Why Compare Banks and Nonbank Intermediaries?
Banks and nonbank financial intermediaries both connect savers with borrowers, but they do not necessarily raise funds in the same way or offer the same services. A bank may accept transaction deposits used to make payments. An insurer, pension fund, finance company, or investment fund may instead obtain funds through premiums, contributions, borrowing, or sales of investment claims. Those funds can support lending and investment without giving customers a bank-style payment account.
These are general institutional patterns, not absolute rules. Laws differ across jurisdictions, and some nonbank firms offer payment services. To compare institutions, ask three separate questions: Where do their funds come from? What financial service do they provide? Can customers use their claims directly to make payments? This comparison is aligned with the SOA VEE Economics (Validation by Educational Experience) syllabus.
Funding, Services, and Payment Roles
A funding source is a way an institution obtains resources to support its activities. For banks, customer deposits are a central funding source; banks may also use other borrowing and capital. Nonbanks have a wider variety of funding models. For example, an insurer collects premiums under insurance contracts, a pension fund receives contributions for future retirement benefits, and an investment fund receives money when investors buy fund shares. A finance company may borrow in financial markets or issue debt to fund lending.
The services to savers differ with the type of claim offered. A bank customer may hold a transaction deposit that can be used to pay a bill or transfer funds, subject to account terms and local rules. An investor in a mutual fund owns fund shares whose value depends on the fund’s investments. An insurance policyholder has contractual protection, not an ordinary account balance available for unrestricted spending. A pension participant has a claim to retirement benefits under the plan’s rules, not necessarily a balance that can be withdrawn on demand.
Both banks and nonbanks can channel funds to borrowers. Banks commonly make loans to households and businesses. Finance companies also lend, often focusing on particular types of borrowers or credit. Insurers and pension funds may invest in bonds or other assets that provide financing to governments and businesses. A mutual fund may buy debt securities or shares, providing capital to issuers through financial markets. The intermediary’s particular assets and customers vary; the important comparison is how it obtains funds and what claims it gives in return.
| Feature | Banks | Nonbank intermediaries |
|---|---|---|
| Common funding sources | Transaction and other deposits; potentially other borrowing and capital | Premiums, contributions, fund shares, market borrowing, or other sources |
| Typical service to savers | Deposit accounts, which may include payment functionality | Insurance protection, retirement claims, investment exposure, or other financial claims |
| Typical service to users of funds | Loans and other financing | Loans, investment in securities, or other financing |
| Payment role | Transaction deposits commonly support direct payments | Many claims are not directly spendable; payment services depend on the institution and rules |
Payment use is a particularly useful distinction, but it should not be treated as a complete definition of a bank. A nonbank may help customers make payments, and a bank deposit may have restrictions or fees. The relevant question is whether a particular claim functions as a payment instrument under its terms and the applicable system, rather than simply whether it is held at a familiar financial institution.
How Funding Shares Are Compared
A simple way to compare funding is to calculate the share supplied by each source. The sources must be measured on the same basis and at the same date. If they are mutually exclusive categories and together include all funding being measured, their shares add to one hundred percent.
Here, \(F_j\) is the amount from source \(j\), and \(T\) is the total amount across the included sources. The shares sum to one because \(\sum_{j=1}^{n} F_j/T = (\sum_{j=1}^{n} F_j)/T = T/T = 1\), provided \(T>0\) and the categories are exhaustive. This calculation describes the funding mix; it does not by itself show the riskiness, liquidity, or payment usefulness of the resulting claims.
Worked Example: A Bank and a Finance Company
Hypothetical case. A regional bank reports $70 million in customer deposits and $30 million in other borrowing and capital for this comparison. A finance company reports $60 million in bond funding, $30 million in short-term market borrowing, and $10 million in capital. Both institutions use funds to support lending. Compare their funding mixes and payment roles. Use total reported funding as the denominator for each institution.
Method. First total the listed sources for each institution, then divide each source by that institution’s own total. Do not compare a source at one institution with a percentage based on the other institution’s total.
For the bank, total funding is \(70+30=100\) million dollars. Deposits account for \(70/100=0.70\), or 70 percent; other borrowing and capital account for \(30/100=0.30\), or 30 percent. The listed amounts reconcile: \(70+30=100\) percent of the total.
For the finance company, total funding is \(60+30+10=100\) million dollars. Bonds account for \(60/100=0.60\), or 60 percent; short-term market borrowing accounts for \(30/100=0.30\), or 30 percent; and capital accounts for \(10/100=0.10\), or 10 percent. These shares also sum to 100 percent.
The bank’s customer deposits are a prominent funding source and may include transaction accounts used for payments. The finance company’s listed sources are market borrowing and capital, not customer transaction deposits. It can still provide credit to borrowers, but that fact alone does not make its bond or borrowing claims bank deposits.
Check. Each institution’s listed sources total $100 million, and the calculated shares for each add to 100 percent. The common mistake avoided is treating both institutions’ funding as if it were all customer deposits merely because both lend.
Different Claims Serve Different Needs
A saver chooses among financial claims partly according to the service desired. A deposit account may combine safekeeping, access to funds, and payment functionality. An insurance contract transfers specified risks in exchange for premiums. A pension arrangement pools or invests contributions to support future retirement benefits. An investment fund gives investors exposure to a portfolio, subject to the fund’s terms and the value of its assets.
These claims should not be treated as interchangeable just because each has a dollar value. A financial asset may be valuable and relatively liquid without being money that can be used immediately at a shop. Whether a nonbank claim can be redeemed quickly, at a predictable value, or directly used for payment depends on its contract and institutional arrangements. Nor does the word “liquid” mean “a transaction deposit”: it describes how readily an asset can be converted to spendable funds, not the asset’s legal or monetary classification.
Worked Example: Premiums and an Insurer’s Funding
Hypothetical case. An insurer collects $5 million in premiums during a period. It pays $1.1 million in claims and incurs $0.9 million in operating expenses during that period. Assume, just for this simplified calculation, that the amount remaining after these outflows is available for investment. The insurer allocates $2 million to bonds, $0.6 million to loans, and the balance to liquid assets. Identify the amount available for investment, calculate the portfolio shares, and explain whether the policyholders’ premiums are transaction deposits.
Method. Subtract the stated outflows from premiums to find the amount available for investment, then calculate each allocation as a share of that amount.
The amount available for investment is \(5.0-1.1-0.9=3.0\) million dollars. The amount allocated to liquid assets is \(3.0-2.0-0.6=0.4\) million dollars. The allocations reconcile: \(2.0+0.6+0.4=3.0\) million dollars.
The bond share is \(2.0/3.0=0.6667\), or 66.67 percent to two decimal places. The loan share is \(0.6/3.0=0.20\), or 20.00 percent. The liquid-asset share is \(0.4/3.0=0.1333\), or 13.33 percent. Rounded shares total \(66.67+20.00+13.33=100.00\) percent.
The premiums are funding received under insurance contracts. They are not transaction deposits merely because the insurer can invest them or because the policy has a stated monetary benefit. A policyholder’s right to a payment depends on the contract’s terms and covered events; it is not automatically a right to withdraw the premium amount on demand.
Check. The insurer invests $3.0 million, and the three allocations total exactly $3.0 million before rounding. The common mistake avoided is counting all premiums as funds freely available for investment without deducting the stated claims and expenses.
Payment Access and Liquidity Are Not the Same
Banks are especially important to everyday payments because transaction deposits commonly provide a way to make payments without first selling an investment. Other intermediaries may offer redemption, transfers, or payment-related services, but the details depend on their contracts and applicable rules. A nonbank’s customers may need to redeem an investment, wait for processing, or receive a value that changes with market prices before the funds can be spent.
This distinction matters to households and firms planning cash needs. A claim can be worth more than an upcoming bill and still fail to meet that bill’s timing requirement. Comparing the face value of financial assets without checking access conditions can therefore give a misleading impression of payment capacity.
Worked Example: A Fund Investment and a Bill Due Today
Hypothetical case. A household has $1,500 in a bank transaction account and owns mutual fund shares valued at $24,000. Under the fund’s stated terms in this scenario, a redemption request will be paid on the next business day, and the share value may change before payment. The household has a $4,000 bill due today. Determine whether its total stated financial assets cover the bill, and whether all of those assets are available for payment today.
Method. Compare total stated asset value with the bill, then separately compare funds available today with the bill. Keep value and timing as distinct questions.
Total stated assets are \(1{,}500+24{,}000=25{,}500\) dollars. That exceeds the bill by \(25{,}500-4{,}000=21{,}500\) dollars, before any change in the fund’s value. However, the amount available today from the stated transaction account is only $1,500. The shortfall today is \(4{,}000-1{,}500=2{,}500\) dollars.
The fund shares may be valuable and redeemable, but under the scenario’s terms they do not provide the full $2,500 shortfall today. The household could have sufficient assets in total while lacking enough immediately available payment funds. This conclusion depends on the stated redemption timing; it is not a claim that all investment funds have the same terms.
Check. The household has $25,500 in stated assets, but only $1,500 is specified as available for payment today, leaving a $2,500 shortfall. The common mistake avoided is treating the mutual fund’s full stated value as if it were already a transaction-account balance.
Common Comparison Traps
- Equating lending with banking. Banks and nonbanks can both lend. Lending alone does not identify an institution as a bank.
- Calling every financial claim money. A policy benefit, pension claim, fund share, and transaction deposit may all have value, but their access and payment properties differ.
- Confusing funding with the use of funds. Deposits, premiums, contributions, and market borrowing are sources. Loans, bonds, and other investments are uses of funds or assets.
- Assuming all nonbanks work alike. An insurer’s contractual obligations differ from a mutual fund’s investment claims and a finance company’s borrowing-funded loans.
- Ignoring terms and jurisdiction. Payment access, redemption timing, and institutional permissions vary. State the relevant assumptions before classifying a particular service.
Check Your Understanding
For each original scenario, classify the funding or claim and distinguish its financial value from any direct payment role.
- A hypothetical credit union has $36 million in member deposits and $4 million in other reported funding for a comparison. What percentage of its listed funding is deposits, and what role might transaction deposits have? (Answer: 90 percent; qualifying transaction deposits may support direct payments.)
- A hypothetical finance company borrows $18 million by issuing bonds and lends $15 million to equipment buyers, retaining the rest for other needs. Are the bonds customer transaction deposits, and what intermediary service does the company provide? (Answer: No; it raises market funding and channels funds to borrowers through equipment lending.)
- A pension fund receives $8 million in contributions and pays $2 million in benefits and expenses during a period. Assuming the remainder is invested, how much is invested, and are the contributions automatically demand deposits? (Answer: $6 million; no, contributions are pension funding and are not automatically demand deposits.)
- A household has $900 in a transaction account and $6,000 in fund shares payable two business days after redemption. It owes $1,400 today. How much is the stated same-day shortfall, and why does total wealth not remove it under these terms? (Answer: $500; the fund redemption is not payable until two business days later.)
- A hypothetical intermediary is funded by insurance premiums and invests in corporate bonds. It does not offer transaction accounts. Identify its broad institutional type and one reason its claims should not be treated as bank deposits. (Answer: It is a nonbank intermediary, such as an insurer; premiums fund contractual insurance claims and do not by themselves create demand-payment access.)