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What Is a Financial Institution?

DEFINITION:

A financial institution is an organization that engages in a range of monetary activities, such as cash deposits, loans, trading securities, and raising capital.

Key Takeaways

Financial institutions assist facilitate financial transactions between persons saving and those spending money. 

Services that financial organizations may provide include bank accounts, loans, investments, insurance policies, and foreign currency exchange. 

Depository financial institutions take deposits from consumers, whereas non-depository financial organizations will offer financial services without taking deposits. 

Examples of financial institutions include retail and commercial banks, investment banks, insurance businesses, financing companies, credit unions, brokerage firms, and savings and loan organizations. 

You’ll likely employ a range of financial institutions to execute activities such as saving for retirement, acquiring a mortgage, and trading stocks. 

Definition and Examples of Financial Institutions

Financial institutions are enterprises that offer various forms of financial services to consumers. They utilize the cash that clients supply, then distribute them to people and companies that need them. Thus, they link savers and spenders to ease transactions in the financial markets. For example, these firms make it feasible for borrowers to get loans using the cash that savers have made accessible.

These organizations also play roles in helping clients raise funds and invest their money. This involves enabling the purchasing and selling of securities like bonds and stocks. Some financial firms also aid consumers with preserving their assets, while assisting them with managing their money. For example, some may sell insurance plans that cover houses or automobiles from financial harm. Financial institutions may also purchase and sell foreign currencies.

Two of the most frequent examples of financial institutions are consumer banks and credit unions. These organizations let consumers to create checking and savings accounts to safely and easily keep their money. Banks and credit unions then utilize consumer deposits to make loans and credit to other customers, making money by charging interest. You may also handle a range of additional chores via these organizations, such as cashing checks, exchanging currencies, putting money in a retirement account, and paying bills.
  • Acronym: FI

How Does a Financial Institution Work?

Financial institutions exist to tackle the challenge of making money accessible to the individuals and enterprises that need it. Without these groups and a common framework, it would be hard and unsafe to link up those with excess income with others who need to borrow. For example, you’d likely need to locate numerous willing persons to give you enough money for a significant purchase, and the borrowers would need to take on the risk that you may not pay them back.
Note
Financial institutions assist the whole economy work smoothly in general so that individuals may manage day-to-day financial transactions effectively.
An example of dealing with a financial institution might involve conducting business with your local bank. If you create a savings account and deposit $100, you’ve supplied the bank with some money it can contribute to its pool for lending. You receive a little amount of interest in exchange for your deposit combined with protection from FDIC insurance. When another client at the bank chooses to take out a $20,000 vehicle loan, the bank may utilize your $100 to help finance the loan, and will charge the customer interest. The bank’s profit for this transaction would be the difference between the interest charged to the client and the interest it paid you.

FDIC

The government controls financial firms via numerous organizations to safeguard savers and investors. For example, the Federal Deposit Insurance Corporation (FDIC) offers insurance for $250,000 per depositor at banks,1 while the National Credit Union Administration (NCUA) provides the same coverage at credit unions.2 These protections protect customers’ cash if an institution collapses, and also lessen the danger of a bank run. Financial transactions involving the trade of securities (stock, ETFs, etc.) are regulated largely under the Securities and trade Commission (SEC).

Depository vs. Non-Depository

Financial institutions split into two categories: depository and non-depository institutions. Depository institutions include deposit-focused enterprises such as credit unions, banks, and savings societies. In contrast, non-depository institutions include brokerage businesses and insurance companies.

Types of Financial Institutions

There are numerous sorts of financial institutions that may fit your individual demands. They might be for-profit or charity, serve various categories of clients, have a certain purpose, or specialize on certain services. The primary kinds of financial institutions include:

Retail and Commercial Banks

Retail and commercial banks enable you to create deposit accounts and access a broad variety of financial services linked to saving and borrowing money. Retail banks serve people, whereas commercial banks service corporate clients.
Note
Online banks and online banking platforms may not have physical facilities, but they do provide some of the same sorts of financial services as brick-and-mortar banks.

Credit Unions

Differing from banks, credit unions reinvest money gained from charging interest so they may keep expenses low and benefit their consumers. These depository organizations generally target a certain community or group of individuals and demand membership. They provide a variety of typical banking services that vary from checking and savings accounts to credit card and loan programs.

Insurance Companies

Insurance firms provide numerous sorts of insurance plans to give financial security. For example, insurance businesses generally market goods such as life, health, and house insurance. They deposit the money that comes from insurance premiums into a pool to support the policy coverage.

Brokerage Firms

Brokerages help with transactions relating securities such as stocks, mutual funds, and bonds. People who wish to purchase or sell stocks utilize brokerage companies to ease the process. Some businesses also give financial advice and operate as consultants.

Savings and Loan Associations

Also called as “thrift institutions” and less usual to locate, these depository institutions typically specialize on supplying house loans and savings accounts. However, they also feature other forms of loans and account possibilities, so they might look comparable to retail banks at times.

Investment Banks

Investment banks deal with firms, governments, and other entities that require finance and financial expertise. They don’t deal with consumer deposits, but rather aid with financing via instruments such as bonds and stocks. They also give assistance on company strategy and issues such as mergers.

Do I Need a Financial Institution?

Whether you want to save for retirement, purchase a house, secure your assets, or have your paychecks deposited directly into a bank account, there’s a strong chance you’ll require the services of one or more sorts of financial institutions.

While you may elect to store your money in a safe at home or carry it in a wallet, depositing it with a financial institution insures its safety. Since government restrictions guarantee some protection for your money if a bank collapse happens, you have an added layer of safety, too. You may also elect to utilize a financial institution to earn interest on a deposit account (CDs, money market, savings, or checking), or you might use your money to purchase stocks and bonds via a brokerage.

Financial institutions may also supply you with a broad selection of loan solutions that enable purchasing a house, paying for an education, or establishing a company financially realistic. Without a financial institution, you could have to depend on your own resources or seek for loans from friends and relatives. So having access to these institutions brings up chances you would not have without the capacity to borrow.

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