Financial institutions exist to solve the problem of providing money to people and businesses that need it. Without these organizations and the standard system, it would be difficult and risky to match people who have extra money with those who need to borrow. For example, you would probably need to find a few people willing to lend you enough money for a major purchase, and the borrowers would have to take the risk that you could not pay it back.
Financial institutions help the economy as a whole to function properly so that people can efficiently process everyday financial transactions.
An example of working with a financial institution would be 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 its pool for lending. You get a small amount of interest in exchange for your deposit along with FDIC insurance protection. When another customer at the bank decides to take out a $20,000 auto loan, the bank can use your $100 to fund the loan and charge the customer interest. The bank’s profit from this transaction will be equal to the difference between the interest charged to the customer and the interest they paid you.
FDIC
The government regulates financial institutions through various agencies to protect depositors and investors. For example, the Federal Deposit Insurance Corporation (FDIC) provides $250,000 worth of insurance per depositor at banks, while the National Credit Union Administration (NCUA) provides the same insurance at credit unions. These measures protect customer funds in the event of an institution’s bankruptcy and also reduce the likelihood of a bank run. Financial activities involving the exchange of securities (stocks, ETFs, etc.) are primarily regulated by the Securities and Exchange Commission (SEC).
Depositary vs. non-depositary
Financial institutions fall into two categories: depository and non-depository. Depository institutions include depository businesses such as credit unions, banks, and savings associations. In contrast, nondepository institutions include brokerage firms and insurance companies.
Types of financial institutions
There are different 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 specific services. The main types of financial institutions include:
Retail and commercial banks
Retail and commercial banks allow you to open deposit accounts and access a wide range of financial services related to saving and borrowing money. Retail banks serve individuals and commercial banks serve business customers.
Online banking platforms may not have a physical location, but they offer some of the same types of financial services as conventional banks.
Credit Unions.
Unlike banks, credit unions reinvest the money they earn from interest charges to keep costs low and benefit their customers. These depository institutions typically target a specific community or group of people and require membership. They offer a variety of traditional banking services, from current and savings accounts to credit cards and credit programs.
Insurance companies
Insurance companies offer different types of insurance policies to offer financial protection. For example, insurance companies often sell products such as life, health and home insurance. They put money from premiums into a pool to finance insurance coverage.
Brokerage Firms.
Brokers help with transactions in securities such as stocks, mutual funds and bonds. People who want to buy or sell securities use brokerage firms to facilitate the transaction. Some firms also offer financial advice and act as advisors.
Savings and Loan Associations.
These depository institutions, also known as “savings institutions” and less common, focus mainly on providing home loans and savings accounts. However, some also have other types of loans and account options, so they can sometimes seem similar to retail banks.
Investment banks
Investment banks work with corporations, 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.
