THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 320

CHAPTER 12

Nonbank Financial Institutions

LEA RNI NG OB JECTI VES
After studying this chapter you should be able to
1. identify the difference between banks and nonbank financial institutions
(insurance companies, pension funds, finance companies, mutual funds, and
investment banks)
2. explain the regulation of nonbank financial institutions in the context of asymmetric information problems
3. report how recent financial-sector legislation is expected to lead to larger and
increasingly complex financial groups, engaging in a full gamut of financial
activities

PRE VI EW

Banking is not the only type of financial intermediation you are likely to
encounter. You might decide to purchase insurance, take out an instalment loan,
or buy a share of stock. In each of these transactions you will be engaged in nonbank finance and will deal with nonbank financial institutions. In our economy,
nonbank finance also plays an important role in channelling funds from lendersavers to borrower-spenders. Furthermore, the process of financial innovation we
discussed in Chapter 11 has increased the importance of nonbank finance and is
blurring the distinction between different financial institutions. This chapter examines in more detail how institutions engaged in nonbank finance operate, how
they are regulated, and recent trends in nonbank finance.

IN SU RAN CE
Every day we face the possibility of the occurrence of certain catastrophic events
that could lead to large financial losses. A spouse s earnings might disappear due
to death or illness; a car accident might result in costly repair bills or payments to
an injured party. Because financial losses from crises could be large relative to our
financial resources, we protect ourselves against them by purchasing insurance
coverage that will pay a sum of money if catastrophic events occur. Life insurance

companies sell policies that provide income if a person dies, is incapacitated by
illness, or retires. Property and casualty companies specialize in policies that pay
for losses incurred as a result of accidents, fire, or theft.

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