Insurance Companies vs. Banks: What’s the Difference?

policy Companies vs. Banks : An overview

Both banks and indemnity companies are fiscal institutions, but they don ’ t have ampere much in common as you might think. Although they do have some similarities, their operations are based on different models that lead to some noteworthy contrasts between them .

While banks are subject to federal and department of state oversight and have come under greater scrutiny since the 2007 fiscal crisis that led to the Dodd-Frank Act, indemnity companies are submit only to state-level regulation. respective parties have called for greater federal regulation of insurance companies, particularly considering that American International Group, Inc., ( AIG ) an insurance company, played a major function in the crisis.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed by the Obama Administration in 2010, established newly government agencies in care of regulating the banking organization. President Trump pledged to repeal Dodd-Frank and in May 2018, the House of Representatives voted to repeal aspects of the Act .

Key Takeaways

  • Banks and insurance companies are both financial institutions, but they have different business models and face different risks.
  • While both are subject to interest rate risk, banks have more of a systemic linkage and are more susceptible to runs by depositors.
  • While insurance companies’ liabilities are more long-term and don’t tend to face the risk of a run on their funds, they have been taking on more risk in recent years, leading to calls for greater regulation of the industry.

Insurance Companies vs. Banks
Investopedia / Sabrina Jiang

insurance Companies

Both banks and policy companies are fiscal intermediaries. however, their functions are unlike. An indemnity company ensures its customers against certain risks, such as the risk of having a car accident or the hazard that a theater catches on arouse. In return for this insurance, their customers pay them unconstipated indemnity premiums .

insurance companies manage these premiums by making suitable investments, thereby besides functioning as fiscal intermediaries between customers and the channels that receive their money. For case, policy companies may channel the money into investments such as commercial real number estate and bonds .

insurance companies invest and manage the monies they receive from their customers for their own benefit. Their enterprise does not create money in the fiscal system .

Banks

Operating differently, a bank takes deposits and pays concern for their use, and then turns about and lends out the money to borrowers who typically pay for it at a higher interest rate. frankincense, the bank makes money on the deviation between the sake pace it pays you and the interest rate that it charges those who borrow money from it. It effectively acts as a fiscal mediator between savers who deposit their money with the bank and investors who need this money .

Banks use the monies that their customers deposit to make a larger base of loans and thereby create money. Since their depositors demand only a assign of their deposits every day, banks keep only a fortune of these deposits in reserve and lend out the rest of their deposits to others .

Key Differences

Banks accept short-run deposits and make long-run loans. This means that there is a mismatch between their liabilities and their assets. In casing a large number of their depositors want their money back, for case in a bank run scenario, they might have to come up with the money in a rush .

For an policy company, however, its liabilities are based on certain cover events happening. Their customers can get a payout if the event they are insured against, such as their house burning down, does happen. They don ’ t have a claim on the indemnity company otherwise .

policy companies tend to invest the agio money they receive for the long-run so that they are in a position to meet their liabilities as they arise. While it is possible to cash in sealed insurance policies prematurely, this is done based on an person ’ s needs. It is unlikely that a identical large number of people will want their money at the like fourth dimension, as happens in the case of a run on the bank. This means that indemnity companies are in a better position to manage their gamble .

Another remainder between banks and insurance companies is in the nature of their systemic ties. Banks operate as part of a wide-eyed deposit arrangement and have access to a centralized payment and clearing constitution that ties them together. This means that it is possible for systemic contagious disease to spread from one bank to another because of this screen of interconnection. U.S. banks besides have access to a central bank organization, through the Federal Reserve, and its facilities and accompaniment .

indemnity companies, however, are not separate of a centralized clear and requital arrangement. This means that they are not as susceptible to systemic infection as banks are. however, they don ’ t have any lender of last recourse, in the sort of role that the Federal Reserve serves for the bank system .

special Considerations

There are risks pertaining to both interest rates and to regulative control that impact both policy companies and banks, although in different ways .

interest pace risk

Changes in interest rates affect all sorts of fiscal institutions. Banks and insurance companies are no exceptions. Considering that a bank pays its depositors an concern rate that is competitive, it might have to hike its rates if economic conditions warrant. broadly, this gamble is mitigated since the bank can besides charge a higher interest rate on its loans. Changes in interest rates could besides adversely impact the value of a bank ’ sulfur investments .

policy companies are besides subject to pastime rate risk. Since they invest their premium monies in diverse investments, such as bonds and very estate of the realm, they could see a decay in the value of their investments when concern rates go up. And during times of low-interest rates, they face the hazard of not getting a sufficient return from their investments to pay their policyholders when claims come due .

Regulatory Authority

In the United States, banks and policy companies are subject to different regulative authorities. National banks and their subsidiaries are regulated by the Office of the Comptroller of the Currency ( OCC ) .

In the case of state-chartered banks, they are regulated by the Federal Reserve Board for banks that are members of the Federal Reserve System. As for other state-chartered banks, they fall under the horizon of the Federal Deposit Insurance Corporation, which insures them. versatile state trust regulators besides supervise the state banks .

indemnity companies, however, are not topic to union regulative authority. alternatively, they fall under the horizon of diverse state of matter guarantee associations in the 50 states. In case an policy company fails, the state guarantee ship’s company collects money from other policy companies in the state to pay the fail company ’ second policyholders .

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