Chapter 3: Financial Institutions
Outline of the chapter
3. 1 Deposit type institutions
3.2 . General Types of Financial Institution
3.3 . Investment funds
3.4. Other types of financial institutions
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Introduction
Financial Institutions:
✓An institution which collects funds from the public and places
them in financial assets, such as deposits, loans, bonds and etc.
✓It is an establishment that focus on dealing with financial
transactions such as Investments, loans and deposits.
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Features of Financial Institution
✓It is an institution as well as intermediary.
✓It channelizes savings fund into investment fund.
✓It creates financial assets such as deposits, loans,
securities etc,
✓It includes banking and non banking institutions
✓and also includes both organized and unorganized
institutions,
✓Established with a clear operating function.
✓Regulated by the government and regulating authority.
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3.1. Types of Financial Institutions
1. Bank 1. Central Bank
A bank is a commercial or state A central bank, reserve bank or
institution that provides monetary authority, is an entity
financial services, including responsible for the monetary
issuing money in various forms, policy of its country or of a group
receiving deposits of money, of member states, such as the
lending money and processing European Central Bank (ECB) in
transactions and the creating of the European Union, the Federal
credit. Reserve System in the United States
of America, State Bank in Pakistan.
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Cont.
1. Central Bank 2. Commercial Banks
Its primary responsibility is to
A commercial bank accepts
maintain the stability of the
deposits from customers and in
national currency and money
turn makes loans, even in excess
supply, but more active duties
of the deposits; a process known
include controlling subsidized-
loan interest rates, and acting as as fractional-reserve banking.
a "lender of last resort" to the Some banks (called Banks of
banking sector during times of issue) issue banknotes as legal
financial crisis. tender.
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Cont.
3. Investment Banks
✓Investment banks help 4. Saving Banks
companies and governments
and their agencies to raise ✓ A savings bank is a
money by issuing and selling financial institution whose
securities in the primary
market. primary purpose is
✓They assist public and private
corporations in raising funds accepting savings deposits.
in the capital markets (both ✓ It may also perform some
equity and debt), as well as in
providing strategic advisory other functions.
services for mergers,
acquisitions and other types of
financial transactions.
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Cont.
5. Micro Finance Banks 6. Islamic Banks
✓For the purpose of poverty ✓Islamic banking refers to a system
reduction program, such kind of of banking or banking activity
banks are working in the different that is consistent with Islamic law
countries with the contribution of (Sharia) principles and guided by
UNO or World Bank. Islamic economics. In particular,
Islamic law prohibits usury the
✓Currently in Ethiopia there are
collection and payment of
more than 35 MFIs operating
interest, also commonly called
riba in Islamic discourse.
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2. Non-banking financial company
✓Non-bank financial companies (NBFCs) also known as a non-bank
or a non-bank bank, are financial institutions that provide banking
services without meeting the legal definition of a bank, i.e. one that
does not hold a banking license.
✓Non-bank institutions frequently acts as suppliers of loans and
credit facilities, supporting investments in property, providing
services relating to events within peoples lives such as funding
private education, wealth management and retirement planning
✓However they are typically not allowed to take deposits from the
general public and have to find other means of funding their
operations such as issuing debt instruments.
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1. Investment company
✓Generally, an "investment company" is a company
(corporation, business trust, partnership, or limited liability
company) that issues securities and is primarily engaged in
the business of investing in securities.
✓An investment company invests the money it receives
from investors on a collective basis, and each investor
shares in the profits and losses in proportion to the investor's
interest in the investment company.
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2. Brokerage Houses
✓Stock brokers assist people in investing, online only
companies are called 'discount brokerages', companies
with a branch presence are called 'full service brokerages'
or 'private client services
3. Leasing Companies
A lease or tenancy is the right to use or occupy personal
property or real property given by a lessor to another person
(usually called the lessee or tenant) for a fixed or indefinite
period of time, whereby the lessee obtains exclusive
possession of the property in return for paying the lessor a
fixed or determinable consideration (payment). 10
4. Insurances Companies
Insurance companies may be classified as:
1. Life insurance companies: which sell life insurance,
annuities and pensions products.
2. Non-life or general insurance companies: which sell
other types of insurance.
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5. Mutual Fund
✓An investment which is comprised of a pool of funds
collected from many investors for the purpose of
investing in securities such as stocks, bonds, money market
securities and similar assets.
✓Mutual funds are operated by money mangers, who invest
the fund's capital and attempt to produce capital gains and
income for the fund's investors.
✓A mutual fund's portfolio is structured and maintained to
match the investment objectives stated in its prospectus.
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3.2. General Types of Financial Institution
• They are divided in to three broad categories:
I. depository institutions,
II. contractual saving institutions,
III. investment intermediaries
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I. Depository institutions
Are financial intermediaries that accept deposits from
individuals & institutions and make loans.
These intuitions include commercial banks, savings
and loan associations, microfinance institutions and
credit unions.
They are unique from the other intermediaries in that
they are directly engaged in accepting deposit and
channelling it to others.
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II. Contractual saving Institutions
Are financial institutions that acquire funds at periodic
intervals on a contractual basis.
This group of financial intermediaries includes d/t insurance
companies and pension funds.
Their main purpose is giving different services (insurance and
pension services).
But, they are also important financial institutions because
they raise huge fund which they channel to investors in
different ways.
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III. Investment Institutions
✓ This group of financial intermediaries includes investment banks,
security brokers and mutual funds which are involved in the
purchase and sale of different securities such as bonds and stocks.
✓ One of their functions is to help firms issue and sell securities.
✓ They advise investors about their portfolio choice & pricing of d/t
securities.
✓ They also serve as security traders by arranging traders among
borrowers and lenders.
✓ Besides, they acquire funds by issuing and selling d/t securities
and use the funds so raised to purchase diversified portfolio of
securities.
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Financial institution
The financial system:
✓The group of institutions that helps match the saving of one
person with the investment of another.
✓When people save or invest their money, their funds become
available for businesses to use to expand and grow.
✓In this way, investment promotes economic growth for the entire
economy.
✓Financial institutions: financial markets and financial
intermediaries
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Commercial Banks
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Characteristics / Features of a Bank
1. Dealing in money
2. Individual/firm/company
3. Acceptance of deposit
4. Giving advances
5. Payment and withdrawal
6. Agency and utility services
7. Profit and service orientation
8. Ever-increasing
9. Connecting link
10. Banking business
11. Name identity
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Development Financial Institutions
✓A financial agencies that provide medium and long-term financial
assistance and engaged in promotion and development of
industry, agriculture and other key sectors.
✓It provide finance to the private sector for investments that
promote development.
✓They focus on developing countries and regions where access to
private sector funding is limited.
Example
✓International Bank for reconstruction
✓World Bank
✓ International Monetary Fund (IMF)
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3.4. Other Financial Institutions
1. Mortgage companies- offer home loans
2. Finance companies- offer short term loans to businesses
and consumers
3. Insurance companies- provide protection against
problems and offer loans to businesses and consumers.
4. Brokerage firms- sell stocks and bonds
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• End of the chapter
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