What is a Financial Institution and Its type?

What is a Financial Institution?

A financial institution (FI) is a company that deals with financial and monetary transactions such as deposits, loans, investments, and currency exchange.

Financial institutions encompass a wide range of business activities within the financial services sector, including banks, trusts, insurance companies, brokerage firms, and asset dealers.

Almost everyone living in a developed economy has an ongoing or at least intermittent, need for the services of financial institutions.

Financial institutions, also known as banking institutions, are companies that provide services as intermediaries for financial markets. Broadly speaking, there are three main types of financial institutions:

  • Depository institutions: deposit-taking institutions that accept and manage deposits and make loans, including banks, building societies, credit unions, trust companies, and mortgage loan companies;
  • Contractual institutions: insurance companies and pension funds
  • Investment institutions: investment banks, underwriters, and other different types of financial entities managing investments.

Financial institutions can be distinguished broadly into two categories according to ownership structure:

  • Commercial banks
  • Cooperative banks

Some experts see a trend towards the homogenization of financial institutions, that is, a tendency to invest in similar areas and pursue similar business strategies. A consequence of this could be fewer banks serving certain target groups and small producers could be underserved.

For this reason, the United Nations Sustainable Development Goal 10 aims to improve and strengthen the regulation and oversight of global financial institutions.

financial institution

Types of Financial Institutes

Financial institutions offer a wide range of products and services for private and commercial customers. The specific services offered vary widely between different types of financial institutions.

1. Central Banks

Central banks are the financial institutions responsible for the supervision and administration of all other banks. In the United States, the central bank is the Federal Reserve Bank, which is responsible for conducting monetary policy and overseeing and regulating financial institutions.

Individual consumers have no direct contact with a central bank; Instead, major financial institutions work directly with the Federal Reserve Bank to provide products and services to the general public.

2. Commercial Banks

These are very common and important types of financial institutions that every individual deal with as well. These banks accept deposits and offer security and convenience to their customers. Part of the original purpose of banks was to provide customers with safekeeping for their money. With these banks, consumers no longer have to hold large amounts of money; Transactions can instead be made using checks, debit cards, or credit cards.

3. Internet Banks

Internet banks, which operate in a similar way to retail banks, are a new entrant in the market for financial institutions. Internet banks offer the same products and services as conventional banks, but via online platforms instead of stationary locations.

There are two categories of internet banks: digital banks and neo banks. Digital banks are purely online platforms that are connected to traditional banks. Neobanks are purely digital native banks that do not belong to any bank other than themselves.

4. Credit Unions

According to their affiliation, credit unions serve a specific demographic group, such as Teachers or members of the military. While the products on offer are similar to those offered by retail banks, credit unions are owned and operated by their members and work to their advantage.

5. Savings and Loan Associations

Mutually owned financial institutions that do not give more than 20% of total corporate lending fall into the category of savings banks. Private customers use savings and credit associations for deposit accounts, personal loans, and mortgage loans.

6. Investment Banks and Companies

Investment banks are the financial intermediaries who provide a whole range of services to businesses and some governments. A wide range of services includes underwriting debt and equity issues, acting as an intermediary between an issuer of securities and the investing public, brokering markets, facilitating mergers and other corporate restructurings, and acting as a broker for institutional clients.

Investment Companies are the corporations or a trust through which individuals invest in diversified, professionally managed portfolios of securities by pooling their funds with those of other investors.  Some major types of Financial Institutions are as follows:

  • Unit Investment Trusts,
  • Managed Investment Companies
  • Face Amount Certificate Companies 

7. Brokerage Firms

Brokerage firms assist individuals and institutions in buying and selling securities from available investors. Brokerage clients can place trades in stocks, bonds, mutual funds, exchange-traded funds (ETFs), and some alternative investments.

8. Insurance Companies

Insurance companies take risks by collecting premiums from individuals and organizations wishing to protect themselves and their families against specific harm such as fire, car accidents, illness, litigation, disability, or death. Insurance helps individuals and companies manage risk and preserve wealth. In general, all insurance companies use statistical analysis to predict their actual losses within a given class.

9. Mortgage Companies

Financial institutions that provide or finance mortgage loans are mortgage lenders. While most mortgage companies serve the individual consumer market, some specialize in lending options for commercial real estate only.