Financial Institutions and Markets - An Overview of Financial Institutions

Learning Objectives

This is going to be an introduction article to our course on financial institutions and markets. In this article, we will present an overview of the financial system and how it allocates the flow of money throughout the economy.

We will also understand the concept of Surplus Spending Units (SSU’s) and Deficit Spending Units (DSU’s). 

In this article, we will learn how the interaction between the SSU and DSU happens. Money flows from Surplus Spending Units (SSU’s) to Deficit Spending Units (DSU’s) either directly (securities market, bonds market, futures and options, and derivatives market) or through financial intermediaries (banks, mutual funds, hedge funds, pension funds, etc.)

Get set go !!!!! Let’s begin 

What is Financial Institution - Definition of a financial institution

A financial system consists of financial markets and financial institutions. Financial markets are a marketplace for selling financial instruments like bonds, stocks, futures contracts, and all sorts of financial instruments. Financial transactions can involve billions of dollars and hence are very much risky. Hence, financial markets are subject to strict regulations by the Federal Reserve and the Central Banks of a country

Financial Institutions are firms such as commercial banks, public sector banks, credit unions, pension funds, Asset Management companies like (WODS), mutual funds, insurance companies, and hedge funds that provide financial services to its consumers.

Also, read - Secret tools of Stock Market valuation

What is the role of Financial Institutions?

Financial Institutions play a crucial role in the economic system. Its fundamental function is to transfer money from Surplus Spending Units (SSU’s) to Deficit Spending Units (DSU’s). 

Banks and other financial institutions like Mutual Funds and insurance companies gather money form households and other consumers in small amounts and then make loans to corporations and businesses who need money for business expansion, CAPEX, new product launches, etc.

Another important function of financial institutions is to allocate money to the most productive investment projects in the economy. So, if we have a competitive financial ecosystem, projects with high risk-adjusted rates of return will get accepted

Types of Financial Institutions

Type of Institutions	Examples
Deposit-type Institutions	Commercial Banks; Thrift Institutions; Credit Unions; Co-operative Banks
Contractual Savings Institutions	Life Insurance Companies; Casualty Insurance Companies; Pension Funds; PPF's
Investment Funds	Investment Banking; Mutual Funds; Hedge Funds; Money Market Funds
Other Financial Institutions	NBFC's, Microlending institutions, Federal Agencies

Deposit-type Institutions (Most important)

Contractual savings institutions

Investment Funds

Other Financial Institutions

Deposit-type Financial Institutions

Deposit-type financial institutions are the most commonly recognized financial intermediaries as the majority of people use their services on a daily basis. Typically, deposit-type financial institutions issue a variety of checking or saving accounts for households and other SSU’S. They use these funds to make business loans, consumer loans, personal loans, car loans, mortgages, gold loans, etc.

These institutions are generally regulated by the Central Bank of the country. Federal Reserve regulates all banking rules and legislations for deposit-type institutions in the US. In India, these institutions are governed by the Reserve Bank of India.

Commercial Banks

Commercial Banks are the largest and most diversified financial intermediaries on the basis of assets held and liabilities issued. They hold nearly $20 trillion worth of financial assets as of Sep 2020. 

Commercial banks are the highest regulated among all financial institutions.

Thrift Institutions

Savings, loan associations, and mutual savings banks are called thrift institutions. They obtain funds by issuing current accounts, savings account, and various kind of time deposits. They use these funds to purchase real estate loans consisting primarily of long term mortgages. These financial institutions are the largest providers of residential loan mortgages to consumers.

Credit Unions

These are small, nonprofit co-operative consumer organized institutions owned entirely by the members of the institution. Primary liabilities of credit unions include checking accounts also called share drafts and savings accounts. They primarily provide short-term customer loans.

Contractual Savings Financial Institutions

Life Insurance Companies

Life Insurance companies obtain funds by selling life insurance policies that help them to protect their families from financial loss due to the premature death of the earning member.

Casualty Insurance Companies

These insurance companies sell policies that protect policyholders against loss due to theft, fire, property, accidents, and negligence.

Pension Funds

Pension funds usually collect funds from employers and employees during the employees’ working period and provide monthly payments to the workers after their retirement. Pension funds usually invest money in corporate bonds and AAA+ rated Gsec’s. The main objective of pension funds is to provide financial planning for workers after their retirement

Investment Funds - Financial Institutions

Investment funds sell stocks and equity shares to investors and use these funds to purchase various financial instruments. They offer investors protection against default risk

Mutual Funds

A mutual fund is an instrument (in the form of a “trust”) that mobilize money from investors, to invest in different markets and securities, in line with the common investment objectives agreed upon, between the asset management company and the investors. In other words, through investment in a mutual fund, a small retail investor can get access to equities, bonds, money market instruments, and/or other securities, that may otherwise be unavailable to them and it also offers greater security and protection against default risk since the funds are managed by professional money managers.

For more details on mutual funds click here

Money Market Mutual Funds

A money market mutual fund (MMMF) is a type of mutual fund that invests primarily in short term money market securities like TRTO, repo rates, and short term corporate bonds or arbitrage instruments. These mutual funds have very low default risk

List of Major Financial Institutions - Top 7 Global Financial Institutions

Here are the top 10 investment banking companies in the world as per total assets

Industrial and Commercial Bank Of China Ltd. (IDCBY)

The largest bank in the world as per total assets controlled Total Assets - $4.52 trillion

Agricultural Bank of China Ltd.

Agricultural Bank of China provides international commercial banking and financial services. It operates through the following segments: Corporate Banking, Personal Banking, Treasury Operations, and Others & Unallocated
Total Assets - $3.69 trillion

JPMorgan Chase & Co. (JPM)

It is one of the largest multinational investment banking companies in the world. Headquartered in New York, this bank is listed on the New York Stock Exchange Total Assets - $3.21 trillion

China Construction Bank Corp. (CICHY)

Second Chinese bank in our top 10 global list. It provides investment banking, corporate banking, corporate lending, and personal banking services Total Assets - $3.09 trillion

BNP Paribas SA

BNP Paribas S.A. is a French investment banking group. It is the world's 5th largest bank by total assets, and currently operates with a presence in 72 countries Total Assets - $2.9 trillion

Japan Post Holdings Co. Ltd. (JPHLF)

It is the largest financial institution in Japan. It provides investment banking, insurance, and logistics services to corporations. Total Assets - $2.7 trillion

Bank of America Corp. (BAC)

Bank of America is a U.S. based investment banking company that offers services for individual clients and businesses of all sizes. Total Assets - $2.6 trillion

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