What Is a Nonmember Bank?

Nonmember Banks Explained in Less Than 5 Minutes

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Nonmember banks are commercial banks that are not members of the Federal Reserve System. While national banks must join the Federal Reserve, it’s not a requirement for state banks. Still, many state banks can and do join.

Even though some banks are not members of the Federal Reserve System, these institutions are still regulated by the Fed. This means such banks can still take advantage of services like check clearing, wire transfers, and short-term loans even if they do not have enough funds themselves. However, as nonmembers, they don’t have as much oversight or regulation compared to member banks.

Learn how nonmember banks operate and what working with one might look like.

Definition and Examples of a Nonmember Bank

A nonmember bank is a commercial bank that is not part of the Federal Reserve System. A member bank, then, is a financial institution that is part of the Fed. Nonmember banks can include commercial banks, credit unions, and industrial banks.

While national banks are required to join the Fed, others can join if they wish to as long as they meet the eligibility requirements. Nonmember banks only follow state laws, which might have less regulation and red tape compared to member banks that follow federal-level mandates. This could be an incentive for banks to not become part of the Fed—however, with less regulation comes less protection. While nonmember banks may not have as much oversight, they do have to follow some Fed regulations, like how they handle wire transfers and clearing checks.

Most state-chartered banks that are not members of the Federal Reserve System are supervised and regulated by the Federal Deposit Insurance Corporation (FDIC). Member banks, on the other hand, face oversight by the Federal Reserve Board.

Two examples of nonmember banks include the Bank of North Dakota as well as the Bank of the West, which is based in San Francisco, California.

How Does a Nonmember Bank Work?

Nonmember banks operate similarly to regular banks, but they’re not members of the Fed. The Federal Reserve System is one way to regulate banks and financial institutions, but it’s not the only way.

Nonmember banks might be commercial banks, which are small and community-focused. They offer savings accounts as well as the ability to make deposits, take out cash, and borrow loans. Often, nonmember banks only have one or a handful of locations within one concentrated area. Other nonmember banks might be global, like Wells Fargo or Bank of America.

Credit unions—nonprofit financial institutions that are member-owned—can also be nonmember banks. There are federal, state, and corporate credit unions that offer many of the same products and services as traditional banks.

Both community banks and credit unions have institutions that oversee regulation. In addition to the FDIC, for instance, there’s the National Credit Union Administration (NCUA), which looks out for state-chartered banks that are not members of the Federal Reserve System or another type of state-chartered savings association.

To become a member bank, a financial institution simply has to fill out an application, and there is no cost associated with the process. The Federal Reserve considers the following factors for a financial institution looking to become a member bank:

  • Its financial condition
  • The general character of its leadership and management
  • Its record of meeting the community’s needs
  • Whether its character and powers are consistent with the Federal Reserve Act

Pros and Cons of a Nonmember Bank

Pros
    • Local appeal
    • More money for the people
    • Less regulation
Cons
    • Not as much oversight
    • Less availability

Pros Explained

  • Local appeal: Most nonmember banks are community-based and do not have hundreds of branches. With this kind of bank, you’re likely not putting your money into a large corporate institution; rather, you’re keeping it local.
  • More money for the people: Member banks are required to use a percentage of their funds to buy Fed stock, which can’t be bought, sold, or used as a loan. Nonmembers don’t need to have this money set aside, which means more money remains for borrowers and investors.
  • Less regulation: Member banks have limitations on certain types of investments and loans they can make. Nonmember banks don’t have the same regulation and oversight, which means they have a little bit more freedom for handling money-related services and products.

Cons Explained

  • Not as much oversight: The Bank of North Dakota isn’t a Fed member bank and it isn’t FDIC-insured. The less oversight, the less protection a bank—and, therefore, its customer—has. One of the main responsibilities of the Fed is to protect the rights of consumers. If a bank isn’t a member, it’s riskier for the consumer to keep their money at that institution.
  • Less availability: Member banks tend to be larger, offering more branches available in your location. If you are part of a nonmember bank and find yourself out of the area, accessing your bank may be challenging. Having a bank with a location only where you live might not be good enough, especially if you move or travel.

Key Takeaways

  • Nonmember banks are financial institutions that are not members of the Federal Reserve System. They can be community banks, credit unions, or industrial banks.
  • National banks are required to join the Fed, while state banks can join if they meet certain requirements.
  • A nonmember bank operates in the same capacity as a member bank, but without oversight from the Fed.
  • Many nonmember banks are overseen by other institutions, like the National Credit Union Association or the Federal Deposit Insurance Corporation.