What are Financial Institutions?
Financial institutions are companies in the financial sector that provide a broad range of business and services including banking, insurance, and investment management. Governments of the country consider it important to oversee and to regulate these institutions as they play an integral part in the economy of the country.
Types of Financial Institutions
There are many different types of financial institutions exist in the financial market for the fund flows. These are divided primarily on the basis of the type of transactions performed by them i.e., some of them are involved in the depositary type of the transaction while others are involved in the non-depositary type of transactions.
#1 – Depository Institutions:
Types of Depository Institutions are –
Depository institutions are allowed to accept monetary deposits from the consumers legally. These include commercial banks, savings banks, credit unions, and savings and loan associations. The different types of depository institutions are explained as below:
- #1 – Commercial Banks – Commercial banks accept deposits from the public and offer security to their customers. Due to commercial banks, it is no longer required to keep huge large currency on hand. Using commercial bank facilities, transactions can be done through checks or credit/debit cards.
- #2 – Saving Banks – Saving banks perform the function of accepting the savings from the individuals and lending to the other consumers.
- #3 – Credit Unions – Credit unions are the associations which are created, owned, and also operated by the participants who are voluntarily associated for the purpose of saving their money and then lending it members of their union only. As such, these institutions are the not-for-profit organizations enjoying tax-exempt status.
- #4 – Saving and Loan Association – These institutions collect the funds of many of the small savers and then lend them to home buyers or other types of borrowers. They specialize in proving help to the people in getting residential mortgages.
# 2 – Non-Depository Institutions:
Nondepository institutions serve as the intermediary between the savers and the borrowers but they do not accept the time deposits. Such institutions perform their activities of lending to the public either by the way of selling securities or through the insurance policies. Nondepository institutions include insurance companies, finance companies, pension funds, and mutual funds.
Federal Deposits Insurance Corporation (FDIC) in the United States ensures the regular deposit accounts in order to reassure the individuals and businesses with respect to the safety of their finances with the financial institutions.
- An important role of financial institution in the case of the new companies that may face difficulties in getting the finances from the general public. In that scenario, financial institutions can make the funds available to these companies. Also, the expansion and modernization can also be financed without taking much strain by the companies.
- It provides both risk and loan capital. These institutions also provide underwriting facilities. Along with these services, expert guidance or advice can also be obtained from these institutions for the successful planning and monitoring of the projects of the company.
- In case the companies want to import some of the machinery or equipment outside their home country, then they can take the help of the financial institutions as these institutions provide loans and guarantees for the foreign currency along with the facility of the deferred payments.
- The basic facilities of repayment procedures and the interest rates of these financial institutions are generally convenient as well as economical. Along with these facilities for the repayment of the loans in the easy installments are also made available to deserving concerns.
- There are various documentation and the other facilities through which a concern requiring finance from the financial institutions has to undergo. This requires time and efforts of the concerns requiring the finance. also, many of the deserving concerns may also fail to get the assistance for non-fulfilling certain condition that is laid down by the institutions or due to the want of the security.
- Sometimes, convertibility clauses are also laid down in the loan agreements for the loan given to the parties which place restrictions on autonomy of the management of the concerned person. They also sometimes insist on appointing their nominees in borrowing the company’s board of directors.
- At several scales, these financial institutions can operate i.e., from the credit unions at the local community to the international investment banks. These institutions can vary on the basis of size, geography, and scope.
- They are divided primarily into two categories, depository institutions, and the non-depository institutions on the basis of the type of transactions performed by them.
- They are engaged in dealing with monetary and financial transactions like deposits, loans, insurance, investments, and currency exchange.
Thus it can be concluded that the financial institutions provide a broad range of business operations within the financial services sector. While some of these institutions have a focus on providing the services to the general public, on the other hand, others serve only to certain consumers with more specialized offerings.
This has been a guide to what are financial institutions and its definition. Here we discuss types of financial institutions along with an example, advantages and disadvantages. You can learn more about corporate finance from the following articles –