Short definitions of the types of financial institutions
You probably know about the two kinds of banking options that most people use: credit unions and banks. However, you may not know that much community development lending is funded by other financial institutions that you can’t support through deposits. This distinction divides financial institutions into two categories of depository and non-depository. Although we almost entirely bank at depository financial institutions like banks and credit unions, it’s important to remember that other kinds of lending are happening in our communities, and even though many people don’t have as easy access as they do to a checking account, you may want to look at working with one of these kinds of financial institutions to make an even bigger impact with your money.
Here are different kinds of financial institutions where individuals and businesses can invest their money, and each will use your funds differently.
Depository institutions-
Despite the fact that they don’t work directly with individuals, central banks must be mentioned because of their importance in the functioning of economies. Central banks are federal institutions, like our Federal Reserve Bank, which oversee and regulate other financial institutions and help them provide financial products and services.
While commercial banks provide products mostly to businesses, corporations, or other larger institutional organizations, and retail banks provide products to individuals, they both fall under the category of traditional banks. They’re privately owned and operated, and provide basic banking services such as checking and savings accounts, business or mortgage loans, certificate of deposits (CDs), or consumer loans. Traditional banks are for-profit, and their goal is to make their shareholders as much money as possible.
Credit unions only extend membership to a specific group of people, for example people that live within a certain area or those employed by a certain company. They typically offer the same products and services as traditional banks, but are cooperatively owned and operated, meaning that each member has a say in how the institution is run, instead of the board being directly responsible to the shareholders of the bank. Credit unions, unlike banks, are non-for-profit, meaning that the institution itself only makes enough profit to pay maintenance costs, and there are no shareholders to appease.
Online banks offer the same products and services as traditional banks and credit unions, but because they don’t have the same maintenance costs as banks- mainly maintaining the brick and mortar buildings and the employees who work in them- they may have lower or fewer fees. They’re also accessible to anyone with an internet connection, making it possible for even those in isolated locations to have banking options.
Both mutual savings banks and savings and loan associations are similar to banks, but with more specific purposes. They both pool the money of individuals in their community in order to make loans. For savings and loan associations, most of the loans will be mortgage loans, while mutual savings banks’ loans can be for just about anything an individual might need. Both of these institutions emphasize savings accounts, which allow them to use the collected savings for lending.
Non- depository institutions-
The main type of non-depository institution that we’d like to talk about (and that is possible for most people to invest in or contribute to) are community development loan funds. These are non-for-profit institutions, like credit unions, and can be designated CDFIs. Their objective is to give smaller, short term loans to borrowers who would be considered “high-risk” by traditional lenders, but most loan funds have a fantastic rate of return. Community development loan funds can finance mortgages, emergency loans, and more, but typically do more small business lending than anything. They get this capital from banks, grants, donations, and community development networks and organizations, but unlike money kept in depository institutions, any money in a loan fund isn’t insured by the FDIC or the NCUA, which means that loan funds are unable to leverage their assets, and instead can only lend out the assets they currently have.
Similar to loan fund lending is microcredit lending, which is primarily small business loans to “high-risk” borrowers, but in the microcredit model, these borrowers are from countries where there’s not a lot of lending capital to go around. While they make similar kinds of loans, the main difference between loan funds and microcredit lending is that microcredit is internationally focused, and because of this, is unable to receive any kind of federal funding or support.
Mutual funds or investment banks/companies are financial institutions which pool the assets of individuals and institutions to allow them to participate in the securities market, meaning they can buy and sell stocks. Their primary goal is to help participating groups raise capital through these securities. Essentially, this is a portfolio of stocks and bonds, owned by a collective, managed by the mutual fund.
Brokerage firms are similar to mutual funds or investment banks in that they help individuals build capital through securities, but instead of pooling the resources of many small investors, these companies help large investors manage their personal portfolio. They essentially act as middlemen between buyers and sellers of stocks and securities.
Although you might not think of insurance companies as in the same category as banks, both are there to protect your finances. Insurance companies protect you and your family from financial loss in the case of death, illness, disability, natural disaster, and other misfortunate occurrences, by transferring risk of loss.
Finance/mortgage companies are non-depository financial institutions that provide loans, leasing, project financing, and other kinds of real estate financing, either to an individual or to a corporation or company. Their key difference from banks is that they do not receive cash deposits from clients, nor do they provide banking services like checking accounts.
While everyone needs basic banking services like a checking or savings account, non-depository financial institutions are important to know about as well as they contribute to the overall health of our economy, and depending on the exact institution, they can be a great way to make your investment portfolio ethical and effective in your communities, in addition to your banking practices.