Banking

What Are Nonbank Banks and How Do They Work? 

What Are Nonbank Banks and How Do They Work?

Nonbanks look, act, and feel like traditional banks but they are not. Also legally, they are not subject to the same regulation as their traditional counterparts.

Nonbank banks offer some of the same financial services as traditional banks but don’t accept deposits or provide other services such as lending. Check out how nonbank banks work and how they might fit into your future plans.

Nonbanks Definition and Example

Nonbank banks are banks that can be referred to as alternative or limited-service financial institutions that act as a bank but may not necessarily offer the traditional banking services you find in your local bank branch.

Nonbank banks, also known as non-depository banks, don’t take deposits. These companies offer a full range of financial services to their clients, similar to traditional banks. They are becoming more popular due to the technological innovations they may have as well as lower fees and interest rates.

For example, a mortgage loan company may act in the capacity of a lender; however, they generally do not accept deposit accounts. You may find that traditional banks are not the perfect option for your financial needs. A nonbank bank can provide similar services but is typically built around a specific financial product, such as mortgage loans or credit cards.

Acronym: NBFI (Nonbank Financial Institution)

According to Bank Holding Act of 1956 (BHCA) traditional banks are financial institutions that receive deposits with the legal right of a depositor to request and be provided at any point in time, with the bank having legal powers to engage in the business of making commercial loans.

Banks, like traditional banks and credit unions, are there to help you with your financial needs. Non-traditional banks, known as nonbanks—think payday lenders, insurance companies, credit unions and mortgage brokers—have a charter that allows them to serve the same function.

And just like traditional banks, they operate under the rules and regulations of the federal government. Nonbank Banks do not have a charter and the ability to accept deposits. They are financial institutions that do not take deposits, and thus are exempt from federal regulations surrounding traditional banks.

Whether you borrow from a nonbank bank or a traditional bank, be sure to understand the interest rate, loan amount, monthly payment, and any charges that may accompany your loan.

Nonbank banks can include several different types of institutions that engage in lending. A major difference between these institutions and traditional banks is that they don’t tend to accept deposits.

Alternate names of Nonbanks include limited-service bank; limited-purpose bank; nonbank financial institution.

Some people come across a nonbank bank while trying to acquire a new car. For instance, if you got the financing for the car via the car dealership’s finance company, you have utilized a nonbank’s banking services.

How Do Nonbank Banks Work?

Nonbank banks work similarly to traditional banks in many ways. They function primarily like a traditional bank by taking deposits and making loans. However, there are differences between the two.

The biggest difference between a nonbank bank and a traditional bank is that nonbank banks don’t provide insurance on the funds they hold in their accounts.

They might be called savings and loans, credit unions, or simply financial services companies. While the name may change, nonbank banks typically offer most of the same services as their retail counterparts.

They don’t hold federal deposit insurance, which means that their money isn’t backed by the federal government.

As long as accepting loans and making loans are non-existent in the same place, Nonbanks fall outside the limited definition of the word “bank” located in the BHCA. That implies that while they are full-scale banks, they can offer financial services without being restricted to traditional banks’ regulations.

There are, however, Nonbanks that run as a money service business (MSB). These banks are mandated to obtain license with the state. In addition, Nonbanks operating under the authority of a state or federal charter can receive FDIC-insured deposits.

Examples of Nonbanks that must have a proper license are foreign exchange dealers, Prepaid card sellers, traveler’s cheque issuers, and money order providers.

When opening an account at a bank, consider all of your financial needs and the bank’s services to determine if it meets all of those requirements. While a bank can offer checking accounts and also offer credit cards, loans, and other financial products as well, some banks only provide certain services.

A nonbank bank can be a company that offers only one primary service, like a mortgage lender providing home loans. However, some nonbank banks can have a primary business that provides ancillary services.

For instance, a grocery store sells groceries as its chief source of revenue. However, they may also offer additional check cashing, money orders, and money transmission services. So, let’s say you had a family member who lives in a foreign country and needs some money wired. Using a nonbank bank like Western Union may be a faster and more affordable option than using a traditional bank. Traditional banks will usually have you wait five days to do such a transfer.

Nonbank banks make your finances accessible on the go. Providing minimum balance requirements, unlimited check writing, and no monthly service fees, along with competitive savings rates, nonbank banks are a wise choice for anyone looking to maximize their time and money.

They can come in different forms. However, its primary characteristic is that it is not a traditional bank but rather an establishment that facilitates money-related services.

Types of Nonbank Banks

The companies listed below can be categorized as Nonbanks:

  • Investment firms
  • Loan or finance companies
  • Casinos and card clubs
  • Insurance companies
  • Check cashing businesses
  • Payday lenders
  • Securities and commodities firms
  • Mortgage brokers
  • Credit card system operators
  • Money services businesses (MSB)
  • Pawnbrokers
  • Precious metal dealers

Nonbank banks came about due to a loophole in the Bank Holding Company Act (BHCA), which defined a bank as any institution that accepts deposits and offers commercial loans. Since the definition is expressed with the conjunctive “and,” many companies can avoid banking regulations by only conducting one of those activities instead of both.

Nonbank banks are typically regulated under the rules for “investment companies,” rather than the rules for “commercial banks.” However, since 1980, the United States has made it more difficult for new Nonbanks to emerge, as restrictions are in place on the chartering of new ones.

Do I Need a Nonbank Bank?

Before determining if a nonbank bank is the right financial institution for you, consider the following question:

Are you in control of your spending? 

If you’re looking for an account that will help you keep your costs down, a nonbank bank may be an option to consider. Many nonbank banks offer accounts with low-to-no service fees when certain conditions are met. Nonbank banks also give customers the ability to do their banking at ATMs and stores as well as online or on mobile devices without paying additional fees.

If a traditional bank doesn’t adequately meet all of your financial needs, a nonbank can be an affordable alternative. A money order bought at your local grocery store is an example.

Some banks require you to have a personal loan, mortgage, or credit card with the bank to waive a monthly checking account fee. Nonbanks don’t do this and are more flexible with fees.

For instance, fees for a money order from a grocery store may be as low as $1. In comparison, replacing a lost or stolen bank debit card can often cost about $5 to $10, and domestic ATM withdrawal fees can cost another $2 to $3 on top of this.

Also, to waive the $15 monthly checking account fee, customers may be required to have a personal loan, mortgage, or credit card with the bank. On the other hand, picking up a money order while at the grocery store may be a much more affordable option, depending on your financial situation.

So, if you want to avoid high monthly fees or avoid opening multiple accounts at different institutions, depending on your financial standing, nonbanking institutions, such as money order providers, may be a more affordable alternative to traditional banks.

You may need a nonbank bank if you’re looking for financial services like money orders and bill paying, but also want a checking account. If your traditional bank doesn’t have what you’re looking for, shopping around and comparing costs could point you to another option.

Consider your goals and needs. If you don’t intend to apply for a mortgage or other large loan in the near future, it may be worth changing banks. A nonbank bank can help you with the specific services your banking needs call for. For example, if you need to cash a check with an amount larger than what your bank allows, you may find them a comfortable, safe and affordable option.

Conclusion

In general, a nonbank bank is a company that offers limited financial services and typically does not accept demand deposits. Nonbank banks can include mortgage lenders, payday loans, auto finance companies, and grocery store check cashing facilities, among others.

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