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 essential 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 that exist in the financial market for fund flows. These are divided primarily based on the type of transactions performed by them, i.e., some of them are involved in the depositary type of the transaction. In contrast, others are involved in the non-depositary type of transactions.
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#1 – Depository Institutions:
Types of Depository Institutions are –
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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 banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits.read more, 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 that are created, owned, and also operated by the participants who are voluntarily associated with saving their money and then lending it members of their union only. As such, these institutions are the not-for-profit organizationsThe Not-for-profit OrganizationsA not-for-profit organization refers to a legal entity that isn't created to generate profits or revenue for its owners but aims at social, educational, religious or public welfare and service. Such an organization is tax-exempted and run through donations or any other income it makes.read more 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 providing help to the people in getting residential mortgages.
# 2 – Non-Depository Institutions:
Non-depository 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 way of selling securities or through the insurance policies. Non-depository institutions include insurance companies, finance companies, pension funds, and mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks.read more.
Federal Deposits Insurance Corporation (FDIC) in the United States ensures the regular deposit accounts to reassure the individuals and businesses with respect to the safety of their finances with the financial institutions.
Advantages
- An essential role of a financial institutionRole Of A Financial InstitutionFinancial Institutions are dedicated towards the growth of individual's funds and also contribute to the national economy. They're governed by various authorities to protect the investor's funds and keep a check on malafide practices. read more 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 be financed without taking much strain by the companies.
- It provides both risk and loan capitalLoan CapitalLoan Capital refers to the capital required to manage the business's operations raised from the external sources such as financial institutions by issuing debentures. It only includes long term funds utilized for business goals by bearing some interest or charge.read more. 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. 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.
Disadvantages
- There are various documentation and the other facilities through which a concern requiring finance from the financial institutions has to undergo. It 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 places restrictions on the autonomy of the management of the concerned person. They also sometimes insist on appointing their nominees in borrowing the company’s board of directors.
Important Points
- 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 based on size, geography, and scope.
- They are divided primarily into two categories, depository institutions and the non-depository institutions based on 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.
Conclusion
Thus it can be concluded that the financial institutions provide a broad range of business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more 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.
Recommended Articles
This article 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 –
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