You’ve heard about the term “financial institution” at least once in your life. Probably more. You’ve heard about it at school when you were about to get your own place, and any time you’ll be committing yourself to anything that involves spending any amount of money.
The popular belief of what financial institutions is that they consist mainly of banks. Banks are indeed financial institutions, but they’re not everything that’s under the umbrella.
To get on with the subject, financial institutions are entities involved in business that deals with monetary and financial transactions such as deposits, loans, investments, and currency exchange.
Financial institutions are more than banks. They also include other businesses operating in the financial services sector, such as trust companies, brokerage firms, investment dealers, and insurance companies.
How do financial institutions work?
In any economy, financial institutions serve people during financial operations, such as investing and other types of transactions. They work under the auspices of respective governments—under tight regulations that come with their own sanctions once breached.
Financial institutions are so integral to economies that their failure can lead to total economic collapse, as recorded in history.
In the United States, financial institutions that provide deposit services such as savings accounts are regulated by the Federal Deposit Insurance Corporation (FDIC). The FDIC is in charge of insuring regular deposit accounts to give deposit clients such as individuals and businesses that their finances are safe in the hands of FDIC-accredited financial institutions.
What are the major types of financial institutions?
Financial institutions offer a wide variety of financial services to consumers who can be individual or commercial clients. You can discern these types based on the clients they mostly serve and the services they offer.
- Central banks
A central bank is a type of financial institution that oversees and manages other banks in its jurisdiction. In the US, the central bank is called the Federal Reserve Bank, or the Fed. They’re responsible for creating monetary policy and other financial institutions’ supervision and regulation in all the country’s 50 states.
Individual consumers don’t get to transact with a central bank directly. Instead, big financial institutions are the ones who work with central banks to provide the right services to the public.
Around the world, there are only nine countries without their own central bank.
- Commercial and retail banks
The traditional definition for these two is that commercial banks work with businesses, and retail ones work with individuals. But today, we have commercial and retail banks that work with both individuals and businesses.
The two banks offer checking accounts, savings accounts, certificates of deposits, personal loans, mortgage loans, credit cards, and business accounts.
- Digital banks
The newest members of the financial institution umbrella are digital or internet banks. They provide the same services as retail banks, but they don’t operate in traditional brick and mortar locations. Smartphone applications mostly power them.
- Credit unions
Credit unions or credit providers serve specific individuals based on their membership. They may serve teachers, military members, or other demographics based on the type of membership. Credit unions are owned and used by members and operate for their own benefit.
- Savings and loans associations
These are mutually owned and managed lending businesses that provide deposit account, personal loans, and mortgage lending services.
- Investment banks
These banks don’t take deposits. What they do is connect individuals, businesses, and governments to corporations and issue securities. They pool funds from investors to provide them access to securities.
- Brokerage firms
They assist individuals and institutions in buying and selling securities to investors. They trade stocks, bonds, mutual funds, exchange-traded funds, and other tradable investments on behalf of their clients.
- Insurance companies
Apart from retail and commercial banks, insurance companies are probably among the most popular financial institutions out there. They help individuals protect themselves against financial instability due to death, disability, property damage, and other stipulated occurrences.
- Mortgage companies
This financial institution fund mortgage loans and only serve the commercial and residential markets.