These financial institutions are known as nonbank financial businesses (NBFCs). The general public is not permitted to place conventional demand deposits (also known as monies that are immediately accessible, such as those found in checking or savings accounts) in these types of financial organizations. Because of this constraint, they are not subject to the traditional scrutiny of federal and state financial authorities. This means that nonbank financial companies are subject to the oversight of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Understanding NBFCs
According to the Dodd-Frank Wall Street Reform and Consumer Protection Act, there are three kinds of nonbank financial companies. These are foreign nonbank financial companies, U.S.
Foreign Nonbank Financial Firms
Firms that are not banks but deal in financial transactions but are based outside of the United States and have their headquarters outside the country are called foreign nonbank financial companies. Foreign financial institutions that aren't banks may have branches in the United States.
U.S. Nonbank Financial Firms
Nonbank financial businesses based in the United States, like their nonbank counterparts based in other countries, are primarily involved in nonbank financial operations but have been established or formed in the United States. Nonbank financial institutions in the United States are not allowed to participate in the Farm Credit System, national securities exchanges, or any other form of financial organization.
The Shadow Banking System and the Financial Crisis Of 2008
Long before the Dodd-Frank Act was passed, NBFCs were already in existence. In 2007, economist Paul McCulley, who was at the time the managing director of Pacific Investment Management Company LLC (PIMCO), gave them the name "shadow banks" to describe the expanding matrix of institutions that were contributing to the then-current easy-money lending environment. This, in turn, led to the collapse of the subprime mortgage market and the subsequent financial crisis that occurred in 2008.
Traditional banking institutions were under increased regulatory scrutiny as a direct consequence of the subsequent financial crisis, which resulted in a protracted reduction in the amount of money they could lend to customers. When the authorities increased their scrutiny of the banks, the banks, in turn, increased their scrutiny of anyone applying for loans or credit.
The Controversy over NBFC
Those who favor nonbank financial companies (NBFCs) claim that these organizations play a significant part in satisfying the growing demand for credit, loans, and other financial services. Customers might be people or enterprises, particularly those who would have difficulty qualifying for a loan under the more severe conditions that regular banks often impose.
Proponents argue that nonbank financial companies (NBFCs) provide alternative sources of credit and offer more effective sources. Disintermediation is the process by which nonbank financial companies (NBFCs) eliminate the need for a middleman, which banks typically fill. As a result, customers may do business with NBFCs directly, reducing expenses, fees, and interest rates. It is essential to maintain a healthy economy and a liquid money supply, both of which may be accomplished via the provision of funding and credit.
Pros
- Alternative methods of obtaining loans and financing
- Direct interaction with customers, without going through any middlemen
- Profitability on the part of the investor
- Providing the financial system with liquidity
Cons
- Non-regulated and exempt from any supervision
- activities that are not clear
- threat to the economy and the financial system as a whole
Despite this, skeptics are worried that nonbank financial companies (NBFCs) are not accountable to authorities and can operate outside the specific laws and regulations governing banking. If they are public companies, they may be subject to the Securities and Exchange Commission (SEC) supervision. If they are brokerages, they may be subject to the Financial Industry Regulatory Authority (FINRA) supervision. Both of these regulatory agencies are discussed further below. In other circumstances, on the other hand, they may be able to get away with operating without full openness. The whole situation can potentially place an increasing burden on the monetary system. The nonbank financial companies (NBFCs) were at the core of the financial crisis that began in 2008 and contributed to the Great Recession. Those opposed to it point out that since then, their population has grown, and as a result, they pose a larger threat than they ever have before.
An NBFC in the Real World as an Example
Mortgage lender Quicken Loans and investment management company Fidelity Investments are both examples of companies that meet the criteria to be classified as NBFCs. Peer-to-peer (P2P) lending, on the other hand, has been the subset of the nonbank lending industry that has been expanding at the quickest rate. The power of social networking, which connects individuals with similar interests from all over the globe, has been a major driving force behind the expansion of peer-to-peer lending. (LC), StreetShares, and Prosper, are intended to link people interested in borrowing money with others who are prepared to invest their money in loans that have the potential to provide large returns.
