Financial Institutions

The goal of financial Institutions is to provide access to financial markets, a.k.a. financial intermediaries (they serve as middlemen) and indirect finance. Most financial institutions are regulated by the government. For every $1 that an American business raises by borrowing or selling stocks directly to/from Households (HHS), $20 raised through indirect finance.

financial institutions

Types of Financial Institutions

1. Depository institutions

These financial institutions get their funds mostly through public deposits. Some examples of depository institutions are banks and credit unions. Their main liabilities are deposit and their main assets are loans.

2. Insurance companies

Insurance companies collect premiums and pay compensation if certain events occur. They invest the premiums in securities and real estate (main assets).

3. Pension funds

Pension funds collect contributions from current workers and pay contributions to retired workers. They organize and invest funds contributed by employers and employees towards employee retirement.

4. Securities firms

Securities firms provide individuals and firms access to financial markets.

Examples of securities firms:

  • Investment Banks sell new securities. They don’t hold any deposits or make loans.
  • Underwriters perform the same functions as investment banks but also buy leftover securities. They help companies issue and distribute public securities.
  • Broker buy and sell old securities on behalf of individuals.
  • Mutual Funds pool people’s money and invest in stock indices or other securities.
  • Hedge Fund pool rich people’s money and invest in riskier securities.

5. Finance companies

Finance companies are like banks (loan money), but instead of deposits, they raise cash by selling bonds/commercial papers.

6. Federal Credit Agencies

Government-sponsored enterprises are federal credit agencies. Ex: Provider of loans directly to farmers or homebuyers. They buy up private loans, mortgages and student loans.

Examples of Non-Bank Financial Institutions

Some examples of nonbank financial institutions (NBFI) include those financial institutions that do not have a full banking license. A national or international banking regulatory agency does not supervise them. Non-Bank Financial Institutions also add competition in the provision of financial services. While banks may offer a set of financial services as a packaged deal, Non-Bank Financial Institutions unbundle and tailor these service to meet the needs of specific clients.

1. Insurance Companies

Insurance companies hold and invest people’s savings over a long period. They offer annuity plans which make a fixed monthly payment after retirement till death.

2. Pension Funds

Pension funds are schemes which provide retirement income. These funds typically have large amounts of money to invest. They are major investors in listed and private companies. They are especially important to the stock market where large institutional investors have dominance. There are two types of pension funds – defined contributed plan and defined benefit plan.

3. Defined Contributed Plan

In a defined contributed plan, the employer or employee or both make contributions on a regular basis.

4. Defined Benefit Plan

In a defined benefit plan, an employer/sponsor promises a specified monthly benefit on retirement. The employer predetermines this benefit based on a formula accounting for the employee’s earnings history, the tenure of service and age.

5. Finance companies

Finance companies issue securities to raise funds, in which they invest.

6. Mutual Funds

Mutual funds pool people’s money to make investments. People commonly refer to them as “investment companies” or “registered investment companies.” Hedge funds are not mutual funds, simply because they cannot be sold to the general public.

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