BANKING AND FINANCIAL INSTITUTIONS

Chapter 1:
THE CONCEPT AND PRINCIPLE OF BANKING AND FINANCIAL
INSTITUTIONS

This course provides basic information on the organizations and

operations of various banking and non-banking forms of
institutions including the informal financial institutions like the
different forms of unlicensed money lending. In addition, Global
Banking and International Monetary Fund, Asian development
Bank, World Bank have been given substantial coverage in view
of their great influence on our financial system as well as on our
whole national economy. Be oriented with the organizations and
operations of the various banking and non-banking financial
institutions in our social economic development. It is designed to
develop an understanding of financial institutions and financial
market and their relationship to the management and public
policies including the studies of market structures, profit
strategies, relationship of commercial banks and other financial
institutions, problems of asset and liability management, theory
of interest and asset price. To provide the concepts and
fundamentals of banking and non-banking and other financial
services especially those who are considering a career in this
field. The nature and necessity of banking and financial that is
essential to our economy. The elements and general functions of
banking and financial system must be implemented in banking
institutions. The different structures of Philippine Banking and
Financial Institutions must be organized by the Central Bank.

Chapter 2:
CENTRAL BANK OF THE PHILIPPINES

The Development of Central Bank of the Philippines

According to Fajardo (1994), the concept of a central bank was
developed in 1933 by Miguel Cuaderno, the first governor of the
Central Bank of the Philippines (now Bangko Sentral ng Pilipinas).
For 13 years, he conducted a research on the various central
banks of many countries. In 1946, a formal preparation for the
establishment of a central bank began upon the instruction of the
then President Manuel Roxas. Miguel Cuaderno was assigned the
task of governor. As governor, he chose the charter of the Central
Bank of Guatemala as the model for the charter of the Central
Bank of the Philippines because of the similar economic and social
conditions of Guatemala and the Philippines.
The Board that governs the Central Bank called the Monetary
Board. Its members are appointed by the President of the
Philippines and the Chairman is the Governor of the Central Bank.
Five members come from the private sector and two members
coming from the government institutions. The “New Central Bank
Act” took effect on June 14, 1993 during the reign of then
President Fidel Ramos. It is established an independent Central
Monetary Authority, which is now known as Bangko Sentral ng
Pilipinas (BSP).
The powers and functions of Bangko Sentral ng Pilipinas are
exercised by its Monetary Board, which has seven members
appointed by the President of the Philippines. Under the New
Central Bank Act, one of the government sector members by the
Monetary Board must also be a member of the Cabinet
designated by the Philippines.
The Bangko Sentral ng Pilipinas (BSP) is the central bank of the
Republic of the Philippines. It was established on 3 July 1993
pursuant to the provisions of the 1987 Philippine Constitution and
the New Central Bank Act of 1993. The BSP took over from the
Central Bank of Philippines, which was established on 3 January
1949, as the country’s central monetary authority. The BSP enjoys
fiscal and administrative autonomy from the National Government
in the pursuit of its mandated responsibilities. The BSP aims to be
recognized globally as the monetary authority and primary
financial system supervisor that supports a strong economy and
promotes a high quality of life for all Filipinos. BSP mission is to
promote and maintain price stability, a strong financial system,
and a safe and efficient payments and settlements system
conducive to a sustainable and inclusive growth of the economy.
The Bangko Sentral ng Pilipinas (BSP) is the central bank of the
Republic of the Philippines. It was established on 3 July 1993
pursuant to the provisions of the 1987 Philippine Constitution and
the New Central Bank Act of 1993. The BSP took over from the
Central Bank of Philippines, which was established on 3 January
1949, as the country’s central monetary authority. The BSP enjoys
fiscal and administrative autonomy from the National Government
in the pursuit of its mandated responsibility. The BSP aims to be
recognized globally as the monetary authority and primary
financial system supervisor that supports a strong economy and
promotes a high quality of life for all Filipinos. The BSP mission
is to promote and maintain price stability, a strong financial
system, and a safe and efficient payments and settlements
system conducive to a sustainable and inclusive growth of the
economy.

The new BSP logo is a perfect round shape in blue that features
three gold stars and a stylized Philippine eagle rendered in white
strokes. These main elements are framed on the left side with the
text inscription “Bangko Sentral ng Pilipinas” underscored by a
gold line drawn in half circle. The right side remains open,
signifying freedom, openness, and readiness of the BSP, as
represented by the Philippine eagle, to soar and fly toward its
goal. Putting all these elements together is a solid blue
background to signify stability.Principal Elements:

1. The Philippine Eagle, our national bird, is the world’s largest

eagle and is a symbol of strength, clear vision and freedom, the
qualities we aspire for as a central bank.

2. The three stars represent the three pillars of central banking:

price stability, stable banking system, and a safe and reliable
payments system. It may also be interpreted as a geographical
representation of BSP’s equal concern for the impact of its
policies and programs on all Filipinos, whether they are in Luzon,
Visayas or Mindanao.
Colors
1. The blue background signifies stability.
2. The stars are rendered in gold to symbolize wisdom, wealth,
idealism, and high quality.
3. The white color of the eagle and the text for BSP represents
purity, neutrality, and mental clarity.

Font or Type Face

Non-serif, bold for “BANGKO SENTRAL NG PILIPINAS” to suggest
solidity, strength, and stability. The use of non-serif fonts
characterized by clean lines portrays the no-nonsense
professional manner of doing business at the BSP.

Shape
Round shape to symbolize the continuing and unending quest to
become an excellent monetary authority committed to improve
the quality of life of Filipinos. This round shape is also evocative of
our coins, the basic units of our currency.

The BSP Main Complex

The BSP Main Complex in Manila houses the offices of the

Governor, the Monetary Board and the different operating
departments/ offices. The Complex has several buildings, namely:
5-Storey building, Multi-storey building, the EDPC building and the
BSP Money Museum, which showcases the Bank's collection of
currencies

The BSP Security Plant Complex

The Security Plant Complex which is located in Quezon City

houses a banknote printing plant,
a securities printing plant, a mint and a gold refinery. The
banknote printing plant and the mint take care of producing
currency notes and coins, respectively.

Chapter 3:
GOVERNMENT BANKING INSTITUTION
The Philippine government has been active in banking business.
This does not mean, though that the government deliberately
competes with the private banking industry. The role of the
government in the banking system is to supplement the credit
facilities of the private financial institutions. There are areas of
the economy where the private banks has been reluctant to
operate not because of huge investments but due to poor
economic returns. In other cases, viability is not even certain. For
these reasons, the government had to establish banks with
special lending programs like the socio-economic development of
the small farmers, the Moslem regions, and the rural areas,
among others.
In many instances, the provisions of social goods and services
are only feasible if these are handled by the government
institutions. The government is responsible primarily to render
services while the private institutions operate basically for profit.
For instance, the Philippine National Bank handled 45% of the
financing program of agricultural sector. This may be one of a
particular type of project which the private banks not likely to
invest as it is a risky venture. Even in the rural areas, private
commercial banks are very rare. The government has to
penetrate these areas where good credit resources are scarce.
Thus it has fielded branches of the Government Banking
Institutions in the areas. It then became the largest retail of credit
in the agricultural sector and in the small rural communities. This
chapter presents the various organizations and powers of the
different government banking institutions, such as follows:
Philippine National Bank, Land Bank of the Philippines,
Development bank of the Philippines, and Philippine Islamic Bank
(formerly Philippine Amanah Bank).

PHILIPPINE NATIONAL BANK

It was established as a government-owned banking institution on

July 22, 1916. Its primary mandate was to provide financial
services to Philippine industry and agriculture and support the
government's economic development effort. World War I, then
raging in Europe, generated huge demand for the country's major
exports namely: sugar, copra, coconut oil, Manila hemp and
tobacco. However, not much was being done to develop the
industries that produced these sought-after crops since access to
credit facilities was limited. To solve this problem, Henderson
Martin, Vice Governor of the Philippines, together with Miguel
Cuaderno (who later became Central Bank governor) drafted a
charter for a national bank.
On February 4, 1916, Public Act 2612 was passed by
the Philippine Legislature providing for the establishment of PNB
to replace the small P1 million government-owned Agricultural
Bank. PNB's first head office was the Masonic Temple
along Escolta, Manila, and the "Wall Street of the Philippines"
then, in the bustling district of Santa Cruz in Manila. An
American, Henry Parker Willis, was its first president.
With PNB's establishment, Filipinos had a bank of their own. PNB
was authorized to grant short and long-term loans to agriculture
and industry. Filipino farmers then could avail of loans.
PNB has also functioned as the de facto Central Bank of the
Philippines until 1949. It was given the special power to issue
circulating notes. PNB briefly ceased operations in January 1942
but reopened the next month under the supervision
of Japanese authorities. After the Second World War, PNB
reopened immediately and acquired the assets and assumed the
liabilities of the banking division of the Bangko Sentral ng
Pilipinas. With the establishment of the Central Bank in 1949,
PNB's role as issuer of currency notes, custodianship of bank
reserves, sole depository of government funds and clearing house
of the banking system ceased.

LANDBANK OF THE PHILIPPINES:

Land Bank of the Philippines (Filipino: Bangko sa Lupa ng
Pilipinas, Spanish: Banco Hipotecario de Filipinas), stylized
as LANDBANK or also known by its initials, LBP, is a universal
bank in the Philippines owned by the Philippine government with
a special focus on serving the needs of farmers and fishermen.
While it provides the services of a universal bank, it is officially
classified as a "specialized government bank" with a universal
banking license.
Land bank is the fourth largest bank in the Philippines in terms of
assets and is the largest government-owned bank. It is also one of
the biggest government owned and controlled corporations in the
Philippines.
Unlike most Philippine banks, Land bank has an extensive rural
branch network with 365 Branches/Units and 1,607 ATMs. It
services many rural sector clients in areas where banking is either
limited to rural banks or is non-existent.
In 2015, it planned to merge with DBP but it did not push through.
On February 4, 2016, President Benigno Aquino III approved the
Executive Order #198 on the merger between Land Bank and the
DBP, with the former as the surviving entity.
Land bank was established on August 8, 1963 as part of
the Agricultural Land Reform Code as part of a program of land
reform in the Philippines. It was to help with the purchase of
agricultural estates for division and resale to small landholders
and the purchase of land by the agricultural lessee. In 1965, Land
bank’s by-laws were approved and its first board of trustees was
formed, with the Secretary of Finance as Chairman.
On October 21, 1972, Presidential Decree No. 27, signed by
President Ferdinand Marcos, emancipated all tenant farmers
working on private agricultural lands devoted to rice and corn,
whether working on a landed estate or not. The system was
implemented through a system of sharecropping or lease-
tenancy. Land bank was tasked to collect 15-year
land amortizations from beneficiaries at the cost of the value of
the land plus six percent interest per annum.
By 1973, Land bank was in financial distress. It lacked the
resources and the capital needed to implement the land reform
programs and lacked the structure to implement the programs
efficiently. On July 21, Marcos signed Presidential Decree No. 251
which revitalized the bank. The decree granted Land bank a
universal banking license (the first bank in the Philippines to be
issued such a license) with a social mission to spur countryside
development. The decree expanded Land bank’s powers to
include lending for agricultural, industrial, homebuilding and
home-financing projects and other productive enterprises, as well
as lending to farmers' cooperatives and associations to facilitate
production, marketing of crops and acquisition of essential
commodities. Land bank was also required by the decree to
provide timely and adequate support in all phases involved in the
execution of agrarian reform and also increased its
authorized capital to 3 billion pesos. It also became exempted
from all national, provincial, city and municipal taxes and
assessments.
Land bank was reorganized in 1977 when it was divided into three
sectors to better assess the needs of its customers. It was divided
into Agrarian, Banking and Operations sectors to strengthen
operations and ensure long-term viability.
In 1982, the Agricultural Credit Administration (ACA), established
under the same law as Land bank, was abolished and all its assets
and functions transferred to Land bank. ACA's function was to
extend credit to small farmers. Also in this year, Union Bank of
the Philippines (Union Bank) was formed, with Land bank having a
40-percent stake in the government-owned commercial bank.
Land bank became the financial intermediary for
the Comprehensive Agrarian Reform Program (CARP) in 1988. It
was also in that year that Union Bank started a gradual
privatization. The Aboitiz Group of Companies acquired Land
bank’s 40% share of Union Bank then which it continues to own.
LANDBANK also became the third member of Express net,
an interbank network in December 1991 but now a Banc
Net member.
On February 23, 1995, Land bank’s charter was once again
amended. Its authorized capital was increased to nine billion
pesos and it became an official government depository. The
number of members of the board of trustees was also increased
to nine. On August 25, 1998, Land bank’s authorized capital was
once again increased to 25 billion pesos, and it then increased to
200 billion pesos, after the DBP-Land bank merger in 2016.
DEVELOPMENT BANK OF THE PHILIPPINES
In the Philippines, development financing institutions play a
pivotal role in the quest for sustainable growth and development.
And at the helm of the country’s march toward progress is the
Development Bank of the Philippines. As the country’s pre-
eminent development financial institution, DBP has taken upon
itself the strategic task of influencing and accelerating sustainable
economic growth, through the provision of resources, for the
continued well-being of the Filipino people.
The DBP, under its new charter, is classified as a development
bank and may perform all other functions of a thrift bank. Its
primary objective is to provide banking services principally to
cater to the medium and long-term needs of agricultural and
industrial enterprises with emphasis on small and medium-scale
industries The affairs and business of the Bank are directed, and
its properties managed and preserved, and its corporate powers
exercised by a Board of Directors consisting of nine (9) members
appointed by the President of the Republic of the Philippines. The
Chief Executive Officer of the Bank is also the President who is
elected by the Board of Directors. The President is also the Vice
Chairman of the Board. The history can be traced back during the
Commonwealth when the early infrastructure for development
financing was laid by the government. In 1935 – The National
Loan and Investment Board (NLIB) was created to coordinate and
manage government trust funds such as the Postal Savings Fund
and the Teacher’s Retirement Fund. In 1939 – The Agricultural
and Industrial Bank (AIB), which absorbed the functions of the
NLIB, was created and started to harness government resources
until the outbreak of war. In 1947 – The government created the
Rehabilitation Finance Corporation (RFC) under R.A. No. 85 which
absorbed the assets and took over the functions of the AIB. The
RFC provided credit facilities for the development of agriculture,
commerce and industry and the reconstruction of properties
damaged by the war. In 1958 – The RFC was reorganized into the
Development Bank of the Philippines. The change in corporate
name marked the shift from rehabilitation to broader activities.
With an initial capital of P500 million subscribed by the
government, the DBP expanded its facilities and operations to
accelerate national development efforts. This forward thrust saw
the establishment of a network of branches throughout the
country. The DBP tapped both foreign and local fund sources to
complement its capital resources. Credits were obtained directly
from international financial institutions. The DBP delivered to the
economy substantial benefits in capital formation, employment
generation and increased revenues, particularly in the
countryside. In the late seventies and early eighties, however, its
viability was undermined by an increasing number of non-
performing accounts following a period of economic difficulty.
1969 – Construction of the DBP Head Office Building which was
completed in 1971. 1986 – Former President Corazon Aquino
issued E.O. No. 81 which provided for the 1986 Revised Charter
that called for a clean-up of DBP’s books, staff reorganization and
infusion of initial operating budget. The rehabilitation program
restored its financial viability and DBP resumed lending
operations. With the transfer of non-performing assets together
with liabilities in June 30, 1986 to the National Government, the
DBP implemented an institutional strengthening program
covering a thorough revision of the credit process and a training
program for the intensive implementation of new lending thrusts.
The Bank likewise reopened its lending windows for housing,
agriculture, and small and medium scale industries. 1995 – The
DBP was granted an expanded banking license and attained
universal banking status. 1998 – Former President Fidel V. Ramos
signed R.A. 8523 amending DBP’s 1986 Charter. Among the major
provisions incorporated in the new DBP Charter were the increase
of authorized capital stock from P5 billion to P35 billion, and the
creation of the position of President and CEO. These
developments paved the way for the pursuit of other activities
that allowed the Bank to fulfill its development mandate more
meaningfully. Today, DBP sharpens its development focus as the
country’s Infrastructure Bank. The bank spurs national growth by
funding projects that raise the economy’s competitiveness.
Focusing on sectors with the biggest and most immediate impact
on every Filipino’s well-being, DBP spearheads infrastructure
projects such as roads and highways, power and water generation
and distribution, schools, and hospitals. On October 30, 2008, the
Development Bank of the Philippines (DBP) obtained ownership of
the 99.9% shareholdings by acquiring the shares of the National
Government, SSS and GSIS. It was on November 14, 2007 when
DBP approved the acquisition of AAIIBP and on July 16, 2008 it
took over full control of AIIBP’s operation. On October 22, 2009,
the Monetary Board approved the Bank's 5-year Rehabilitation
Plan, which focused on four corporate strategies (4Rs), namely,
Recapitalization, Restoration of Financial Viability, Reorganization
and Reforms Institutionalization. Under the Rehabilitation Plan,
AAIIBP is allowed to continuously do both conventional and
Islamic banking. In November 2009, DBP, marking the partial
completion of recapitalization strategy, infused Php1.0 billion
capital to AAIIBP. To be the leading and choice Islamic financial
institution providing alternative banking services in response to
the emerging global Islamic markets and to promote and
accelerate the socio-economic developments of the Islamic
communities in the Philippines by 2022.

AMANAH ISLAMIC BANK

In 1973, Presidential Decree No. 264 created the Amana Islamic
Bank with an initial capitalization of 50 Million pesos. Intended to
become a development bank, it invested 75% of its total loanable
funds on providing, among others, reasonable medium and long-
term credit facilities for the people of the Muslim-dominated
provinces in Cotabato, South Cotabato, Lanao del Sur, Lanao del
Norte, Sulu, Basilan, Zamboanga del Norte, Zamboanga del Sur
and Palawan. In 1974, Presidential Decree No. 542 retuned the
direction of the Bank to adopt the "no interest principle" in Islamic
banking and partnership principles. However, the lack of
recognition and support of Islamic banking in the Country made
the Bank less competitive in the predominantly conventional
banking in the Country. In 1990, the Bank became a Universal
Bank through enactment of Republic Act No. 6848, otherwise
known as the Charter of Al-Amana Islamic Investment Bank of
the Philippines (AAIIBP), with an authorized capital stock of P1
billion consisting of 10 million common shares. Its mandate is
primarily to participate in the socio-economic development of the
Autonomous Region of Muslim Mindanao (ARMM) by promoting
and utilizing Islamic banking, financing and investment in
agricultural, commercial and industrial ventures in the ARMM. By
mid-1990, three (3) of its branches, Cotabato, Marawi and Jolo
began accepting and transforming ordinary deposits into Islamic
deposits. The other branches have been transacting both
conventional and Islamic banking products, services and
facilities. From 1990 to 2007, AAIIBP managed its operation with
the support of the Bureau of Treasury. On October 30, 2008, the
Development Bank of the Philippines (DBP) obtained ownership of
the 99.9% shareholdings by acquiring the shares of the National
Government, SSS and GSIS. It was on November 14, 2007 when
DBP approved the acquisition of AAIIBP and on July 16, 2008 it
took over full control of AIIBP’s operation. On October 22, 2009,
the Monetary Board approved the Bank's 5-year Rehabilitation
Plan, which focused on four corporate strategies (4Rs), namely,
Recapitalization, Restoration of Financial Viability, Reorganization
and Reforms Institutionalization. Under the Rehabilitation Plan,
AAIIBP is allowed to continuously do both conventional and
Islamic banking. In November 2009, DBP, marking the partial
completion of recapitalization strategy, infused Php1.0 billion
capital to AAIIBP. To be the leading and choice Islamic financial
institution providing alternative banking services in response to
the emerging global Islamic markets and to promote and
accelerate the socio-economic developments of the Islamic
communities in the Philippines by 2022.

Commercial Bank can be described as a financial institution that

offers basic investment products like a savings account, current
account, and other services to the individuals and corporates.
Along with that, it provides a range of financial services to the
general public such as accepting deposits, granting loans and
advances to the customers. It is a profit making company, which
pays interest at a low rate to the depositors and charges higher
rate of interest to the borrowers and in this way, the bank earns
the profit. Commercial banks are classified into two categories
i.e. scheduled commercial banks and non-scheduled commercial
banks. Further, scheduled commercial banks are further classified
into three types: Private Bank: When the private individuals own
more than 51% of the share capital, then that banking company is
a private one. However, these banks are publicly listed companies
in a recognized exchange. Public Bank: When the Government
holds more than 51% of the share capital of a publicly listed
banking company, then that bank is called as Public sector bank.
Foreign Bank: Banks set up in foreign countries, and operate their
branches in the home country are called as foreign banks.
Primary functions: Accepting Deposits: The primary function for
which the commercial banks were established is to accept
deposits from the general public, who possess surplus funds and
are willing to deposit them so as to earn interest on it. The
primary function for which the commercial banks were
established is to accept deposits from the general public, who
possess surplus funds and are willing to deposit them so as to
earn interest on it. Accepting Deposits: The primary function for
which the commercial banks were established is to accept
deposits from the general public, who possess surplus funds and
are willing to deposit them so as to earn interest on it.
Commercial bank organized chiefly to handle the everyday
financial transactions of businesses (as through demand deposit
accounts and short-term commercial loans) It is a financial
institution which performs the functions of accepting deposits
from the general public and giving loans for investment with the
aim of earning profit. ... They generally finance trade and
commerce with short-term loans. Commercial banks form a
significant part of the country's Financial Institution System. ...
The main source of income of a commercial bank is the difference
between these two rates which they charge to borrowers and pay
to depositors. Examples of commercial banks – ICICI Bank,
State Bank of India, Axis Bank, and HDFC Bank. The functions of
commercial banks are broadly classified into primary functions
and secondary functions.
Commercial banks are of three types, which are as follows:
(a) Public Sector Banks
(b) Private Sector Banks
Chapter 4:
Private Banking Institution

THRIFT BANK

Thrift Bank means a financial organization that focuses on basic

banking services. These kinds of banks are usually community-
focused institutions, smaller than commercial banks. Thrift Bank
emphasis on individuals and small businesses. Their services are
built around taking deposits and originating home mortgages.
A thrift bank–also just called a thrift–is a type of financial
institution that specializes in offering savings accounts and
originating home mortgages for consumers. Thrift banks are also
sometimes referred to as Savings and Loan Associations. Thrift
banks often have access to low-cost funding from Federal
Home Loan Banks, which allows them to offer a competitive rate
of interest. It is a financial organization that focuses on basic
banking services. These kinds of banks are usually community-
focused institutions, smaller than retail
and commercial banks. Thrift Banks lay an emphasis on
individuals and small businesses. Their services are built around
taking deposits and originating home mortgages.

RURAL BANK

RURAL BANKS IN THE PHILIPPINES. -

government-sponsored/assisted banks which are privately
managed and largely privately owned that provide credit facilities
to farmers and merchants, or to cooperatives of such farmers or
merchants at reasonable terms and in general, to the people of
the rural community. Rural banking is simply a banking service
that serves smaller, rural communities. They tend to be deeply
embedded in the communities they serve. The main objectives of
these banks are to provide credit and other facilities particularly
to small and marginal farmers, agricultural labourers', rural
artisans and small entrepreneurs so as to develop agriculture,
trade, commerce, industry and other productive activities in rural
areas. It plays a pivotal role in the economic development of
the rural India. The main goal of establishing regional rural
banks in India was to provide credit to the rural people who are
not economically strong enough, especially the small and
marginal farmers, artisans, agricultural labours, and even small
entrepreneurs. Rural banking is simply a banking service that
serves smaller, rural communities. They tend to be deeply
embedded in the communities they serve.
Chapter 5:
NON-BANK FINANCIAL INSTITUTIONS

A nonbank financial institution (NBFI) is a financial institution that

does not have a full banking license and cannot accept deposits
from the public. However, NBFIs do facilitate alternative financial
services, such as investment (both 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 nonbank 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. It is a Risk pooling institutions.
Insurance companies underwrite economic risks associated with
death, illness, damage to or loss of property, and other risk of
loss. They provide a contingent promise of economic protection in
the case of loss. There are two main types of insurance
companies: life insurance and general insurance. General
insurance tends to be short-term, while life insurance is a longer
contract, ending at the death of the insured. Both types of
insurance, life and property, are available to all sectors of the
community. Because of the nature of the insurance industry
(companies must access a plethora of information to assess the
risk in each individual case), insurance companies enjoy a high
level of information efficiency.

Life insurance companies insure against economic loss of the

insured’s premature death. The insured will pay a fixed sum as an
insurance premium every term. Because the probability of death
increases with age while premiums remain constant, the insured
overpays in the earlier stages and underpays in the later years.
The overpayment in the early years of the agreement is the cash
value of the insurance policy.

General insurance is further divided into two categories: market

and social insurance. Social insurance is against the risk of loss of
income due to sudden unemployment, disability, illness, and
natural disasters. Because of the unpredictability of these risks,
the ease at which the insured can hide pertinent information from
the insurer, and the presence of moral hazard, private insurance
companies frequently do not provide social insurance, a gap in
the insurance industry which government usually fills. Social
insurance is more prevalent in industrialized Western societies
where family networks and other organic social support groups
are not as prevalent.

Market insurance is privatized insurance for damage or loss of

property. General insurance companies take a single premium
payment. In return, the companies will make a specified payment
contingent on the event that it is being insured against. Examples
include theft, fire, damage, natural disaster, etc.

Investment savings institutions (also called institutional investors)

provide the opportunity for individuals to invest in collective
investment vehicles in a fiduciary rather than a principle role.
Collective investment vehicles invest the pooled resources of the
individuals and firms into numerous equity, debt, and derivatives
promises. The individual, however, holds equity in itself rather to
invest in specifically. The two most popular examples of
investment savings institutions are mutual funds and private
pension plans.

The two main types of mutual funds are open-end and closed-end
funds. Open-end funds generate new investments by allowing the
public buy new shares at any time. Shareholders can liquidate
their shares by selling them back to the open-end fund at the net
asset value. Closed-end funds issue a fixed number of shares in
an IPO. The shareholders capitalize on the value of their assets by
selling their shares in a stock exchange.

Mutual funds can be delineated along the nature of their

investments. For example, some funds make high-risk, high
return investments, while others focus on tax-exempt securities.
Still others specialize in speculative trading (i.e. hedge funds), a
specific sector, or cross-border investments.

Pension funds are mutual funds that limit the investor’s ability to
access their investment until after a certain date. In return,
pension funds are granted large tax breaks in order to incentivize
the working public to set aside a percentage of their current
income for a later date when they are no longer amongst the
labor force (retirement income).

Other nonbank financial institutions

Market makers are broker-dealer institutions that quote both a

buy and sell price for an asset held in inventory. Such assets
include equities, government and corporate debt, derivatives, and
foreign currencies. Once an order is received, the market maker
immediately sells from its inventory or makes a purchase to offset
the loss in inventory. The difference in the buying and selling
quotes, or the bid-offer spread, is how the market-maker makes
profit. Market makers improve the liquidity of any asset in their
inventory.

Specialized sectorial financiers provide a limited range of financial

services to a targeted sector. For example, leasing companies
provide financing for equipment, while real estate financiers
channel capital to prospective homeowners. Leasing companies
generally have two unique advantages over other specialized
sectorial financiers. They are somewhat insulated against the risk
of default because they own the leased equipment as part of their
collateral agreement. Additionally, leasing companies enjoy the
preferential tax treatment on equipment investment.

Other financial service providers include brokers (both securities

and mortgage), management consultants, and financial advisors.
They operate on a fee-for-service basis. For the most part,
financial service providers improve informational efficiency for the
investor. However, in the case of brokers, they do offer a
transactions service by which an investor can liquidate existing
assets.

Role in Financial System

NBFIs supplement banks in providing financial services to

individuals and firms. They can provide competition for banks in
the provision of these services. While banks may offer a set of
financial services as a package deal, NBFIs unbundle these
services, tailoring their services to particular groups. Additionally,
individual NBFIs may specialize in a particular sector, gaining an
informational advantage. By this unbundling, targeting, and
specializing, NBFIs promote competition within the financial
services industry.

Having a multi-faceted financial system, which includes non-bank

financial institutions, can protect economies from financial shocks
and recover from those shocks. NBFIs provide multiple
alternatives to transform an economy's savings into capital
investment, which act as backup facilities should the primary
form of intermediation fail.

However, in countries that lack effective regulations, non-bank

financial institutions can exacerbate the fragility of the financial
system. While not all NBFIs are lightly regulated, the NBFIs that
comprise the shadow banking system are. In the run-up to the
recent global financial crisis, institutions such as hedge funds
and structured investment vehicles, were largely overlooked by
regulators, who focused NBFI supervision on pension funds and
insurance companies. If a large share of the financial system is in
NBFIs that operate largely unsupervised by government
regulators and anybody else, it can put the stability of the entire
system at risk. Weaknesses in NBFI regulation can fuel a credit
bubble and asset overpricing, followed by asset price collapse and
loan defaults.

Bank/non-bank integration and supervisory integration

The banking, securities, and insurance markets have become

increasingly integrated, with linkages across the markets rapidly
increasing. In response, one of the most notable developments in
financial sector regulation in the past 20 years has been a shift
from the traditional sector-by-sector approach to supervision
(with separate supervisors for banks, securities markets, and
insurance companies) toward a greater cross-sector integration of
financial supervision. This had an important impact on the
practice of supervision and regulation around the globe.

Three broad models are being used around the world: a three-
pillar or “sectoral” model (banking, insurance, and securities); a
two-pillar or “twin peak” model (prudential and business
conduct); and an integrated model (all types of supervision under
one roof). One of the arguably most remarkable developments of
the past 10 years, confirmed by the World Bank’s Bank Regulation
and Supervision Survey, has been a trend from the three-pillar
model toward either the two-pillar model or the integrated model
(with the twin peak model gaining traction in the early 2000s). In
a recent study, examined the drivers of supervisory structures for
prudential and business conduct supervision over the past decade
in 98 countries, finding among other things that countries
advancing to a higher stage of economic development tend to
integrate their supervisory structures, small open economies tend
to opt for more integrated supervisory structures, financial
deepening makes countries integrate supervision progressively
more, and the lobbying power of the concentrated and highly
profitable banking sector acts as a negative force against
business conduct integration.
How do these various institutional structures compare in terms of
crisis frequency and the limiting of the crisis impact? Cross-
country regressions using data for a wide set of developing and
developed economies provide some evidence in favor of the twin
peak model and against the sectoral model. Indeed, during the
global financial crisis, some of the twin peak jurisdictions
(particularly Australia and Canada) have been relatively
unaffected, while the United States, a jurisdiction with a
fractionalized sectoral approach to supervision, has been at the
crisis epicenter. However, the crisis experience is far from black
and white, with the Netherlands, one of the examples of the twin
peaks model, being involved in the Fortis failure, one of the major
European bank failures. It is still early to make a firm overall
conclusion, and isolating the effects of supervisory architecture
from other effects is notoriously hard.