What Is a Financial Institution?

A financial institution is an organization that handles a variety of currency transactions, such as cash deposits, loans, securities exchanges, and capital raising. Mediates transactions between people who deposit or invest money and people who need to borrow or withdraw money.

Learn more about how a financial institution works, what types exist, and why you may need one to complete daily financial transactions.

Definition and examples of financial institutions

Financial institutions are companies that provide different types of financial services to clients. They use funds provided by clients and then distribute them to the people and businesses that need them.

Therefore, they connect savers and spenders to facilitate transactions in financial markets. For example, these arrangements make it possible for borrowers to borrow with funds made available by savers.

These organizations also help clients raise funds and invest their money. This includes making it easier to buy and sell securities like bonds and stocks.

Some financial institutions also help clients protect their assets and help them manage their money. For example, some offer insurance policies that protect homes or cars against financial loss. Financial institutions can also buy and sell currencies.

Two of the most common examples of financial institutions are consumer banks and credit unions. These institutions allow clients to open checking and savings accounts to store their money safely and conveniently.

Banks and credit unions use customer deposits to make loans and credits to other customers, generating income through interest charges. You can also manage a variety of other tasks through these institutions, such as cashing checks, exchanging currency, investing money in a retirement account, and paying bills.

Financial institutions exist to solve the problem of making money available to the people and businesses that need it. Without these organizations and a standard system, it would be challenging and risky to combine people with additional funds and people in need of a loan.

For example, you would probably need to find several people willing to lend you enough money for a large purchase, and borrowers would have to take the risk that you would not pay them back.

How Does a Financial Institution Work?

Financial institutions help the overall economy run smoothly overall, so that people can handle day-to-day financial transactions efficiently.

An example of working with a financial institution would include doing business with your local bank. If you open a savings account and deposit $ 100, you have provided the bank with some money that it can add to your loan fund. You receive a small amount of interest in exchange for your deposit, along with FDIC insurance protection.

When another bank customer decides to take out a $ 20,000 auto loan, the bank can use their $ 100 to help finance the loan and will charge the customer interest. The bank's profit from this transaction would be the difference between the interest charged to the customer and the interest paid to him.

FDIC

The government regulates financial institutions through various agencies to protect savers and investors. For example, the Federal Deposit Insurance Corporation (FDIC) offers insurance for $ 250,000 per depositor at banks, while the National Credit Union Administration (NCUA) offers the same coverage at credit unions.

These measures protect clients' funds in the event of an institution bankruptcy and also reduce the possibility of a bank run. Financial activities that involve the exchange of securities (stocks, ETFs, etc.) are mainly regulated by the Securities and Exchange Commission (SEC).

Custodian vs. Non depositary

Financial institutions are divided into two categories: depository and non-depository institutions. Depository institutions include deposit-focused companies such as credit unions, banks, and savings associations. In contrast, non-depository institutions include insurance companies and brokers.

Types of Financial Institutions

There are several types of financial institutions that can meet your specific needs. They can be for-profit or non-profit, serve different types of clients, provide a specific purpose, or focus on certain services. The main types of financial institutions include:

Commercial and retail banks

Commercial and retail banks allow you to open deposit accounts and access a wide range of financial services related to saving and borrowing. Retail banks serve individuals, while commercial banks serve corporate clients.

Credit unions

Unlike banks, credit unions reinvest money earned by charging interest in order to keep costs down and benefit their clients. These fiduciary organizations usually target a specific community or group of people and require membership. They offer a range of traditional banking services ranging from checking and savings accounts to credit cards and loan programs.

Insurers

Insurers offer several types of insurance policies to provide financial protection. For example, insurers often sell products such as life, health, and home insurance. They put the money that comes from insurance premiums in a common fund to finance the coverage of the policy.

Corridors

Brokers help with transactions related to securities such as stocks, mutual funds, and bonds. People who want to buy or sell securities use brokers to facilitate the transaction. Some companies also offer financial advice and act as consultants.

Savings and credit associations

Also known as "savings institutions" and less common to find, these depository institutions primarily focus on providing mortgages and savings accounts. However, some also have other types of loans and account options, so they can sometimes resemble retail banking.

Investment banks

Investment banks work with companies, governments and other institutions that need capital and financial advice. They do not handle customer deposits, but help with financing through securities such as bonds and stocks. They also offer advice on business planning and decisions such as mergers.

Do i need a financial institution?

If you plan to save for retirement, buy a home, protect your assets, or deposit your paychecks directly into a bank account, you will most likely need the services of one or more types of financial institutions.

While you can choose to keep your money in a safe at home or carry it in your wallet, depositing it with a financial institution ensures its safety. Because government regulations provide some protection for your deposits in the event of a bank failure, you also have an extra layer of protection.

You can also choose to use a financial institution to earn interest on a deposit account (CD, money market, savings, or checking), or you can use your money to buy stocks and bonds through a brokerage.

Financial institutions can also provide a wide range of loan products that make buying a home, paying for an education, or starting a business financially viable. Without a financial institution, you may have to rely on your own savings or borrow funds from friends and family.

Therefore, having access to these institutions opens up opportunities that you would not have without the ability to borrow.

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Source: Generation Wealthy

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