Insurance and banking are two important processes of the financial system. However, each of these functions in a different way from the other. Whereas banking is a constant and dependable institution that is uniform for specific segments, insurance is based on a variety of subjective variables, which makes it a different experience for different individuals.
Principles of Banking
Banking consists of two major components, lending and borrowing. Banks rely much less on their own capital when compared to the total volume of the financial transactions performed. Though banks do maintain a reserve, they mainly use the funds obtained by the deposits that their customers make. The reserves are simply maintained as a precaution against losses such as failed loans.
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Principles of Insurance
There are four main principles by which insurance operates. The first is utmost faith in the system, the second is insurable interest, the third is indemnity--both subrogation and contribution--and finally, there is proximate cause. Insurance companies give material information on the risks and rates of insurance premiums. If the insured incurs a loss, the principle of indemnity allows the insured to be placed in the same position he was in earlier, before the loss was incurred.
Banking has several types of services that allow a consumer to retain liquidity. This means that the money in the bank account of a person can be removed at any point in time, depending on the type of account. In insurance, however, the money is invested for a term period, and is only made available when the term period is finished or as indemnity.
Insurance is a big business and deals with many people. If there is a catastrophe and large numbers of repayments have to be made, there is a high chance that a shortage of funds will drive up the prices in the reinsurance market. Since banks use a large amount of leverage, they are exposed to liquidity risks, credit risks and interest rate risks.
Meeting of Banking and Insurance
The marketization and globalization of finance have allowed the banking and insurance sectors to work very closely. While there was a time when these two were separate entities, today, a lot of banks also offer insurances as investment opportunities, linking them with savings components. The institutional reposition of finance has played a major role in bringing the two industries closer.