Financial Institution Definition | Easy Explanation (2020)

Financial Institution facilitates a wide range of services like processing loans, opening bank accounts, equity offerings, brokerages, wealth management services, etc. A great example of a financial institution is a Bank. A bank is a financial institution that offers multiple money-related services.

What are financial institution | The Definition

Financial institutions are companies that facilitate different types of money related services that can be availed by individuals and companies. The financial institution services include banking services, brokerage services, loan-related services, insurance, and many more services. Financial institutions are also called as banking institutions.

Types of financial institutions

In a broad view a financial institutions can be categorized as

  1. Depository Institutions
  2. Non-Depository Institutions

Depository Institutions are the ones that are legally allowed to accept deposits from consumers. Examples of depository institutions are

  1. Saving Banks
  2. Commercial Banks
  3. Credit Unions
  4. Saving & Loan Association (S&L’s)

Whereas on the other side, Non Depository Institutions are the ones which serves as an intermediary company between consumers who wants to deposit and borrowers who wants to borrow money. Few examples of Non Depository Institutions are

  1. Insurance Companies
  2. Brokerage Houses
  3. Loan Companies
  4. Investment Banks
  5. Hedge Funds Companies
  6. Mutual Fund Companies

26 Types Of entities which can be considered as a financial institution

As per Title 31 of the United States Code which holds the Federal Laws relating to Money & Finance following entities can be considered as Financial Institutions

  1. An insured bank
  2. A commercial bank or trust company
  3. A private banker
  4. An agency or branch of a foreign bank in the United States
  5. Any credit union
  6. A thrift institution
  7. A broker or dealer registered with the Securities and Exchange Commission
  8. A broker or dealer in securities or commodities
  9. An investment banker or investment company
  10. A currency exchange
  11. An issuer, redeemer, or cashier of travelers’ checks, checks, money orders, or similar instruments
  12. An operator of a credit card system
  13. An insurance company
  14. A dealer in precious metals, stones, or jewels
  15. Pawnbroker
  16. A loan or finance company
  17. Travel agency
  18. A licensed sender of money or any other person who engages as a business in the transmission of funds, including any person who engages as a business in an informal money transfer system or any network of people who engage as a business in facilitating the transfer of money domestically or internationally outside of the conventional financial institution’s system
  19. Telegraph company
  20. A business engaged in vehicle sales, including automobile, airplane, and boat sales
  21. Persons involved in real estate closings and settlements
  22. The United States Postal Service
  23. United States Government or of a State or local government agency
  24. A casino, gambling casino, or gaming establishment

Source: Cornell Law School

Financial institutions regulations

To ensure stability throughout the financial system, regulations and regulatory bodies are mandatory. These regulations are meant to protect consumers from becoming victims of any sorts of financial crimes or financial frauds. U.S. Securities and Exchange Commission(SEC) is an example of a Financial regulatory body.

How financial Institution makes money

There are virous ways in which a financial institution makes money. Some examples of how a financial institutions earns profits is through interest on loans, commissions and transaction fees.

A simple example- How bank makes money

For the sake of example, lets’s assume that a customer named John has $10000 as his savings and wants to deposit it. So he visits a near by Bank. Bank lets john deposit his $10000 and offers him an interest rate on his deposit. For this example we can assume the interest rate to be 5% p.a.. On the other hand, we have another customer named Patric. Mr Patric is looking for an loan amount of $10000 from the bank for expanding his business. Patric visits the bank and get approval for a $10000 loan at an interest rate of 9% p.a.. Remember, Patric has to pay interest rates to the bank as he has borrowed money from the bank. Bank simply transferred Mr John’s money for an higher interest rate to Mr Patric. Overall bank made an 5 % profit on the enitre transaction involving Mr John and Mr Patric.

List of few International Financial Institutions (IFIs)

Below, we have listed few of the biggest International Financial Institutions(IFIs)

  1. African Development Bank
  2. Asian Development Bank
  3. Caribbean Development Bank
  4. European Bank for Reconstruction & Development
  5. Inter-American Development Bank
  6. World Bank

Few Important Functions & Roles Of Financial Institutions In Financial System

Financial institution plays a very vital role in the well being of an countries economy. Below we have listed few important functions of financial institutions.

  • Assisting & directing the payment system
  • Loan Arrangement
  • Insurance
  • Facilitating Mergers & Acquisitions
  • Financial Advising
  • Facilitating Financial Instruments

Conclusion

As you saw the above example, different financial institution follows different strategies for making money from consumers. Hope you got an fair understnading of what an financial institution is in this blog post. Pls use the comment box to share your thoughts and ask as any query you have about this post.

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