What are financial institutions?
Objectives of financial institution
Types of Financial institutions
Importance of financial institutions
Functions of financial institutions
What are financial institutions?
Financial institutions are businesses that are formed to deal with financial and monetary
transactions. These organizations primarily accept deposits, advance loans, make
investments, and provide foreign exchange services. Financial institutions include, but are
not limited to, banks, insurance companies, trust companies, brokerage firms, and
investment bankers. Because financial institutions play such an important role in the
economy in terms of monetary transactions, regulating their activities has become a
requirement for governmental authorities. As a result, the government creates a multitude of
laws and regulations to oversee the activities of financial institutions.
Objectives of financial institution
Satisfy financial needs
Financial institutions provide a variety of services to their customers. Satisfying the needs of
the customers and clients is an important objective for every financial institution. Each and
every customer’s financial needs vary, thus financial institutions require to take quick actions
to maintain their business by satisfying the customer needs.
Assist customers
The financial institution helps people by offering various types of financial assistance like
investment services, savings services, loans, etc. It helps their clients to choose the
investment based on their interest and risk tolerance and also teaches them how to maintain
investments.
Mobilize savings
The financial institution encourages saving by accepting deposits from customers through
different savings plans. By paying interest on deposits, it increases the customer’s financial
income. Banks, insurance companies, and investment companies encourage people to save
money by using the services offered by them.
Types of Financial institutions
Credit unions
Credit unions are non-profit institutions managed by their own financial cooperative
members. Credit unions pool their members' assets or savings to provide loans and other
financial services to them. Members typically belong to a specific sectorial group and form a
union to financially support their lives. Credit unions offer lower interest rates on loans and
higher interest rates on investment instruments such as certificates of deposit and savings.
Commercial bank
The primary function of a commercial bank is to accept deposits. It is a for-profit financial
institution that provides loans and other services to its clients. A commercial bank can be
either public or private, as well as domestic or foreign. The government will be a major
stakeholder in public sector banks that operate under the supervision of the nation's central
bank. Private sector banks are similar to limited liability companies in which shareholders are
individuals and the banks are run as private businesses. Foreign banks will have many
branches in various countries and will have their headquarters in another country.
Investment bank
An investment bank is not the same as a commercial bank. Its primary concern is the needs
and interests of businesses and the government. It deals with financing mergers and
acquisitions, initial public offerings, and large projects, among other things. It acts as an
intermediary, underwriter, lender, and consultant.
Importance of financial institutions
Most of the world’s population depends on financial institutions for its daily transactions
without their knowledge. The economy depends on the financial institution. During the
economic recession, the services of financial institutions led to economic growth. Financial
needs are met by financial institutions through financial services. It acts as an intermediary
between people with cash and without cash, offering interest to depositors and charging
interest from borrowers. Thus, the proper functioning of institutions is essential for the
country’s financial stability and development.
Functions of financial institutions
Regulate monetary supply
The financial institution helps to regulate the economy's money supply. These institutions
control inflation and also maintain stability in the money supply. The federal reserve bank
takes various steps by increasing/decreasing repo rates, open market operation, cash
reserve ratios to regulate the country's liquidity. Financial institutions are taking part in buying
and selling the securities of the government which helps to regulate liquidity.
Bank services
Financial institutions which established their business in commercial banks, support people
financially to manage their savings and accept their money to deposit in their respective
banks. It offers credit facilities to its clients who need financial support to lead their lives. This
institution also gives reasonable interest rates for savings and other deposit accounts. They
cover loans like personal, educational, automobile, home, and mortgageable loans for its
customers.
Insurance services
The insurance companies also come under financial institutions as they provide money
through investments to the insurer. Insurance companies provide insurance for vehicles,
stocks, assets, marine, etc. Insurance companies also offer coverage for life insurance and
health insurance. These insurance companies offer their hand in mobilizing savings and
investing in productive investments. Here, they transfer customer risks with financial support
by assuring customers' life and insured asset in times of uncertainty.
Formation of capital
By accepting individuals’ savings, financial institutions provide monetary services to
investors who need external funds for increasing their capital stocks. Investors may need
financial services to implement expansion plans by installing new plants, machinery, tools,
equipment, building a new plant and buying new transport vehicles, etc. Thus, financial
institutions help in the formation of capital.
Investment consultation
Nowadays many investment options are carried out worldwide. A company/individual must
choose wisely for investing in a specific investment option that suits their interest. Many
investors may not be acquainted with numerous investment options. Every financial
institution has investment consulting services to help their clients to adopt the best option
available in the financial markets. Based on the investor’s risk-taking and other interests, the
financial institution suggests the investment option.
Brokerage service
Some financial institutions like commercial banks and non-banking companies offer a
different investment option for investors in the form of brokerage. The institution serves as a
broker between investors and various companies for selling stocks, bonds, shares by getting
a brokerage fee.
Movement of financial resources
Another function of financial institutions is the movement of financial resources from one
area to another area. Through financial institutions, money transfer was made easy for large
funds like investments, real estate purchases, and other huge transactions from one party to
another party.
Managing risk
The financial institution manages the risk and uncertainties of companies and individuals.
Financial institutions manage the risk by assembling a massive pool of individuals and
businesses to share the risks and difficulties faced by businesses and people.
Practice Problems
Question 1: __________ growth of the country depends on the functions of financial
institution.
1. Economic
2. Historical
3. Geographical
Answer: Option 1 is correct.
Explanation: Financial institutions deal with the monetary transaction and the economic
growth of a country depends on the healthy functioning of financial institutions. The financial
institution plays a crucial role in the economy of a country.
Question 2: A financial institution that accepts savings & deposits, gives loans, and with a
reasonable rate of interest to its customers is called ____________.
1. Share market
2. Commercial banks
3. Scrap market
Answer: Option 2 is correct.
Explanation: Commercial banks are financial institution that accepts savings and deposits
from their customers by giving a reasonable interest. They also provide loans and offer
investment choices to them.
Question 3: _________ is one of the financial institution functions which helps investors to
find a perfect investment option for investment.
1. Monetary regulation
2. Service
3. Investment consultation
Answer: Option 3 is correct.
Explanation: Investment consultation services help the investor to access many
investments option and to find a perfect investment to invest in. Most financial institutions
have such consultation services to assist the investor by showing the variety of options
available in the market.
Question 4: Insurance companies accepts risk of uncertain of people with ___________ .
1. Financial assistance
2. Regulation of money
3. Commercial banks
Answer: Option 1 is correct.
Explanation: The insurance company accepts the risk of its clients and assists them with
finance. Here they assure the life or assets of the insurer at the time of uncertainty. They
assist their clients to save money for an uncertain future by investing.
Question 5: Managing assets & investing in the financial market on behalf of the customers
the financial institutions act as ____________.
1. Credit unions
2. Helper
3. Trustee
Answer: Option 3 is correct.
Explanation: On behalf of the customer financial institutions act as a trustee by deciding
investment, maintaining income, and managing an invested asset in the financial market.
