What are financial institutions?

Financial institutions are businesses that are formed to deal with financial and monetary transactions. These organizations primarily accept deposits, advance loans, make investments, and provide foreign exchange services. Financial institutions include, but are not limited to, banks, insurance companies, trust companies, brokerage firms, and investment bankers. Because financial institutions play such an important role in the economy in terms of monetary transactions, regulating their activities has become a requirement for governmental authorities. As a result, the government creates a multitude of laws and regulations to oversee the activities of financial institutions.

Objectives of financial institution

Satisfy financial needs

Financial institutions provide a variety of services to their customers. Satisfying the needs of the customers and clients is an important objective for every financial institution. Each and every customer’s financial needs vary, thus financial institutions require to take quick actions to maintain their business by satisfying the customer needs.

Assist customers

The financial institution helps people by offering various types of financial assistance like investment services, savings services, loans, etc. It helps their clients to choose the investment based on their interest and risk tolerance and also teaches them how to maintain investments.

Mobilize savings

The financial institution encourages saving by accepting deposits from customers through different savings plans. By paying interest on deposits, it increases the customer’s financial income. Banks, insurance companies, and investment companies encourage people to save money by using the services offered by them.

Types of Financial institutions

Credit unions

Credit unions are non-profit institutions managed by their own financial cooperative members. Credit unions pool their members' assets or savings to provide loans and other financial services to them. Members typically belong to a specific sectorial group and form a union to financially support their lives. Credit unions offer lower interest rates on loans and higher interest rates on investment instruments such as certificates of deposit and savings accounts.

Commercial bank

The primary function of a commercial bank is to accept deposits. It is a for-profit financial institution that provides loans and other services to its clients. A commercial bank can be either public or private, as well as domestic or foreign. The government will be a major stakeholder in public sector banks that operate under the supervision of the nation's central bank. Private sector banks are similar to limited liability companies in which shareholders are individuals and the banks are run as private businesses. Foreign banks will have many branches in various countries and will have their headquarters in another country.

Investment bank

An investment bank is not the same as a commercial bank. Its primary concern is the needs and interests of businesses and the government. It deals with financing mergers and acquisitions, initial public offerings, and large projects, among other things. It acts as an intermediary, underwriter, lender, and consultant.

Importance of financial institutions

Most of the world’s population depends on financial institutions for its daily transactions without their knowledge. The economy depends on the financial institution. During the economic recession, the services of financial institutions led to economic growth. Financial needs are met by financial institutions through financial services. It acts as an intermediary between people with cash and without cash, offering interest to depositors and charging interest from borrowers. Thus, the proper functioning of institutions is essential for the country’s financial stability and development.

Functions of financial institutions

Regulate monetary supply

The financial institution helps to regulate the economy's money supply. These institutions control inflation and also maintain stability in the money supply. The federal reserve bank takes various steps by increasing/decreasing repo rates, open market operation, cash reserve ratios to regulate the country's liquidity. Financial institutions are taking part in buying and selling the securities of the government which helps to regulate liquidity.

Bank services

Financial institutions which established their business in commercial banks, support people financially to manage their savings and accept their money to deposit in their respective banks. It offers credit facilities to its clients who need financial support to lead their lives. This institution also gives reasonable interest rates for savings and other deposit accounts. They cover loans like personal, educational, automobile, home, and mortgageable loans for its customers.

Insurance services

The insurance companies also come under financial institutions as they provide money through investments to the insurer. Insurance companies provide insurance for vehicles, stocks, assets, marine, etc. Insurance companies also offer coverage for life insurance and health insurance. These insurance companies offer their hand in mobilizing savings and investing in productive investments. Here, they transfer customer risks with financial support by assuring customers' life and insured asset in times of uncertainty.

Formation of capital

By accepting individuals’ savings, financial institutions provide monetary services to investors who need external funds for increasing their capital stocks. Investors may need financial services to implement expansion plans by installing new plants, machinery, tools, equipment, building a new plant and buying new transport vehicles, etc. Thus, financial institutions help in the formation of capital.

Investment consultation

Nowadays many investment options are carried out worldwide. A company/individual must choose wisely for investing in a specific investment option that suits their interest. Many investors may not be acquainted with numerous investment options. Every financial institution has investment consulting services to help their clients to adopt the best option available in the financial markets. Based on the investor’s risk-taking and other interests, the financial institution suggests the investment option.

Brokerage service

Some financial institutions like commercial banks and non-banking companies offer a different investment option for investors in form of brokerage. The institution serves as a broker between investors and various companies for selling stocks, bonds, shares by getting a brokerage fee.

Movement of financial resources

Another function of financial institutions is the movement of financial resources from one area to another area. Through financial institutions, money transfer was made easy for large funds like investments, real estate purchases, and other huge transactions from one party to another party.

Managing risk

The financial institution manages the risk and uncertainties of companies and individuals. Financial institutions manage the risk by assembling a massive pool of individuals and businesses to share the risks and difficulties faced by businesses and people.

Context and Applications

This topic is relevant for professional examinations for undergraduate and postgraduate courses such as,

• Bachelors of Science in Finance - Financial Management
• Master of Science in Finance - Financial Management
• Bachelors of Science in Banking and Financial Services
• Master of Science in Banking and Financial Services

Practice Problems

Question 1: __________ growth of the country depends on functions of financial institution.

1. Economic
2. Historical
3. Geographical

Answer: Option 1 is correct.

Explanation: Financial institutions deal with the monetary transaction and the economic growth of a country depends on the healthy functioning of financial institutions. The financial institution plays a crucial role in the economy of a country.

Question 2: A financial institution that accepts savings & deposits, gives loans, and with a reasonable rate of interest to its customers is called ____________.

1. Share market
2. Commercial banks
3. Scrap market

Answer: Option 2 is correct.

Explanation: Commercial banks are financial institution that accepts savings and deposits from their customers by giving a reasonable interest. They also provide loans and offer investment choices to them.

Question 3: _________ is one of the financial institution functions which helps investors to find a perfect investment option for investment.

1. Monetary regulation
2. Service
3. Investment consultation

Answer: Option 3 is correct.

Explanation: Investment consultation services help the investor to access many investments option and to find a perfect investment to invest in. Most financial institutions have such consultation services to assist the investor by showing the variety of options available in the market.

Question 4: Insurance companies accepts risk of uncertain of people with ___________ .

1. Financial assistance
2. Regulation of money
3. Commercial banks

Answer: Option 1 is correct.

Explanation: The insurance company accepts the risk of its clients and assists them with finance. Here they assure the life or assets of the insurer at the time of uncertainty. They assist their clients to save money for an uncertain future by investing.

Question 5: Managing assets & investing in the financial market on behalf of the customers the financial institutions act as ____________.

1. Credit unions
2. Helper
3. Trustee

Answer: Option 3 is correct.

Explanation: On behalf of the customer financial institutions act as a trustee by deciding investment, maintaining income, and managing an invested asset in the financial market.