Insurance and banking are two important activities in the financial industry. However each of these functions in a different way from the other. Whereas the banking is a constant and dependable institution that is uniform for a specific segment, insurance is based on a variety of subjective variables which have different and outcomes for different individuals. The operations of banking and insurance business are based on different financial models which have some contrast features.
The banks are regulated by the Reserve Bank of India which is the apex body to supervise and monitor their day to day operation. The insurance sector is regulated by the IRDA (Insurance and regulatory and Development Authority). Both banking and insurance companies are financial intermediaries.
An insurance company ensures its customers against certain risk and compensates their financial loss in the event of the occurrence of a certain event in return of certain regular fee received from the customer which is known as premium. The insurance company invest this collection of a pool of money in the economy in form of financial instruments like equity, bonds, etc. or directly invest into real estate for generating short term and long term profits. They do not necessarily create money in the financial system, unlike banks.
The primary function of the bank is to accept deposits from individuals or corporate and lend to those who need it on interest. It acts as an intermediary between those who save the money and borrowers who need the money. The banks make a profit out of the difference of interest that it gives to the depositors and the interest it charges from the borrowers.
Since the banks give the collected deposits to those who need it on interest, the bank in a way creator money into the economy.
In the insurance business, there are four major principles under which it operates. The first is the good faith in the system. The second is the presence of insurable interest. The third is the indemnity, both subrogation and contribution. The fourth is the proximate cause. The insurance company gives detailed information’s, risks and rates of insurance premium. If the insured incurs the loss, the principle of indemnity allows the insured to be in the same position he was in earlier, before when the loss is incurred.
Banking has several types of services that allow a customer to retain liquidity. This means that the money in a bank’s account of a customer is repayable at any time on demand in most of the cases. Whereas in, insurance the premium or money invested for a term specified in the agreement and is payable only in case of occurrence of the certain event causing financial loss or at the expiry of the term.
Banks accept short term deposits and give long term loans. It means that there is a mismatch between their assets and liability.
Both banks and insurance business may have the risks of liquidity. In the case of a catastrophic situation, a large member of claims may arise and thus causing a rise in reinsurance market price. Since banks use a large amount of leverage, they are exposed to liquidity risk, credit risk, and interest rate risk, etc.
The marketization and globalization of economy have brought the banking and insurance sectors to operate in close proximity. Till recently both were treated as separate entities, but today a lot of banks also offer insurance as investment products, linking them with saving components. Such institutional re-positioning has brought the two industries of banking and insurance much closer in term of financial operation.