What Are Savings and Loans and How Do They Work?
Demystify savings and loans. Understand these unique financial institutions, their core operations, and how they differ from commercial banks.
Savings and loan associations (S&Ls) are financial institutions specializing in accepting savings deposits and primarily using these funds to provide mortgage loans for residential real estate. They have historically played a significant role in facilitating homeownership across the United States. While sharing similarities with commercial banks, S&Ls maintain distinct characteristics that have shaped their operations and customer focus over time. These institutions are designed to support the financial needs of communities by channeling local savings into local housing investments.
Understanding Savings and Loans
Savings and loan associations specialize in taking savings deposits and using those funds to originate mortgage and other types of loans. Their primary purpose is providing financial assistance for home financing, with a strong focus on residential property. This specialization has been a defining characteristic since their early beginnings in the 19th century, when they were often known as “building and loans.” S&Ls gather funds through various deposit accounts, including traditional savings accounts and certificates of deposit (CDs). Depositors entrust their money to S&Ls, which then serve as a conduit for these savings to be lent out to borrowers, primarily for home purchases and construction.
The core lending activity of an S&L focuses on residential mortgages, including loans for one-to-four family dwellings and multi-family properties. S&Ls may also engage in limited consumer and commercial loans. Federal regulations generally limit commercial loans to no more than 20 percent of an S&L’s total lending assets.
S&Ls operate under two main organizational structures: mutual or stock. In a mutual structure, the institution is owned by its depositors and borrowers, who are members with voting rights. A stock S&L is owned by shareholders, similar to a traditional corporation, with profits distributed to them. Many mutual S&Ls have converted to stock forms through a process known as demutualization.
Key Differences from Commercial Banks
Savings and loan associations differ from commercial banks primarily in their historical business focus and scope of services. Commercial banks provide a broad spectrum of financial products and services to diverse clients, including commercial loans, credit cards, and wealth management. In contrast, S&Ls traditionally specialized in residential mortgages and individual savings accounts.
S&Ls often serve a localized, community-based clientele, emphasizing individual savers and homeowners. This local presence can lead to more personalized service and potentially more flexible lending standards for mortgage applicants. Commercial banks cater to a wider array of customers and operate on a broader scale.
S&Ls historically provided a more limited suite of financial products centered around savings and home loans. While they now offer services like checking accounts, their breadth remains narrower than a typical commercial bank. Commercial banks provide comprehensive services, including various types of checking accounts and extensive business lending.
Historically, S&Ls and commercial banks operated under distinct regulatory frameworks. S&Ls were once primarily regulated by the Federal Home Loan Bank Board (FHLBB) and their deposits insured by the Federal Savings and Loan Insurance Corporation (FSLIC). Commercial banks were overseen by agencies such as the Office of the Comptroller of the Currency and the Federal Reserve, with deposit insurance by the Federal Deposit Insurance Corporation. Many regulatory distinctions have blurred over time, and the FDIC now insures S&L deposits.
Safeguards for Depositors
Depositors at savings and loan associations benefit from robust safeguards. The primary protection comes from deposit insurance provided by the Federal Deposit Insurance Corporation (FDIC). The FDIC is an independent agency of the U.S. government that insures deposits at member financial institutions, including S&Ls, up to a statutory limit. This insurance covers deposit products such as checking accounts, savings accounts, and certificates of deposit.
The standard maximum deposit insurance amount is $250,000 per depositor, per FDIC-insured institution, for each ownership category. This means an individual could be insured for more than $250,000 at the same institution if they hold accounts in different ownership categories. The FDIC guarantees depositors will not lose their insured funds in the unlikely event of an insured institution’s failure, either through a transfer to another insured bank or by direct payment.
Beyond deposit insurance, S&Ls are subject to comprehensive regulatory oversight. Federally chartered savings associations fall under the supervision of the Office of the Comptroller of the Currency (OCC). State-chartered S&Ls are regulated by their respective state banking departments and the FDIC.
These regulatory agencies impose capital requirements on S&Ls to ensure their financial soundness. Institutions must maintain specific minimum capital ratios, such as common equity tier 1 capital, tier 1 capital, and total capital ratios. These requirements ensure S&Ls hold sufficient financial reserves to absorb potential losses and protect depositors’ funds.