Banking vs Insurance: How do they differ in terms of purpose and scope?

A nation’s economy, well-being, stability, and success depend upon the important institutions of banking and insurance. Effective banking ensures that credit is passed on to business ventures that can effectively utilise this credit and create powerful growth engines that increase the prosperity of a nation.

Effective insurance ensures that the risk is born by the people and institutions that are capable of bearing these risks, ensuring stability in an economy, as the risk is transferred from people and individuals to institutions, it inherently increases the stability of a nation.

Let us now talk about some of the most important aspects of banking and insurance, including similarities and differences, among other topics.

• Purpose and Scope of Banking and Insurance
• Risk Management in Banking vs. Insurance
• Types of Products Offered
• Regulation of Banking vs. Insurance

Purpose and Scope of Banking and Insurance

Purpose and Scope of Banking

Let us talk about the most important purposes and scope of banking.

• Effective lending: The fundamental purpose of a bank is to make money. How does it do this? It earns a profit if it lends effectively. The interest the bank earns through loan disbursements is their primary source of its income. Further, effective lending ensures that large and small businesses receive the credit that they require for business expansion as well as short-term credit requirements.
• Mode of payment: Money, along with being a store of value, is also a mode of payment. Banks ensure the smooth facilitation of modes of payment through technologies like wire transfers, NEFT / RTGS, credit and debit cards, and more. This ensures that money is sent where it needs to be sent.
• Managing inflation: Banks also have the role of controlling inflation in a country. This is, however, an indirect role, as the reserve bank of a nation decides on the rate of inflation and advises banks to adhere to certain terms and regulations that ensure that inflation in a nation is at a certain pre-determined rate.
• Vehicle of saving and investment: Banks also act as vehicles of savings and investments, as customers can put their money in a variety of savings and investment vehicles to earn interest on their principal. Some instruments include savings accounts, term deposits, recurring deposits, and beyond.
• Dispersion of money: The reserve bank of a nation creates the money, and the banks ensure that this money gets effectively dispersed within an economy.
• Facilitates international trade: Banks facilitate international imports and exports in a variety of ways. Some of the ways include conversion of foreign exchange, issuing bankers checks, giving bank guarantees, and beyond. Businessmen use these avenues to further their trade endeavours.

Purpose and Scope of Insurance

Let us talk about the most important purposes and scope of insurance.

• Effective risk bearing: Handling and managing risk is of fundamental importance to an insurance company. It exists for the purpose of transferring risk from individuals and entities to insurance companies. The risk gets transferred from weak hands to stronger hands that are capable of bearing such risks. Further, an insurance company even goes beyond and hands their risk over to reinsurance companies, thereby even reducing their own risk exposure. You can even learn about reinsurance and get an understanding of how it works.
• Creates stability: Risk creates uncertainty and instability if it is born by a person or entity that can’t handle it. Insurance and reinsurance companies are specifically geared and primed to handle such risks, thereby creating an environment of stability in a country.
• Business stability: Business, by its very nature, is risky. Some of the risks can, however, be mitigated by transferring them to an insurance company, thereby reducing the risk of a business and increasing its stability.
• Instrument of investment: Modern insurance policies can even act as an instrument of investment along with coverage. These plans are called unit-linked insurance policies (ULIP).

Risk Management in Banking vs. Insurance

Risk Management in Banking

• Credit risk: This is the fundamental risk of banking. A bank lends to an individual or a corporation with the goal of earning interest and receiving the principle amount back. There are, however, cases where the bank is unable to recover the interest and even has to forego the principle amount, thereby resulting in a non-performing asset (NPA). Banks have to ensure that their NPAs do not go above a certain threshold to ensure the bank’s stability and survival.
• Liquidity Risk: Liquidity risk essentially means the inability of a bank to maintain its day-to-day operations due to a lack of money. Liquidity risk generally means poor management of funds.
• Operational Risk: There are certain inherent operational risks, such as acts of fraud, acts of terror, natural disasters, and beyond. Banks need to be cognizant of them and ensure that appropriate measures are taken to mitigate them.
• Market Risk: Market risks are risks that crop up due to changing market environments, such as changes in foreign exchange rates or fluctuations in interest rates.

Risk Management in Insurance

• Underwriting Risk: This is the fundamental risk in insurance. If an insurance policy is not effectively underwritten, there is a risk to the stability of the insurance company. The underwriter of an insurance company needs to look at a variety of important aspects to ensure that effective insurance underwriting happens.
• Catastrophic Risk: There are certain catastrophic risks, such as floods, earthquakes, tsunamis, forest fires, and beyond, that can lead to a massive inflow of claims in a very short time. This could lead to the insurance company going bankrupt. How can such a catastrophic risk be handled? The answer is reinsurance.

Types of Products Offered

These are some of the general products and services offered by banks and insurance companies.

Regulation of Banking vs. Insurance

It is critical that banks and insurance companies are subject to a certain amount of oversight and regulation, as they can have a massive impact on the economy and thereby the nation.

Regulation of Banking

Indian banks are regulated by the Reserve Bank of India. The RBI subjects Indian banks to a variety of checks and regulations with the aim of creating stability in the banking sector. These regulations include:

• Setting of interest rates
• Auditing banks
• Setting the monetary policy
• Foreign exchange stability
• Developing the banking sector

The US banking sector is primarily regulated by the Federal Reserve, commonly referred to as the Fed.

Regulation of Insurance

The Indian insurance sector is regulated by the IRDA of India. The IRDA of India places a variety of regulations on insurance companies operating in India, such as:

• Auditing of insurance companies
• Regulation of premiums
• Issuing insurance licences
• Develop the Indian insurance sector.

We hope that through this article you have gotten a satisfactory understanding of banking and insurance and the purpose, scope, and differences between the two.