Insurance Companies vs. Banks: Understanding the Difference – by Jose Miguel Artiles Caballos

Banks and Insurance Companies, both are considered as a type of financial intermediaries. However, even though they have a few similarities, they don’t have as much in common as one might think. The operations in both of these financial intermediaries are based on different models that create some notable differences between them. 

In this article, Jose Miguel Artiles Caballos, the director of Bandania Formula Capital LTD, explains the key differences between the two financial intermediaries, i.e. banks and insurance companies. 

To understand the differences between them, it is important to understand them individually. Now, we know that banks and insurance companies are both financial intermediaries, but their model of operation is different.

Insurance Companies :

An insurance company makes sure that its customers don’t face certain risks, such as the risk of having a car accident, or the risk of the house catching fire. In return for this risk insurance, the customers pay them regular insurance premiums. 

These premiums are managed by insurance companies by making suitable investments, thereby also operating as a financial intermediary between customers and the channels that receive their money. For example, an insurance company may channel the funds by investing in other securities, such as commercial real estate and bonds. 

Typically, insurance companies invest and manage the funds they receive from their customers for their benefit. It is important to understand that insurance companies do not create money in the financial system. 

Banks :

Banks operate differently than insurance companies. Usually, a bank takes deposits and pays interest for their use and also lends out the money to interested borrowers who typically pay a higher interest rate for the money they borrowed. 

Therefore, banks make money on the difference between the interest rate it pays you and the interest rate that it charges to borrowers. It effectively acts as a financial intermediary between people who save their money as deposits in the bank and investors who need money. 

Key Differences between Banks and Insurance Companies :

In the case of banks, they accept short-term deposits and offer long-term loans. This means that there is a huge mismatch between their liabilities and their assets. Now, suppose a large number of depositors want their money back, the bank might have to come up with the funds in a hurry. 

However, for an insurance company, its liabilities are based on certain insured events happening. The customers get a pay-out only if the event they are insured against happens, such as the house catching fire. Otherwise, they don’t have any claim on the insurance company. 

Furthermore, insurance companies tend to invest the premium money they collect for the long term. While it is possible to cash in certain policies prematurely, it is unlikely that a large number of people will want their money back at the same time, as it may happen in the case of banks. 

This only means that insurance companies are better positioned to manage their risk compared to the banks. 

Conclusion :

Jose Miguel Artiles Caballos, the director of Bandania Formula Capital LTD, is an expert in financial intermediaries and explains that even though both, banks and insurance companies are financial intermediaries they differ in terms of operation and carry different risk factors.