(MM) Financial Institutions Lesson

Financial Institutions

When you think of the term "financial institution," your first thought is probably of your local bank. While banks are, indeed, financial institutions, they are not the only financial institution. In truth, not even all banks are the same type of financial institution.

Financial institutions come in two types: depository and non-depository. Depository institutions accept deposits from customers. These deposits may be placed in a checking account, a savings account, or certificates of deposit. These deposits are used in three ways: a portion is held in reserve so that any depositor may claim their funds, the majority of the remainder is used to make loans from which the bank earns interest (and its profit), and finally, any excess is invested usually in government bonds. Non-depository institutions do not accept deposits, but do offer their customers a variety of financial services. Let's take a look at the services provided by both types of financial institutions.

Depository

Commercial Banks - These banks offer the largest variety of services for the general public. Commercial or retail banks accept deposits into checking and savings accounts as well as into certificates of deposit. In addition, these banks offer mortgages and loans, financial planning advice, safe deposit boxes, investment advice, and trust services. Commercial banks are for profit organizations who make most of their money from the interest collected on loans.

Savings and Loans Association - This financial institution, also known as a thrift, specializes in accepting savings deposits and making mortgages available to its customers. What sets a Savings and Loans apart from a commercial bank is the fact that it is owned by its customers or members and those members share in the profits through lower interest rates.

Credit Unions - These not-for-profit organizations originally started to promote thrift among small specific groups of people, such as those who worked for the same company or those in the same career. Credit unions receive deposits from their owners, which they use to make loans to other members at low interest rates.

Non-Depository

Investment Banks - By law, investment banks cannot receive deposits. The role of an investment bank is to act as a financial intermediary between investors and the companies who need to raise money. This includes a variety of services including: sale of initial public offerings of securities (stocks), arranging mergers and acquisitions, acting as a financial adviser to corporate clients, and overseeing pension plans.

Financial Services Companies - These companies are in the business of making loans. Some of these companies specialize in certain types of loans (auto, mortgages, etc.) while others may specialize in the size of the loan. Loan companies may require a customer to have collateral with enough value that it could be sold to cover the loan balance if the customer could not pay the loan. Some companies will also offer unsecured loans to customers who are very unlikely to default.

Insurance Companies - Insurance companies offer customers the opportunity to transfer risk for a fee called a premium. The greater the risk and the possible amount of loss, the higher the premium. In addition to offering risk transfer, insurance companies also offer a number of investment products to their customers.

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