DEFINITION of 'Nonbank Banks'

Nonbank banks are financial institutions that are not considered full-scale banks because they do not offer both lending and depositing services. Nonbank banks can engage in credit card operations or other lending services, provided they do not also accept deposits.

The Bank Holding Company Act of 1956 prohibits nonbank companies from owning banks as subsidiaries, but they may own other nonbank banks.

BREAKING DOWN 'Nonbank Banks'

Many nonbank banks that allow deposits are insured by the Federal Deposit Insurance Corporation FDIC, and reserve requirement restrictions will apply to these institutions. Nonbank banking has expanded greatly in recent years, as non-financial institutions such as retail companies and auto makers have entered the lending business. Because many companies try to stretch the rules on banking rights, the U.S. government has massively restricted new chartering of nonbank banks since the late 1980s.

Examples of Nonbank Banks

One example of a nonbank bank is the women’s clothing line Ann Taylor offering customers a credit card for purchases. With the Ann Taylor credit card, customers are able to earn five rewards points for every dollar spent in stores or online. In addition, card holders will receive $20 reward cards for every 2,000 points earned, as well as a $15 birthday gift. With online access card holders can update their profiles, pay their bills, and view statements on desktop or mobile devices.

Providers of payday loans are also considered nonbank banks. A payday loan is a short-term, high-risk loan that is often taken out of a borrower’s next paycheck. Many payday lenders charge excessively high interest rates for these loans, making it very difficult for borrowers to pay back the principal and interest in an emergency situation. Payday lenders will often roll over loans into subsequent paychecks if a borrower cannot pay his or her debts on time, increasing the interest and compounding the risk. These loans are often called predatory loans as they take advantage of already vulnerable individuals and have a reputation for hidden provisions that charge added fees.

While some payday loans may be available online, most payday loan providers are typically small credit merchants with physical locations that allow onsite credit applications and approval. To complete a payday loan application a borrower typically provides recent paystubs. From there, lenders will generally base their loan principal on a percentage of the borrower’s predicted short-term income, using borrower’s wages as collateral.

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