Roles Performed by Financial Institution
Financial institutions play a pivotal role in every economy. They are regulated by a central government organization for banking and non-banking financial institutions. These institutions help in bridging the gap between idle savings and investment and its borrowers, i.e., from net savers to net borrowers.
Following are the list of roles performed by Financial Institutions –
- Regulation of Monetary Supply
- Banking Services
- Insurance Services
- Capital Formation
- Investment Advice
- Brokerage services
- Pension Fund Services
- Trust Fund Services
- Financing the Small and Medium Scale Enterprises
- Act as A Government Agent for Economic Growth
Let us discuss each one of them in detail –
#1 – Regulation of Monetary Supply
Financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. like the central bank help in regulating the money supply in the economy. They do it to maintain stability and control inflation. The central bank applies various measures like increasing or decreasing repo rate, cash reserve ratioCash Reserve RatioCash Reserve Ratio refers to the share of a Bank’s total deposits that need to be maintained with the respective Country’s Central Bank to control financial supply in the economy. , open market operationsOpen Market OperationsAn Open Market Operation or OMO is merely an activity performed by the central bank to either give or take liquidity to a financial institution. The aim of OMO is to strengthen the liquidity status of the commercial banks and also to take surplus liquidity from them., i.e., buying and selling government securities to regulate liquidity in the economy.
#2 – Banking Services
Financial institutions, like 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., help their customers by providing savings and deposit services. They provide credit facilitiesCredit FacilitiesCredit Facility is a pre-approved bank loan facility to businesses allowing them to borrow the capital amount as & when needed for their long-term/short-term requirements without having to re-apply for a loan each time. like overdraft facilities to the customers for catering to the need for short-term funds. Commercial banks also extend several kinds of loans like personal loans, education loans, mortgage or home loans to their customers.
#3 – Insurance Services
Financial institutions, like insurance companies, help to mobilize savings and investment in productive activities. In return, they provide assurance to investors against their life or some particular asset at the time of need. In other words, they transfer their customer’s risk of loss to themselves.
#4 – Capital Formation
Financial institutions help in capital formation, i.e., increase in capital stockCapital StockThe capital stock is the total amount of share capital (including equity capital and preference capital) that has been issued by a company. It is a way of raising funds by the company to meet its various business goals. like the plant, machinery, tools and equipment, buildings, means of transport and communication, etc. They do so by mobilizing the idle savings from individuals in the economy to the investor through various monetary services.
#5 – Investment Advice
There are a number of investment options available at the disposal of individuals as well as businesses. But in the current swift changing environment, it is very difficult to choose the best option. Almost all financial institutions (banking or non-banking) have an investment advisory desk that helps customers, investors, businesses to choose the best investment option available in the market according to their risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation. and other factors.
#6 – Brokerage services
These institutions provide their investors access to a number of investment options available in the market that ranges from stock, bonds (common investment alternative) to hedge fundsHedge FundsA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques., and private equity investment (lesser-known alternative).
#7 – Pension Fund Services
Financial institutions, through their various kinds of investment plans, help the individual in planning their retirement. One such investment options is a pension fundPension FundA pension fund refers to any plan or scheme set up by an employer which generates regular income for employees after their retirement. This pooled contribution from the pension plan is invested conservatively in government securities, blue-chip stocks, and investment-grade bonds to ensure that it generates sufficient returns., where the individual contributes to the pool of investment set up by employers, banks, or other organizations and get the lump sum or monthly income after retirement.
#8 – Trust Fund Services
Some financial organization provides trust fund services to their clients. They manage the client’s assets, invest them in the best option available in the market, and take care of its safekeeping as well.
#9 – Financing the Small and Medium Scale Enterprises
Financial institutions help small and medium scale enterprises set up themselves in their initial days of business. They provide long-term as well as short-term funds to these companies. The long-term fund helps them in the formation of capital, and short-term funds fulfill their day to day needs of working capital.
#10 – Act as A Government Agent for Economic Growth
Financial institutions are regulated by the government on a national level. They act as a government agent and help in the growth of the nation’s economy as a whole. For example, to help out an ailing sector, financial institutions, as per the guidelines from the government, issue selective credit lineCredit LineA line of credit is an agreement between a customer and a bank, allowing the customer a ceiling limit of borrowing. The borrower can access any amount within the credit limit and pays interest; this provides flexibility to run a business. with lower interest rates to help the sector overcome the issues it is facing.
Financial institutions are the backbone of the economy. Without the help of these institutions, the economy will go down and will not be able to stand up. Due to their pivotal role in the development and growth of the economy, the government regulates these institutions through the central bank, insurance regulators, pension fund regulators, and so on. Over the years, their role has expanded from accepting and lending funds to larger areas of services.
This has been a guide to the role of financial institutions. Here we discuss the top 10 role of financial institutions in economic development, which includes banking services, insurance services, trust fund services, etc. You may learn more about financing from the following articles –