Financial institutions are a key element of the financial system of any advanced market economy. A financial institution is defined as a system involved in the transfer of money, credit, investment, and borrowing through various financial instruments. The main purpose of the financial institution is intermediation, i.e. the effective movement of funds (in the direct or indirect form) from savers to borrowers. The former is, figuratively speaking, the owners of a “bag of money”, i.e. they are ready to give them for a reward to a person experiencing financial hunger; the latter have a profitable investment project in the portfolio but do not have sufficient sources of financing for its implementation.
The most common types of financial institutions are banks, savings institutions (cash), insurance and investment companies, brokerage and exchange-traded firms, investment funds, credit units and finance firms, etc. Financial institutions are primarily interested in the reliable and relatively risk-free placement of their own funds, implying:
- Liquidity, i.e. ease access to your money if necessary
- Getting long-term income at an acceptable rate, and to raise the required amount of money for various investment programmers and running costs.
Financial institutions perform the following functions: the financial institutions provide loans and advances to the customers, they give consultancy to the customers for their beneficial investments, and they also serve as a depository for their customers. All the finance related work is done by financial institutions such as:
- Saving financial resources (saving) – The appearance of this function is predetermined by the widespread need to accumulate money for their subsequent use (targeted investment or consumption). Of course, funds can be accumulated without the help of those institutions, but it is less profitable and unsafe.
- Financial transformations (maturity transformation) – is that short-term (financial) assets and liabilities can be transformed into long-term ones. This is achieved, in particular, by securitization of assets, where the credit institution collects into the pool the loans provided to it, secured by relatively homogeneous assets, and issues securities under general security.
- Transfer risk – The vast majority of the transactions are inherently risky, so they always want to either avoid risk or reduce the level of risk. This is achieved in a variety of ways, in particular by obtaining guarantees and security, by transferring part of the risk to a financial intermediary.
- Foreign exchange operations – in today’s economy, the vast majority of companies are linked to varying degrees from currency transactions. In a developed market economy, these operations are predetermined by the company’s desire to enter international markets of benefits and factors of production.
- Organizing operations to change the organizational and legal forms of companies (going public and going-private transactions) – the most typical operation of this kind is the transformation of the company into JSC (joint-stock company). The logic of business development is that as the company becomes more active and expands its activities, its founders either become unable to provide adequate financing to the company, or for some reason are unwilling to do so. In this case, the company changes its organizational and legal form, transforming into JSC and thus getting additional funding opportunities. As such a procedure is complex and time-consuming, a specialized financial institution is used to implement it.
How Financial Institutions Work
Financial institutions generally operate as a banking system. The institutions provide loans and advances to the customers and at the same time set a platform for doing some investments. The customers get exciting offers and returns from them and that is why these institutions are gaining great fame. These kinds of institutions also provide consultancy services to the clients on their investments related to the financial markets where a huge amount of risk is involved…
Types of Financial Institutions
Financial institutions suggest a wide range of products and services for individuals and commercial companies. The specific services offered vary widely between different types of financial institutions.
- Investment Banks
Investment banks specialize in providing services designed to facilitate business operations, such as capital expenditure financing and equity offerings, including initial public offerings (IPOs). They also commonly offer brokerage services for investors, act as market makers for trading exchanges, and manage mergers, acquisitions, and other corporate restructurings.
- Commercial Banks
A commercial bank is a type of financial institution that accepts deposits, offers checking account services, makes business, personal, and mortgage loans, and offers basic financial products like certificates of deposit and savings accounts to individuals and small businesses. A commercial bank is where most people do their banking, as opposed to an investment bank.
- Insurance companies
Among the most familiar financial institutions are insurance companies. Providing insurance, whether for individuals or corporations, is one of the oldest financial services. Protection of assets and protection against financial risk, secured through insurance products, is an essential service that facilitates individual and corporate investments that fuel economic growth.
Financial Institutions vs Banks
- The functions of payments of various services are done by the bank but the financial institutions will not be able to do so.
- It cannot accept the demand deposit whereas the banks can accept the demand deposit by the customers.
- Banks provide the guarantee of repayment of the deposit whereas the financial institutions may fail to do so.
Financial institutions serve most people in some way, as financial operations are a critical part of any economy, with individuals and companies relying on financial institutions for transactions and investing. Governments consider it imperative to oversee and regulate banks and financial institutions because they do play such an integral part of the economy. Historically, bankruptcies of financial institutions can create panic in the country.