Financial Institutions are a part of our daily lives. This is because almost everyone living in a developed economy has a need for the services of financial institutions.
They encompass a broad range of business operations within the financial sector including banks, trust funds, credit unions, underwriters, insurance and investment dealers.
So, if you’ll like to learn more about financial institutions, then you just got lucky as this article will teach you all you need to know about financial institution, its types, importance, and functions.
Let’s get started!
What are Financial Institutions?
Financial Institutions are businesses that focuses solely on financial and monetary transactions such as loans, deposits, investments and currency exchange.
According to Wikipedia, financial institutions, otherwise known as banking institutions are corporations that provide services as intermediaries of financial markets.
Hence, you can say that financial institutions are responsible for the supply of money into the financial market. Without them, no financial transaction can happen.
Large financial institutions such as JP Morgan Chase, HSBC, Goldman Sachs or even Morgan Stanley can control the low of money in an economy.
Furthermore, almost everyone deals with various financial institutions daily. Whether it is depositing money, applying for loans, exchanging currencies, investing into the stock market, or acquiring a new venture.
Thus, this makes them very important to the economy of a nation, and governments personally oversees these institutions.
Importance of Financial Institutions
Financial institutions are very important factors that contribute to the growth or failure of the economy of a nation. Hence, they are very crucial factors.
Below are some of the highlighted importance of financial institutions
- Firstly, financial institutions promotes direct investment by the customers
- Secondly, they explain all the risks associated with financial transactions to their customers
- Thirdly, they provide various kinds of financial services to their customers
- Next, financial Institutions helps in forming the liquidity of the stock in case of an emergency
- Finally, they are known to provide an attractive rate of return to their customers
Functions of Financial Institutions
Financial Institutions perform a wide variety of financial functions to its customers. It involves a wide range of business financial activities including trust funds, banks, insurance companies, brokerage firms, and investment dealers.
Below are the functions of financial institutions.
- Financial institutions provide loans and advances to customers.
- They serve as a depository for their customers.
- They offer high rated consultancy to the customers for their beneficial investments.
- Some financial institution offers a high rate of return in the case of investment.
- They help to minimize the monitoring cost of the company.
- All the finance related work is done by the financial institution or on behalf of the customers.
Types of Financial Institutions
Financial institutions offer a wide range of products and services for individuals and commercial clients. Hence, they vary by size, scope and geography.
There are three major types of financial institutions. They are;
- Depository Institutions
- Contractual institutions
- Investment institutions
#1. Depository Institutions
These are financial institutions that accept and manage deposits and make loans. A depository institution provides security and liquidity in the market, uses money deposited for safekeeping to lend to others, invest in other securities, and offer a fund transfer system.
Hence, they must return the deposit in the same order it was given.
Additionally, they serve as a connection between the public companies that issue financial securities and the investors or shareholders.
Depository institution includes banks, building societies, credit unions, trust companies and mortgage loan companies.
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Functions of a Depository
Below are the functions of depository institutions according to corporate finance institute.
A depository financial institution functions as a connecting link between the public companies that issue financial securities, and the investors or shareholders. The securities are issued by agents associated with depositories, who are known as depository participants. The agents are responsible for transferring the securities from the depositories to the investors.
A depository institution allows traders and investors t hold securities in dematerialized form; thus, eliminating the risk related to holding physical financial securities. The buyers and sellers now do not need to check whether the securities have been transferred successfully without any loss or theft. The depository system reduces such risks by allowing the securities to be held and transferred in electronic form.
#3. Allows the provision of loans and mortgages to interested parties
A depository holds the securities of customers and gives them back when the customers want. The customers receive interest on the deposits, while the depository earns even more interest by lending the deposits to other people or businesses in the form of loans or mortgages.
#4. Accelerate the process of transferring securities
When a trade occurs, a depository transfers the ownership of securities from the account of one investor to another. It helps in reducing the paperwork associated with the finalization of a trade and accelerates the process of transfer of securities.
Types of Depository Institutions
As mentioned earlier, the following are the main categories of depository financial institutions.
#1. Banks
A bank is a financial institution that accepts deposits from the public and creates a demand deposit while still making loans.
The bank can decide to lend directly or indirectly through capital markets. Banks can either be commercial or cooperate banks. However, we will stay within commercial banks.
The range of services offered by commercial banks depends on the size of the banks. For smaller banks, their services are limited to consumer banking, small mortgages, simple deposits and loans.
However, for larger banks, their services can include foreign exchange-related services, money management and investment banking.
#2. Building Societies
A building society is a financial institution owned by its members as a mutual organization. They offer banking and related financial services, especially savings and mortgage lending.
Building societies are similar to credit unions in organizations.
More so, rather than promoting thrift and unsecure business loans, building societies provides home mortgages to its members.
#3. Credit Unions
Credit unions are financial cooperatives owned ad controlled by the members of the group. It operates on the principle of people helping people, providing its members credit at competitive rates, as well as other financial services.
The profits are either paid to the members as dividends or reinvested into the organization.
Since credit unions are non-profit institutions, they pay no federal or state tax.
#4. Trust Companies
A trust company is a financial institution that acts as a trustee or agent of trusts and agencies. It can be owned or owned by a bank or law firm.
A trust company manages investments, keeps records, manages assets, prepare court accounting, pay bills, medical expenses, charitable gifts and other distributions of income.
#2. Contractual Institutions
Contractual institutions are financial institutions that get their funds through contractua agreement.
Usually, when they obtain these funds, they invest them into the capital markets. Also, Contractual institutions have a steady inflow of funds from their contractual agreement, hence, they don’t experience difficulties with liquidity.
This makes them perfect for investors, as they can make them long-term investments in securities and common stock.
More so, they can predict their liabilities, fairly accurately and thus they don’t have to worry about losing funds.
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Types of Contractual Institutions
The following are the main categories of contractual institutions.
#1. Insurance Companies
The most familiar non-bank financial institution are insurance companies. They are the oldest form of financial services and hey provide insurance to either individuals or corporations.
There are several types of insurance companies, but the most popular under this category are the life insurance companies.
Life Insurance Companies
Life insurance companies sell life insurance policies that protect the beneficiaries against financial hazards that follow the death of the insured person.
Depending on the contract, other events such as terminal illness or critical illness can also trigger payment.
The policy holder ( insured person) typically pays a premium, either regularly or as one lump sum. Other expenses, such as funeral expenses, can also be included in the benefits.
These financial institutions acquire funds through payments of premiums by individuals who pay to keep their policies in force.
Life insurance companies can calculate liabilities with a fair degree of accuracy using mortality tables. As a result, they use funds to buy longer-term securities—primarily corporate bonds and mortgages.
#2. Pension Fund
Pension fund is any plan, fund, or scheme that provides retirement income. They usually have large amounts of money to invest and are the top investors in listed or peivate companies.
Additionally, Pension funds are very crucial to the stock market especially there’s a large number of institutional investors.
The Federal Old-age and Survivors Insurance trust Fund is the world’s largest public pension fund which oversees $2.72 trillion USD in assets.
#3. Investment Institutions
Investment institutions, as the name implies are financial institutions that are focused on investments.
They know which security, or stock market to invest in and can guarantee rate of return on an investment.
Generally, they facilitate investments in financial assets by individuals and institutions by pooling resources and investing them according to desired objectives.
Types of Investment Institutions
The financial institutions under this category are;
- Investment banks
- Underwriters
- Brokerage firms.
#1. Investment Banks
Investment banks specialize in providing financial services designed to improve business operations, such as capital expenditure, financing, and equity offerings, including initial public offerings (IPOs).
According to Wikipedia, an investment bank is a financial services company or corporate division that engages in advisory-based financial transactions on behalf of individuals, corporations, and governments.
Traditionally, investment banks are associated with corporate finance, and assist in raising financial capital by acting as a client’s agent in the issuance of securities.
More so, an investment bank may also assist companies involved in mergers and acquisitions (M&A) and provide ancillary services such as market making, trading of derivatives and equity securities, and FICC services ( fixed income instruments, currencies, and commodities).
While an investment bank is also referred to as a regular “bank”, its operations are entirely different and big companies depend solely on them.
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#2. Underwriters
Another type of investment financial institution is Underwriting services. Underwriting services are provided by some large financial institutions and involve a situation whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liability arising from such a deal.
An underwriting agreement may be created in different situations like insurance, issues of security in a public offering, and bank lending.
#3. Brokerage Firms
Brokerage firms are financial institutions that help you buy and sell securities. They act as the middle man between the buyer and the seller of the securities and become the principal party to the deal.
Depending on the brokerage firm type you choose, you can either buy securities through telephone, smartphone, or internet.
Also, brokers can represent the buyer or the seller but not the both at the same time. And they are very crucial in the purchase of financial instruments.
Usually, brokers have the tools and resources to screen potential buyers and sellers for the perfect match. This is because, they are compensated by commissions after a successful transaction.
Brokers are generally cheap especially in smaller markets with smaller accounts, or with a limited line of products.
Wondering which financial institution to work with? Let’s go over the top financial institutions in the world below.
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List Of Financial Institutions
There are several financial institutions in various countries of the world. However, only a few make it to the top as some of the best financial institutions.
Below is a list of the top financial institutions in the world as well as their assets, capital, and revenue.
Bank (Rankings according to Accuity)
| Banks | Assets( $M) | Capital ($M) |
| Industrial & Commercial Bank of China Limited | 4,319,862.00 | 80,709.00 |
| China Construction Bank Corporation | 3,649,392.00 | 35,870.00 |
| Agricultural Bank of China Limited | 3,569,338.00 | 61,676.00 |
| Bank of China Limited | 3,266,821.00 | 42,236.00 |
| BNP Paribas SA | 2,427,625.00 | 30,358.00 |
| China Development Bank | 2,367,945.00 | 60,437.00 |
| JPMorgan Chase Bank National Association | 2,337,646.00 | 2,028.00 |
| MUFG Bank Ltd | 2,217,261.00 | 15,830.00 |
| Crédit Agricole SA | 1,982,329.00 | 9,705.00 |
| Japan Post Bank Co Ltd | 1,950,237.00 | 32,364.00 |
Insurance Companies (Rankings according to Insurance Information Institute)
| Insurance Companies | Revenue( $) | Industry |
| Berkshire Hathaway | 254,616 | Property/casualty |
| Ping An Insurance | 184,280 | Life/health |
| AXA | 148,494 | Life/health |
| China Life Insurance | 131,244 | Life/health |
| Allianz | 130,359 | Life/health |
| Japan Post Holdings | 109,915 | Life/health |
| Assicurazioni Generali | 105,921 | Life/health |
| Prudential | 93,736 | Life/health |
| Legal & General Group | 90,615 | Life/health |
| Aviva | 89,647 | Life/health |
What Is the Meaning of a Financial Institution?
A place where financial transactions like loans, mortgages, and deposits are completed and made easier is often referred to as a financial institution. Consumers can manage their money well at financial institutions and establish a solid financial foundation.
What Is the Main Purpose of Financial Institutions?
Financial institutions facilitate financial transactions by acting as a middleman between savers and spenders. Financial institutions can provide a variety of services, such as deposit accounts, loans, investments, insurance policies, and foreign currency exchange.
What Is Example of Financial Institution?
A few examples of financial institutions are banks. the credit unions. financial institutions for community development.
What Are the Benefits of Financial Institutions?
For medium- and long-term needs, they give corporate groups both owned and borrowed money. In addition to these services, financial institutions also undertake market research, offer financial and technical aid, and offer administrative services to members running an organization.
What Are the Two Purposes of Financial Institutions?
Financial institutions offer a vast array of financial services and products. They carry out transactions involving money, securities, and other financial assets, simplify asset and risk management, and function as a bridge between capital suppliers and beneficiaries.
What Is the Structure of a Financial Institution?
A company’s financial structure describes the proportion of debt and equity it utilizes to fund its activities. Capital structure is another name for it. The framework for creating a company’s financial structure is the same for both private and public organizations, although there are some key distinctions between them.
Conclusion
Financial Institutions are all around us, offering different type of financial products or services.
So, as a customer you should first of all determine what type of financial service you want before choosing which financial institution you’d like to work with.
Additionally, it is imperative that you do proper research before investing your money in a financial institution.
I hope this post helps you.
Good luck!
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FAQs
What is the role of a financial institution?
The primary role of financial institutions is to provide liquidity to the economy and permit a higher level of economic activity than would otherwise be possible. According to the Brookings Institute, banks accomplish this in three main ways: offering credit, managing markets and pooling risk among consumers.
How do financial institutions make money?
Many banks make the majority of their money from charging interest on loaned funds, such as home loans, auto loans or personal loans that are issued to consumers. Many banks also offer loans to small and large businesses.
Can banks lose money?
The most common cause of bank failure occurs when the value of the bank’s assets falls below the market value of the bank’s liabilities, which are the bank’s obligations to creditors and depositors. This might happen because the bank loses too much on its investments.
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