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Introduction

Nonbank financial institutions play a vital role in the flow of money and credit within the financial system, especially the home mortgage market and the market for personal savings.

Recently however, both bank and nonbank financial institutions are “converging” in terms of the services they offer and the markets they serve.

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Savings and Loan Associations

Savings and loan associations (S&Ls) are among the largest of all thrift institutions, accepting deposits and extending loans and other services primarily to household customers.

S&Ls emphasize longer-term loans, especially mortgage loans.

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Savings and Loan Associations

S&Ls began essentially as a single-product industry in the early 19th century, accepting savings deposits from middle-income individuals and families and lending those funds to home buyers.

Later, competition from other financial institutions, deregulation, and many failures, forced S&Ls to diversify their operations and aggressively solicit new customers.

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Savings and Loan Associations

The sharp decline that followed was the result of large numbers of failures and the conversion of some S&Ls into other kinds of financial institutions, most notably commercial banks and savings banks.

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Savings and Loan Associations

One primary cause for the low profitability of S&Ls during the 1980s and 1990s was that many S&L assets (fixed-rate mortgage loans) were interest-rate insensitive while most of their liabilities (deposits) were highly sensitive to interest rates.

So, during periods of rapidly rising market interest rates, the industry’s net interest margin were severely squeezed.

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Savings and Loan Associations

S&Ls need sound diversification decisions, carefully managed loan portfolios, risk management, and further relaxation of government regulations.

Today, more aggressive S&Ls are branching out in at least three different directions – real estate models, family financial centers, and diversified models.

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Savings Banks

Savings banks began in Scotland in the early 19th century, and then took root in the U.S. about 150 years ago to meet the needs of the small saver.

Like S&Ls, they play an active role in the residential mortgage market. However, they are more diversified in their investments, purchasing corporate bonds and common stock, making consumer loans, and investing in commercial mortgages.

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Savings Banks

The number of savings banks operating today is small – at most a few hundred.

They are scattered throughout the U.S., though they are most prominent in the New England and the Middle Atlantic states.

The distinction among S&Ls, savings banks, and commercial banks is becoming blurred, especially because they are readily convertible from one form to another.

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Savings Banks

The savings bank industry faces a number of problems that will significantly affect its future as a conduit for savings and investment.

In particular, savings banks have inflexible asset structures and face competition from other financial institutions.

Their future growth depends on their ability to gain the necessary changes in government regulations to allow them to respond to changing financial market conditions.

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Credit Unions

Credit unions are cooperative, self-help associations of individuals, and savings deposits and loans are offered only to members of each association.

Credit unions came to the U.S. in 1909, and their long-run survival stems mainly from their being able to offer low loan rates and high deposit interest rates and from their relatively low operating costs.

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Credit Unions

Credit unions are organized around a common affiliation or bond among their members. Most members work for the same employer, or for one of a group of related employers.

There is a strong shift today toward fewer, but larger, credit unions. The decline is due primarily to mergers, failures, and a structural shift in the U.S. economy from manufacturing industries toward more service industries.

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Credit Unions

U.S. credit unions are under intense pressure to develop new services and penetrate new markets due to increasing competition from other financial institutions and a decline in the demand for their historically most important credit service – automobile loans.

However, the industry has repeatedly shown its capacity for service innovation and its ability to compete successfully for both consumer loans and savings accounts.

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Money Market Funds

In 1972, the first money market mutual fund – a financial intermediary pooling the savings of individuals and businesses and investing those monies in short-term, high-quality money market instruments – opened for business.

The fund offered share accounts whose yields reflect prevailing money market rates. In contrast, the interest rates on most bank deposits were then restrained by government regulation.

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Data Source: Board of Governors of the Federal Reserve System

Money Market Funds

On the whole, money market funds hold high-quality assets. The short maturity of the assets results in a highly liquid security portfolio that can be adjusted quickly to suit changing market conditions.

They are mostly “no load” funds – there is no commission charge for opening an account, purchasing more shares, or redeeming shares. The accounts can be accessed easily too.

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Money Market Funds

Today, money market funds serve as cash-management vehicles where market rates can

be earned on funds used for daily transactions; tax-sheltering vehicles (when tax-exempt funds

are chosen); a temporary repository for liquid funds; and a safety haven for savings.

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Money Market Funds

However, note that money market fund share accounts are not government insured.

The differential between the yield on the accounts and the rate of return on money market deposits at banks has also narrowed in recent years.