Today's dumb question(s) from teaching monetary and financial institutions:
1. What is the difference between a "depository" and a "non-depository" financial institution?
2. Why is that difference economically important?
The textbook I am using (by Stephen Ceccetti and Angela Redish) makes this distinction, and has a separate chapter discussing each of the two types of financial institutions. It gives examples of the two types of financial institutions, but it doesn't really define what the difference is, or say why it is economically important. An internet search is giving me lots of very similar results. I sense that a lot of people make this distinction and think it is important. But I don't get it.
The usual answer I find goes something like this: "a depository institution accepts deposits, while a non-depository institution does not accept deposits". It then lists examples of "depository" institutions (banks, credit unions, savings and loans); and examples of "non-depository" institutions (mutual funds, pension companies, insurance companies).
But what is the definition of a "deposit"? I can "deposit" $1,000 in my chequing or savings account or in a term deposit at my bank (a "depository" financial institution). But can't I also "deposit" $1,000 in my mutual fund or pension plan?
I can "deposit" my grandfather's watch, or my $1,000 in Bank of Canada notes, in a safety deposit box. And then return later and get back the exact same watch or banknotes I deposited. Unless there's a fire, or someone (including the bank) has stolen them. I know exactly what "deposit" means in that case. But that's not what modern banks do with our money. Even banks with 100% reserves don't do that exactly (though what they do is economically equivalent, since I don't care whether the serial numbers on the notes I get back match those on the notes I deposited).
Pawnshops would be a perfect example of "depository" institutions under that definition, but they seem to be counted as examples of "non-depository" institutions.
Maybe what they mean by "deposit" is when I "deposit" $1,000 the bank promises to give me back exactly $1,000, even if it's not the exact same notes with the exact same serial numbers. But that definition doesn't work when there is interest on deposits.
Maybe what they mean by "deposit" is: when I "deposit" $1,000 the bank promises to give me back some fixed amount of money, where the amount promised is not contingent on anything. If that's how we define "deposit", then a defined benefit pension plan is not a "deposit", since the total amount paid to me depends on how long I live, so the definition works in that example to rule out pension companies as "depository" institutions. But a fixed term annuity, that was paid out to me or my heirs, would count as a "deposit" under that definition. And if I bought a Bank of Montreal bond that would also count as a "deposit" under that definition.
(And a term deposit is no different from a discount bond in that sense, because both promise to pay a fixed amount of money at a fixed future date. And a demand deposit paying a variable rate of interest is no different from a money market mutual fund that implicitly promises never to "break the buck" in that sense either. Nor is buying shares in an equity mutual fund that included sufficient put options to prevent the value of those shares at some future date dropping below the initial "deposit".)
I can't come up with a definition of "deposit" that would work to divide financial institutions into "depository" and "non-depository" institutions to match the lists of examples of each. And even if I could come up with a definition that did work, I'm not at all sure it would be an economically relevant distinction.
I'm beginning to think it is a legal distinction rather than an economic distinction, and it reflects a difference in how the two are regulated. Which suggests that those regulatory differences might not make economic sense.
My preferred distinction would be between financial institutions whose liabilities are and are not used as media of exchange. Some financial institutions issue money, and some do not, and that is an economically important distinction. The liabilities of pawnshops and mutual fund companies (their receipts) are not used as money, but the liabilities of banks (or some of their liabilities) are used as money (whether they be 100% or fractional reserve banks).
Over to you guys. Maybe one of you can make sense of it.