Non-bank depositary and insurance intermediaries: savings and loan association,

saving bank, credit union, insurance company

Financial institutions on the intermediation financial markets are primarily investors. The
hold and finance almost all the primary securities they purchase. The secondary securities
they sell may be divided into debt and equity. Debt securities may be further divided into
unconditional and conditional contracts. Unconditional debt is paid in full according to
the characteristics of the security, such as on maturity and coupon dates. Conditional debt
is paid according to the characteristics of the security and the nature of the future event
triggering the payment, such as death, retirement. Both types of debt may also be divided
by risk and by whether the market value of the security is fixed or variable.

Likewise, primary securities may be divided according to debt or equity, term to maturity,
and degree of risk.

The major types of private financial institutions are following:

- Savings and loan association
- Savings bank
- Credit union
- Life insurance companies
- Private pension fund
- Mutual fund
- Money-market funds

Non-bank financial intermediaries may be classified into four general types:

- Depositary
- Insurance
- Investment
- Other

Depositary Institutions

Non-bank depositary intermediaries sell secondary securities in the form of deposits.

Because the deposits are primarily time and savings deposits that encourage personal
saving, these intermediaries are frequently referred to as thrift institutions. Thrift
institutions invest principally in longer-term residential-mortgage loans. They compete
with commercial banks in both their deposit and lending activities.

Saving and loan association (SLAs) are primary specialized mortgage-lending consumer
thrift institutions. They are by far the largest single provider of residential-mortgage
loans. SLAs were initially organized in the mid-1800s by group of people who wished to
buy their own homes but did not have enough savings to finance the purchase. At the
time, neither commercial banks nor life insurance companies, the major financial
intermediaries of the day, lent money for residential mortgage. The member of the groups
pooled their savings and lent them back to a few members to finance their home
purchases. As the loans were repaid, funds could be lent to the other members of the
group.
The associations were organized on a mutual basis. Every member had voting power
proportionate to the size of his or her deposit. Because these institutions emphasized
lending, they were originally named building and loan associations. Through time, as the
demand for home building increased faster than member savings, the associations had to
expand beyond their own group to search for funds as well as to appeal to a broader range
of Surplus Spending Units. To publicize this change, the associations added savings to
their titles.

There are about 3,500 savings and loan associations in the USA, operating in every state.
SLAs have grown rapidly and are now the second largest intermediary after commercial
banks. Like commercial banks, SLAs can be chartered either by the federal government
or the home-state government.

The asset size of the average SLA is about $220 million, which is considerably larger
than the average commercial bank. SLAs have grown rapidly throughout most of the
period since World War II. However, in recent years, they have experienced severe
financial strains. SLAs engage in both credit and interest-rate intermediation. Fixed-rate
mortgages are longer-term investments. Until 1981, almost all residential mortgages were
fixed-rate mortgages (FRMs) on which interest rates do not change during the life of the
contract. On the other hand, most SLA deposits are shorter-term and must be “roll-over”
during the life of the mortgage. At these times, the interest rates paid can change.

Credit unions are the smallest yet the fastest-growing depositary institutions. They are
principally consumer-orientated savings institutions, organized as cooperative
associations among people who have common employment or geographical locations.
Credit unions exist at the business and government offices to serve the employees, at
neighborhood centers, and among professional and union groups. Most credit unions are
based on common employment. About 55 percent serve employees of private firms, 15
percent serve employees of government agencies, and 10 percent serve employees of
educational institutions. The remaining 20 percent are operated by social, fraternal, or
labour organizations. Often, the facilities and some of the time of the personnel are
donated by the employer or sponsor. Only 30 percent of the employees are full time, and
60 percent are volunteers. Credit unions are the only private intermediaries that are
completely exempt from federal income taxes.

Although their aggregate dollar size is small, there are many credit unions. At year- end
1983, there were about 19,000, 25 percent greater than the number of commercial banks,
five times the number of savings and loan associations, and 50 times the number of
saving banks. The average credit union has only 5$ million in assets, 1/25th as much as
the average commercial bank, 1/45th as much as the average SLAs and less than 1/100th as
much as the average savings bank. Like both commercial banks and SLAs, credit unions
can be chartered either by the state and federal government.

As in the other thrift institutions, the principal secondary securities of credit unions are
time deposits, called shares. The deposits may be insured up to $100,000 by the National
Credit Union Share Insurance Fund and about 90 percent of the credit unions are so
insured, almost all of the rest are insured by state agencies. Credit unions invest primarily
in small consumer loans to their shareholders. The balance sheet of all credit unions is
shown bellow.

Amount Percent

Assets
Cash 13 13
Government securities 30 29
Mortgage loans 6 6
Consumer loans 54 52
Total 103 100

Liabilities
Shares 95 92
Net worth 8 29
Total 103 100

Credit unions are the fourth largest provider of consumer and personal credits.
Commercial banks are the largest, followed by finance companies and life insurance
companies through loans to policyholders. As they have expanded, credit unions have
acquired permission to offer additional services, including mortgage and credit-card loans
and interest-bearing checking accounts, called share drafts. Credit unions are evolving
into complete household financial centers. Because of their small average size and the
volunteer nature of their management, credit unions tend to fail far more frequently than
other financial institutions.

Insurance intermediaries sell secondary securities in the form of insurance policies.

Insurance policies may be classified as conditional debt, they are paid at the time certain
stipulated conditions occur. Policyholders or their beneficiaries receive payment when a
stated event occurs that results in financial loss to the insured party- such as an accident,
theft, fire, injury, retirement or death. Policies pay premiums to the ranging from one day
to a lifetime. Policyholders pay premiums to the insurance intermediary for this
protection. The insurance company uses the proceeds form the premiums to buy primary
securities with maturities and risks that will permit them to pay the amounts of the
policies when required.

Losses from insured events tend to be large relative to the financial resources of the
person purchasing the insurance but small relative to the resources of the company. This
is so because the insurance company sells many policies on similar but independent
events, and by the law of large numbers, the probability that a large loss will occur at any
given time is small. The insurance company reduces its exposure to risk by diversifying
and not “putting all its cars on the same highway at the same time”.

Policyholders purchase insurance in order to share with others the risk of loss in any one
period and avoid the experience of a large sudden loss that would produce severe
financial strains. The cost of the loss is spread over a long period and is thereby less
painful. At times, the insured event may occur early in the policy period when premiums
paid in are small relative to the loss, and the policyholder ends up gaining. At times, the
insured event may occur late in the policy period after most of the premiums have been
paid. Then the cost of insurance in high relative to the loss. In many cases, there may
never be a loss. Then, in retrospect, the policyholder would have been better off without
insurance. In addition, the insurance company may reduce risk further by prescribing
conditions for insurance that reduce either the probability that an event will occur or the
dollar amount of the resulting loss; for example, burglar and fire alarms, or safety
equipment. As a result of all the factors above, it is often efficient for individuals to shift
risk to the insurance company.

The insurance company charges a premium for assuming the risk. The size of the
premium is computed by first multiplying the probability that the particular event will
occur in a specified period by the financial value of the loss, then subtracting the
expected income the company derives from investing the premiums received until
payment is required, and finally adding the cost of operations and a target profit amount.
The greater the expected earnings, the lower the premium. If the premium is correctly
estimated, the sale of insurance is profitable. If it is underestimated, losses will be
realized. However, insurance companies may not sell policies for all risks. Events for
which probabilities cannot be computed with confidence or for which the financial loss is
too large for any one or group of private insurance sellers, are termed uninsurable risks.

Like depositary intermediaries, insurance intermediaries tend to specialize in particular

segments of the market. Life insurance companies specialize in assuming the risks of
income losses due to death, illness, or retirement, casualty insurance companies assume
risks primarily attributed to personal or property injury. The probabilities that different
types of events will occur differ and cannot be estimated with equal confidence.

For example, the probabilities that any person in U.S. will die at any particular age are
well defined on the basis of a large number of historical observations and only slow
changes in the causes of death. On the other hand, the probabilities of losses from
automobile accidents are more difficult to compute and depend on more rapidly changing
factors, such as speed limits, the price of gasoline, the cost of repairs, and the design of
automobiles. As a result, insurance companies selling different types of secondary
securities and assuming different kinds of risks will purchase different typed of primary
securities in order both to be able to pay the insurance claims when required and to
maximize their return.

Life insurance companies are the oldest type of intermediary in the U.S. The first life
insurance company was organized in 1759 in Philadelphia, almost 20 years before the
independence of the U.S. from Great Britain and 23 years before the first commercial
bank.

Most people purchase life insurance for their remaining life or working years. Thus, the
maturities are long-term. Life insurance companies invest primarily in longer-term,
taxable, not highly marketable primary securities, such as corporate bonds and
commercial mortgages. The federal tax code permits life insurance companies to exempt
from taxable income that income that will in time be paid to the policyholders. It is
viewed as a return on the policyholders investment. Life insurance companies major
investments are in corporate bonds and commercial mortgages.