Topic 4: NonDeposit Taking Financial Institutions

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Topic 4 Non-Deposit Taking Financial
Institutions

• Insurance companies
• Unit trusts
• Investment Trusts
• Pension Funds
• Investment companies
• Informal Financial Institutions

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Insurance Companies

• Insurance companies are FIs that undertake
  business of assuring risks on behalf of their
  customers.
• Insurance companies are contractual firms unlike
  deposit-taking institutions
• Insurance companies make a profit by charging
  premiums that are sufficient to cover expected
  claims to customers plus a mark-up
• Insurance business is usually undertaking because
  of uncertainty that characterises life

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Basic fundamentals of Insurance

• There must be a relationship between the insured
  and the beneficiary. Also, beneficiary must be
  capable of suffering a potential loss or harm
• The insured must provide full and accurate
  information to the insurance company
• The insured is not to make profit as a result of
  insurance coverage.
• The loss covered by a policy must be quantifiable
• The insurance company must be able to compute the
  probability of occurrence of loss
• If a third party compensates the insured for a
  loss, the insurance company is reduced by the
  amount of the compensation
• An insurance company must have a large number of
  insured persons in order to spread risk among
  different policies.

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Types of Insurance

• Life insurance provides compensation for life
  disability, illness and retirement.
• - permanent life insurance (whole, universal
  and variable)
• - temporary life insurance (term)
• Products
• - annuity
• - endowment
• - term insurance
• - whole life
• - Universal
• - health insurance

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Classification of Life-Insurance products
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• Non-life insurance provides compensation for
  loss of properties accidents, fire or theft
• - property and casualty
• Health care insurance provides coverage for
  hospital stays, visits to physicians, and
  surgical operations.
• Unit Trusts (Mutual funds)
• - They are financial intermediaries that pool
  funds from small investors through the sales of
  shares, and then use the proceeds to in vest in
  financial securities.
• - Unit trusts has three components trustee,
  the management company and the unit holders

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• - the value of unit fluctuates according to the
  fluctuations in the underlying securities.
• - unit holders receive appreciations from share
  capital
• Types of trusts/funds
• - open end shares can be increased/reduced,
  new savers can join the trust
• - closed end fixed number of shares
• - Hedge fund
• - money market mutual fund
• - Exchange traded fund are designed to mimic
  stock indexes and are usually traded on a stock
  exchange just like stocks.

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Investment Trust

• - investment trusts are financial intermediaries
  that buys stocks on behalf of their customers
• - they specialise in the purchase of new issues
• - they have a fixed number of trust shares at
  every particular time period.
• - they maintain highly liquid securities.
• Pension Funds
• - they provide people with income during
  retirement.

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• - pension funds only serve those who contributed
  into the pool.
• Pension funds are usually invested in long-term
  securities bonds, stocks, mortgages.
• Pension funds are held in highly liquid and low
  risk assets.
• Pension funds my be in the form of
• Defined contribution plan
• Defined benefit plan
• Defined benefit fully funded plan
• Defined benefit under funded plan
• Pension funds may involve vesting
• Pension funds may be private or public.

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Investment Companies

• - Investment companies (banks) originate,
  structure, and place securities in the capital
  market to raise funds for corporations.
• They act as financial intermediaries rather than
  as a lender or investor, and they do not accept
  deposits.
• They receive fees as compensation for their
  efforts of raising funds.
• Investment companies underwrite and distribute
  shares, as well provide advising services.

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Finance Companies

• Finance companies are specialised FIs that
  provide short- and intermediate-term credit to
  consumers and small businesses.
• They raise funds through the sales of commercial
  papers, stocks and bonds.
• Finance companies are usually in the form of
• Sales Finance companies owned by companies for
  the purpose of providing sales credit to
  customers
• Consumer finance companies they may be owned by
  banks, or be a separate companies. They offer
  specific consumption loans
• Business finance companies provide loans and
  equipment leasing.

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Informal Financial Institutions

• IFIs are a feature of developing economies.
• They act as links a link between the formal FIs
  and individuals who do not have direct access to
  formal FIs credit facilities.
• IFIs are usually in the form of Rotating Savings
  and Credit Associations (ROSCAs).
• They are usually made up of members who doubled
  as savers and borrowers.
• A major problem of IFIs is high rate of loan
  default.