities are traditional finance companies, while others are corporations that evolved into offering financial services

In developed economies, non-banking financial institutions still must adhere to some regulation. While these firms are not legally banking institutions and do not hold banking licenses, financial transactions outside of deposits still occur. As a result, there still must be accountability to a regulatory body, even if it's local, and certain guidelines must be followed, such as maintaining minimum capital requirements or financial reserves.

Non-banking financial institutions can be found in some unlikely places, including the automotive industry. In addition to manufacturing and selling vehicles, some auto companies decide to capitalize on the fact that most customers need a loan to buy an automobile and subsequently expand into the financing business. Loans may be extended to customers from the financing arm of the auto company. This financial division does not accept customer deposits but does receive payments with interest on the loans offered. In addition to loans, this type of non-banking institution may offer leasing services and insurance products to customers.

Investment banks are another type of non-banking financial institution. Firms dedicated to investment banking may strictly provide advisory services to clients. This could be in the form of advising a company on a merger or acquisition or in recommending a transaction in which the client could raise money in the financial markets. Also, investment banks provide underwriting services to corporations. These non-banking institutions may take the lead on selling a company's equity or debt to the public.

Understanding NBFCs

Dodd-Frank defines three types of nonbank financial companies: foreign nonbank financial companies, U.S. nonbank financial companies, and U.S. nonbank financial companies supervised by the Federal Reserve Board of Governors. NBFCs can offer services such as loans and credit facilities, currency exchange, retirement planning, money markets, underwriting, and merger activities.

Foreign Nonbank Financial Companies

Foreign nonbank financial companies are incorporated or organized outside the U.S. and predominantly engaged in financial activities such as those listed above. Foreign nonbanks may or may not have branches in the United States.

U.S. Nonbank Financial Companies

U.S. nonbank financial companies, like their foreign nonbank counterparts, are predominantly engaged in nonbank financial activities but have been incorporated or organized in the United States. U.S. nonbanks are restricted from serving as Farm Credit System institutions, national securities exchanges, or any one of several other types of financial institutions.

U.S. Nonbank Financial Companies Supervised by the Board of Governors

The main difference between these nonbank financial companies and others is that they fall under the supervision of the Federal Reserve Board of Governors. This is based on a determination by the Board that financial distress or the “nature, scope, size, scale, concentration, interconnectedness, or mix of activities” at these institutions could threaten the financial stability of the United States.

Real-World Example of NBFCs

Entities ranging from mortgage provider Quicken Loans to financial services firm Fidelity Investments qualify as NBFCs. However, the fastest-growing segment of the non-bank lending sector has been in peer-to-peer (P2P) lending.

The growth of P2P lending has been facilitated by the power of social networking, which brings like-minded people from all over the world together. P2P lending websites, such as LendingClub Corp.(LC), StreetShares, and Prosper, are designed to connect prospective borrowers with investors willing to invest their money in loans that can generate high yields.

P2P borrowers tend to be individuals who could not otherwise qualify for a traditional bank loan or who prefer to do business with non-banks. Investors have the opportunity to build a diversified portfolio of loans by investing small sums across a range of borrowers.

Although P2P lending only represents a small fraction of the total loans issued in the United States, a report from Brand Essence Research suggests that:

Global Peer-to-Peer Lending (P2P) Market is valued at USD 34.16 Billion in 2018 and expected to reach USD 589.05 Billion by 2025 with a CAGR of 50.2% over the forecast period. Universal advancements in technologies which command the processes connected to money lending majorly driving the Global Peer to Peer (P2P) Market