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This article provides an overview of financial institutions and their types. It defines what financial institutions are, what they are meant for and how they work. The information exposes readers to the different categories of financial institutions. In this way, they figure out which category works best in certain circumstances.
What are the Financial Institutions?
Financial institutions are the corporations that engage in monetary transactions and funding. By providing financial services, they act as intermediaries between the debt market and consumers (businesses and individuals) in need of funds in a systemized manner. The money flow takes the form of debit products such as loans, investments, and deposits.
Examples of financial institutions are retail and consumer banks, credit unions, commercial banks, saving and loaning associations, brokerage institutions, mortgage companies, insurance firms, digital financial firms, and online banking systems. They may look similar, but each one of them has its own operating system and objective.
What are the Financial Institutions Meant for?
Financial institutions play a pivotal role in activating businesses and trading processes to achieve economic growth. They meet the financial demands of various cliental categories, whether they be businesses, organizations, individuals, or entrepreneurs. They either serve one of the clientele categories or provide a combination of services to more than one. The objective behind the service brings variety to the types of financial institutions and their mission. As part of the financial system and while acting as government agents, financial institutions
- channel the relationship between lenders and borrowers
- regulate monetary supply
- provide banking, and brokerage services
- provide insurance and pension services
- participate in the formation of capital
- finance small and medium scale businesses
- participate in merging corporations
- provide investment advices and trust fund services
To appreciate the role of financial institutions further, imagine how it would be possible for the economy to flourish, businesses to succeed, and individuals to attain their financial goals without the existence of these institutions.
On the other hand, Financial institutions are primarily interested in the reliable and relatively risk-free placement of their own funds, targeting
- liquidity, i.e. ease access to borrowers’ money, if necessary
- long-term income at an acceptable rate, and
- increment of funds for various investment programs and covering their own costs
How Do Financial Institutions Work?
It is important to know that financial institutions are not self-contained. They are monitored and regulated by the government on a national level. For instance, the largest bank in The United States is the Federal Reserve Bank. However, this bank does not interfere in direct relationships with consumers. Instead, it monitors the smaller financial institutions, highly regulates their performance and service quality against consumers. By regulating the overall process and protecting shareholders’ rights, the Federal Reserve Bank increases the credibility of the American financial institutions that participate in the growth of the national economy.
Each financial institution has a role and accordingly a distinct working style. They generally operate as a banking system providing loans and advances to the customers while some of them set a platform for investments and deliver consultation rather than providing cash. In all cases, customers get exciting offers and returns with less risks. This makes these institutions more appealing to a wide range of clientele categories.
The upcoming paragraph presents the main categories of financial institutions. The presentation helps appreciate the operating system and objective of each financial institution on its own.
The Main Categories of Financial Institutions
Financial institutions can mainly be divided into depositary and non-depository or non-banking financial institutions.
Depository Financial Institutions
Depository institutions have legal permit to receive funds. In other words, they issue deposits and provide commercial bonds until the instrument (monetary fund, debt, physical asset) becomes payable. They provide liquidity facilitating and speeding up trade with full price close to the market price. Examples of depository institutions include banks, credit unions, and saving and loan institutions.
Non-depositary/ Non-Banking Financial Institutions
Non-depository financial institutions can be private and governmental. They work as mediators between lenders and borrowers WITHOUT accepting cash. Examples of these different types of non-banking financial institutions include insurance companies, mutual funds, investment trusts and retirement and pension funds. Pawnshops and venture capital firms are also non-depository institutions, but they are much smaller sources of funds for the economy.
What are the Different Types of Financial Institutions?
Whether depositary or non-banking, here are the most common financial institutions that provide a variety of services.
- Retail and Consumer Banks
Retail banks or consumer banks offer financial services to individuals. These services include saving accounts, certificate of deposits (CDs), personal loans, mortgages, credit and debit cards, and electronic/phone banking services. These banks also offer lockers to their customers for saving valuable objects/documents.
- Commercial Banks
A commercial bank grants deposits, offers checking and savings account services, and makes loans for investment and advanced payments to corporations and businesses rather than individuals. The primary functions of the commercial bank are lending and borrowing.
- Investment Banks
Investment banks mediate the relationship between businesses, governments, and high net worth individuals (people of more than 5 million USD worth assets) for achieving financial gains, corporate mergers, and reorganizations. They help individuals and corporations invest their money in professionally managed portfolios, made up of different stocks or bonds securities. They allow individuals to allocate funds based on their financial objective.
- Brokerage Institutions
These institutions act as middle-man between exchangers and the stock market. Therefore, they buy and sell securities for a commission. Thus, a real estate broker helps you purchase a house, an insurance broker helps you buy insurance, while an investment broker helps you purchase securities.
- Credit Unions
Credit unions are corporations that run as non-profit organizations owned by its members for their own benefits. To apply for membership in a credit union, you should be a member of a qualifying organization and live or work in the community nearby.
- Saving and Loan Associations (S&Ls)
These associations act very similarly to consumer or retail banks but are more specialized in providing residential mortgages. In other words, they support the working class in the purchase of a residence. The offered mortgage types by the S&Ls are more various than the ones provided by commercial banks but with more restrictions on the use of their assets. Apart from mortgages, S&Ls also offer personal credit, saving, checking accounts, and certificates of deposit.
- Mortgage Companies
Mortgage companies originate or fund mortgages for residential or commercial property. They market themselves by offering unique deals on their service fee, providing online loans at competitive rates. They usually seek funding from other financial institutions that serve them as their capital-owning client.
- Insurance Firms
Insurance firms are the non-banking financial institutions that provide the possibility of mitigating risks through insurance contracts. They guarantee payments for uncertain incidents against a smaller payment done by the insurance holder. The most common types of insurances include stock, property and casualty, life, travel, accident, and health insurance.
- Digital Financial Firms / FinTech
Technology is used by digital financial organizations to speed up, automate, and improve financial services. Mobile payments, money transfers, lending, loan management, crowdfunding, and investment are all examples of fintech services. Individuals are not involved in the processes, and they do not require a trip to the bank.
- Online Banking Firms
These firms are also known as internet banking or web banking. They provide banking services traditionally available such as bill payments, transfer of funds, loaning, and deposits online. In fact, every bank now offers an online version of its services both on computers and through mobile applications. To participate in online banking, a bank account and bank card are mandatory.
- Investment Companies
These companies or trusts are involved in investment businesses that utilize funds of investors in the purchase of financial securities. These securities mainly take the shape of stocks that have long-term returns. Participants become shareholders and they are independent in terms of selling their own share or buying the new. Investment companies invest in a variety of fields increasing the potential of a higher return on investment.
There is a strong likelihood that we will seek out the services of financial institutions. It all happens because financialization is continuously pervading our lives. Therefore, it is useful to learn about financial institutions especially when looking for long-term mature financial relationships. Even within the same category, there are differences between the type of services that different institutions offer. For instance, despite the fact of looking so identical, credit unions and banks have differences in their role and processes. Therefore, prior to engaging yourself with an institution look at all possible choices and make your commitment only after.
