FINANCIAL INSTITUTIONS

Meaning:
Financial Institutions are business organizations serving as a link between savers and investors
and so help in the credit allocation process. In simple, Financial Institutions are the institutions
which offer financial services for its clients or members. The most probable service is financial
intermediation. The institutions include banks, trust, companies, insurance companies and
investment dealers.
Definition:
Financial institution is defined as “an establishment that focuses on dealing with financial
transactions, such as investment, loans and deposits.” In other words, the financial institution is
an organization which may be either profit or non-profit, that takes money from clients and
places it in any of a variety of investment vehicles for the benefit of both the client and the
organization.
Salient feature of Financial Institutions:
An understanding of the above meaning and definition provides the following salient features of
financial institutions:
✓ It is an institution as well as intermediary.
✓ It channelizes savings fund into investment fund.
✓ It creates financial assets such as deposits, loans, securities etc.
✓ It includes banking and non-banking institutions.
✓ It includes both organized and unorganized institutions.
✓ Established with a clear operating function.
✓ Regulated by the government and regulating authority.
✓ It accepts deposits.
✓ It provides commercial loans, real estate loans and mortgage loans.
✓ Financial institutions keep money flowing through the economy among consumers,
businesses and government.
Classification of Financial Institutions:
The financial institutions are classified into term lending institutions, refinance institutions,
investment institutions and state level institutions. These are also to be classified into banking
and non-banking institutions.
Banking Institutions:
These are the type of financial institutions which involve in accepting public deposits and
lending the same to the needy customers. These are fundamentally established to earn profit,
secondarily to safeguard the interest of the members. The banking institutions ensure that
deposits accumulated from people are productively utilized.
The following are the types of banking institutions which are running their business in India.
A) Commercial banks: These are also called as business banks. The following are the types
of commercial banks.
i. Public sector.
ii. ii. Private sector.
iii. iii. Regional Rural Banks (RRB`s)
iv. iv. Foreign banks.
B) Cooperative Banks: These are established to safeguard the interest of its members.
These are organized on a co-operative basis, accept deposits and lend money to the required
members.
Non-banking Institutions:
These are the financial institutions that provide banking services without meeting the legal
definition of a bank. The non-banking financial institutions also mobilize financial resources
directly or indirectly from the people. They lend the financial resources mobilized.
The non-banking institutions are classified into organized and unorganized financial
institutions. The following are examples of non-banking institutions:
i. Provident and pension fund.
ii. Small Saving organization.
iii. Life Insurance Corporation (LIC).
iv. General Insurance Corporation (GIC).
v. Unit Trust of India (UTI).
vi. vi. Mutual funds.
vii. vii. Investment Trust, etc.
Non-banking financial institutions can also be categorized as investment companies housing
companies, leasing companies, hire purchase companies, specialized financial institutions
(EXIM Bank), Investment Institutions, State level institutions etc.

Importance of Financial Institutions:

Financial institutions are the key institutions which provide fund for economic activities.
There are many advantages for having sound and healthy financial institutions in a country.
The importance of FI is as follows:
✓ Provide funds: financial institutions provide funds for the investment and industrial
activities.
✓ Infrastructural facilities: financial institutions also offer basic infrastructural facilities
needed for the development and promotion of lucrative ventures. Infrastructural facilities
involve development of industrial estates tech parks, road and water etc.
✓ Promotional activities: promotional activities are undertaken by the financial institutions
to mobilize the funds, reduce the risk of selling financial securities, arrangement of
working and long term capital of the business.
✓ Development of backward areas: apart from the financial activities, financial
institutions also take some social responsibilities of developing the backward areas at free
of cost by offering credit facilities, free education, employment creation etc.
✓ Planned development: financial institutions initiate all planned developments in the
view of economic growth of the state. All planned developments are coordinated with the
government plan and social welfare.
✓ Accelerating industrialization: since the financial institutions are established to earn the
profit and safeguard interest of its members, they accelerate the industrialization to
contribute industrial growth. They support industries by granting finance, project
development and consultancy.
✓ Employment generation: channelizing the funds for investment, building of
infrastructural facilities, and acceleration of industries generates employment to the
educated and qualified people of the state.

Functions of Financial Institutions:

The functions of financial institutions are classified into primary functions and secondary
functions.

Primary functions: these are the basic functions of financial institutions which come in
the respective group of institutions like banks, co-operative societies, insurance industries
etc. the primary functions are as follows:
✓ Accepting deposits: most of the financial institutions viz, commercial banks,
cooperative societies etc., accept deposits from the public. They offer different schemes
to mobilize public deposits from the customers. For the accepted deposits, financial
institutions give return in the form of interest on deposit tenure basis.
✓ Providing commercial loans: accepted deposits are used for commercial lending
operations in the form of loans, advances, cash credits, bill discounting etc., these fetch
good return to the financial institutions.
✓ Providing Real estate loans: the financial institutions also provide loans and advances
for real estate industries to purchase sit, build premises, construction of industrial and
residential parks.
✓ Providing mortgage loans: the financial institutions also provide loans to the needy
group on mortgage of properties and collateral securities. For example, Gold loan,
property loan etc. where gold and properties are mortgaged to avail the loan.
✓ Issuing share certificates: financial institutions also undertake the job of issuing share
certificates of any established corporate to its share-holders. It also constitutes accepting
shares investment money from the investors and issuing them certificates on behalf of
the companies.
Secondary Functions: these are the additional functions performed by the financial
institutions along with the above primary functions. Secondary functions are as follow:
✓ Act as an intermediary: financial institutions act as an intermediary in between the
savings community and industrialist. They receive the public deposit at a lower rate of
interest and lend the same fund to the needy group at higher rate of interest. The
difference amount of interest is the profit for their intermediary work.
✓ Facilitate the flow of money: they also facilitate the flow/channelize the money to the
investment activities. Financial institutions are the interlinked path stones to make
smooth flow o fund from small savers to giant business ventures.