What Are Nonbank Banks?

Nonbank banks are financial organizations that do not have banking licenses. They may perform many of the same functions as a bank, yet are prohibited from performing others, such as accepting deposits. Some nonbank banks are even insured by the Federal Deposit Insurance Corporation (FDIC). Common nonbank institutions include mortgage, insurance, and finance companies.

Though nonbank banks are not licensed, because they offer financial services, they are still usually required to follow bank regulations. These are guidelines and restrictions that are outlined and enforced by the government. Though this requirement is common, it is not universal; there are some areas where nonbanks can practice with few or no regulations.

There is a wide array of services practiced by nonbank banks. Many of these institutions will focus on a few areas, such as investments, retirement planning, or credit services. Others, such as venture capital firms, will perform one primary function.

Some common services provided by nonbank banks include offering money markets and wealth management services and underwriting stocks. Lending is also a common service among nonbank institutions. These can be general loans or the distribution of funds for specific purposes such as education.

Nonbank banks are usually not permitted to accept deposits and thus must find other ways to fund their activities. A common method is to use debt instruments such as mortgages, bonds, and certificates. The entity essentially makes money through the process of transferring debt ownership.

A nonbank bank can also make money by charging a fee for its services, typically as an interest payment. Often this will be for acting as a conduit for transferring funds from one party to another. It is essentially the process of connecting those who need capital with the people who have funds.

The primary challenge for a nonbank is to balance the funds it receives with those it distributes. For this reason, the flow of incoming and outgoing funds must be precisely scheduled. A nonbank will often manage this responsibility by offering long term loans at high rates while borrowing short term at lower rates. This ensures cash flow while lowering the risk of borrowing.

One of the significant differences between a nonbank bank and a licensed bank is that the latter must adhere to more federal regulations. This includes maintaining certain conditions, such as a capital ration requirement. A bank may also periodically turn to the federal government for assistance in boosting cash reserves.