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Financial Institutions: Need and Types

  • Utsav Mishra
  • Jan 31, 2022
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You may be someone who works from 9 to 5 in a corporate job. Maybe you are hustling to build a start-up, freelancing on several projects, or maybe leading a major multinational company. 


No matter the profession you are in, as long as you are earning money and want to secure it, you need someplace to invest it in. You may also receive a handsome rate of return on your investment or you may also like to take a loan on a big purchase you are looking forward to. Financial institutions are the solution to practically all of your financial demands.


In today’s blog, we will explore the different types of financial institutions and understand the role of each type. 


What do we mean by financial institutions?


A corporation that operates in all forms of finance-related activities is referred to as a financial institution. They are distinct from banks and play a vital role in expanding the nation's financial services. 


In comparison to government-centric banks, they offer consumers a relatively appealing rate of return. It offers various types of loans and advances, as well as specializing in certain areas such as hiring, purchasing, and leasing.


Why do we need financial institutions?


A financial institution exists in today's economic resources market to get a wide range of banking, lending, and investing options to people, corporations, or both. 


Although some financial institutions emphasize presenting facilities and accounts to the wider population, others are more prone to supply additional services to a select group of customers. 


It is important for understanding the differences between the sorts of financial institutions and the goals they provide in order to choose which one is most suited to meet a certain demand. (here)


7 Types of Financial Institutions


There are 7 major types of financial institutions that can provide different forms of services. We look at them all here, from central banks to local banks and everything in between. 


  1. Central Banks

  2. Investment Banks and Companies

  3. Retail and Commercial Banks

  4. Credit Unions

  5. Insurance Providers

  6. Exchanges and Clearing Houses

  7. Investment Managers


Let us understand each of these different types of financial institutions one by one. 


  1. Central Banks


Central banks are financial institutions in charge of overseeing and managing all other banks. For example, the Federal Reserve Bank is the central bank of the United States and it is in charge of monetary policy, as well as financial institution supervision and regulation. The Reserve Bank of India is the central bank of our country and has a similar role.


In a given economy, a central bank is the exclusive issuer of legal tender or money. It also sets interest rates in the domestic market and, in many circumstances, the foreign exchange (FX) rate for a currency.


  1. Investment Banks and Companies


Investment banks are entities that do not accept any deposits. They are largely concerned with corporate behavioural finance. 


Investment banks offer business advising services to assist companies in raising cash from the money markets, such as assisting a firm in raising shares through an Initial Public Offering (IPO). 


They also provide additional services, such as prime brokerage, which is a type of brokerage that includes securities lending to large institutional clients.


Investment bank makes their money largely by charging fees for consulting and underwriting services. They make money through trading on the capital markets as well.


  1. Retail and Commercial Banks


Retail banks used to cater to individual customers, while commercial banks dealt directly with enterprises. As of now, the majority of large banks provide both demographics deposit accounts, lending, and basic financial advising. 


Traditional deposit-taking institutions, retail banks take cash deposits from depositors and pay interest on such accounts. They make money by lending deposits to borrowers at a greater interest rate than savings accounts. 


Checking and savings accounts, personal and home loans, credit cards, certificates of deposit (CDs), and corporate banking accounts are all available at retail and commercial banks.


  1. Credit Unions


A credit union is a type of financial institution whose members both own and control it. Credit unions are unique among financial entities (banks, savings, and loans). The members who have accounts with the Credit Union are the Credit Union's owners.


Credit unions cater to a certain population, such as teachers or military personnel, depending on their field of membership.


Cooperative banks in India provide many of the same roles as credit unions. According to WOCCU statistics, the country has roughly 1,935 credit unions with 91,077,299 members. Credit unions are important because they provide major financial support to the country's rural sector.


  1. Insurance Providers


Insurance companies are financial businesses that assist individuals in transferring the risk of loss. Insurance companies safeguard individuals and businesses from financial loss caused by death, unemployment or other disabilities, disasters or accidents, damage to property, and other calamities.


Another important segment of the financial industry is insurance companies. In exchange for a minimal premium paid at regular intervals, they provide protection against unanticipated financial losses resulting from occurrences such as accidents and disasters. They provide services to both people and organizations.


Insurance providers offer multiple types of insurance such as life insurance, medical insurance, vehicle insurance, and home insurance to clients. They supply options for enterprises such as maritime insurance for cargo on ships, insurances for breach of data, worker's compensation insurance, and so on.



  1. Exchanges and Clearing Houses


Exchanges are financial institutions where actual monetary asset trading actually occurs. The stock exchange is the most prevalent type of exchange. Stocks must be listed on an exchange before they may be traded.


In order to be listed on a stock market, a firm must satisfy particular conditions. They compile orders from various market players and enter them into an order book. The trades are carried out when the purchase and sell orders are in sync. Millions of deals may be executed every day on today's computerized platforms.


Clearinghouses, on the other hand, have a separate function. They are in charge of reconciling accounts amongst various market players. They are widespread in the financial sector, where many contracts are cash-settled, meaning that one side pays the other based on the underlying security's price. The clearinghouse is in charge of assigning the payer, recipient, and payment amount.


  1. Investment Managers


Professional businesses that provide investment management services to individual and institutional clients are known as investment managers. Hedge funds, mutual fund, exchange-traded fund (ETF) managers, and other participants are among them.


Managers of mutual funds and exchange-traded funds (ETFs) generally cater to regular investors by providing pre-packaged investment options. They make money by collecting a tiny charge for managing the overall amount of money, which is referred to as assets under management.


Hedge fund clients, on the other hand, are mostly institutions and a few high-net-worth individuals. Hedge funds encompass a wide range of alternative asset managers, including private equity and venture capital, commodities trading advisers (CTAs), highly specialized public market investors, and so on.


Bottom Line


The greatest approach to deposit money and make a fair return on those investments is through financial institutions. The primary contribution of financial institutions is that they attempt to aid our country's economic development. They provide a one-of-a-kind and cutting-edge method of keeping money secure. 


However, customers should also be aware that the institutions' services come with some risk concerns. Customers should read the policies of the institutions very carefully. 


“Adventure is the life of commerce, but caution is the life of banking.” ― Walter Bagehot

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