Meaning of Financial Institutions
In today’s financial services marketplace, a financial institution exists to provide a wide variety of deposit, lending and investment products to individuals, businesses or both. While some financial institutions focus on providing services and accounts for the general public, others are more likely to serve only certain consumers with more specialized offerings.
A financial institution is an intermediary between consumers and the capital or the debt markets providing banking and investment services. A financial institution is responsible for the supply of money to the market through the transfer of funds from investors to the companies in the form of loans, deposits, and investments. Large financial institutions such as JP Morgan Chase, HSBC, Goldman Sachs or Morgan Stanley can even control the flow of money in an economy.
The most common types of financial institutions include commercial banks, investment banks, brokerage firms, insurance companies, and asset management funds. Other types include credit unions and finance firms. Financial institutions are regulated to control the supply of money in the market and protect consumers.
Example- Bank ABC is a shareholder-owned institution that offers banking and investment services to a wide range of customers. The bank acts as an intermediary between retail and institutional investors, who supply the funds through deposits and retail and institutional investors, who are looking for financing. The bank pays a 2% interest on the deposits it accepts from households and businesses from the interest earned from lending services. In addition, the bank offers fund management and health and life insurance services through its subsidiaries.
Furthermore, Bank ABC operates in the wholesale market, seeking to lend large conglomerates and corporations as well as government agencies. In this context, the bank has a highly-equipped advisory team, which offers corporate finance, forex, capital markets and investment management services.
The bank is regulated for the protection of consumers. Hence, its funds undergo strict scrutiny by the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve System. These two Federal agencies are responsible for guaranteeing that the bank will be able to repay the borrowed funds.
Major Types of Financial Institution and their roles in corporate management
Central banks are the financial institutions responsible for the oversight and management of all other banks. In the United States, the central bank is the Federal Reserve Bank, which is responsible for conducting monetary policy and supervision and regulation of financial institutions.
Individual consumers do not have direct contact with a central bank; instead, large financial institutions work directly with the Federal Reserve Bank to provide products and services to the general public.
The major categories of financial institutions include central banks, retail and commercial banks, internet banks, credit unions, savings, and loans associations, investment banks, investment companies, brokerage firms, insurance companies, and mortgage companies.
Retail and Commercial Banks-
Traditionally, retail banks offered products to individual consumers while commercial banks worked directly with businesses. Currently, the majority of large banks offer deposit accounts, lending and limited financial advice to both demographics.
Products offered at retail and commercial banks include checking and savings accounts, certificates of deposit (CDs), personal and mortgage loans, credit cards, and business banking accounts.
A newer entrant to the financial institution market are internet banks, which work similarly to retail banks. Internet banks offer the same products and services as conventional banks, but they do so through online platforms instead of brick and mortar locations.
Credit unions serve a specific demographic per their field of membership, such as teachers or members of the military. While products offered resemble retail bank offerings, credit unions are owned by their members and operate for their benefit.
Savings and Loan Associations-
Financial institutions that are mutually held and provide no more than 20% of total lending to businesses fall under the category of savings and loan associations. Individual consumers use savings and loans associations for deposit accounts, personal loans, and mortgage lending.
Investment Banks and Companies-
Investment banks do not take deposits; instead, they help individuals, businesses and governments raise capital through the issuance of securities. Investment companies, more commonly known as mutual fund companies, pool funds from individual and institutional investors to provide them access to the broader securities market.
Brokerage firms assist individuals and institutions in buying and selling securities among available investors. Customers of brokerage firms can place trades of stocks, bonds, mutual funds, exchange-traded funds (ETFs), and some alternative investments.
Financial institutions that help individuals transfer risk of loss are known as insurance companies. Individuals and businesses use insurance companies to protect against-financial loss due to death, disability, accidents, property damage, and other misfortunes.
Financial institutions that originate or fund mortgage loans are mortgage companies. While most mortgage companies serve the individual consumer market, some specialize in lending options for commercial real estate only.
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