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Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.
If you have a part-time job or full-time job and a credit or debit card, you most likely have a customer relationship with a financial institution. Financial institutions are organizations that process monetary transactions, including business and private loans, customer deposits, and investments. They're key to the financial intermediation process, whereby financial institutions transfer funds from those who save money to those who borrow money. Let's take a look at the three main types of financial institutions: depository, non- depository, and investment.
Depository institutions allow customers to deposit money in an account. You're probably most familiar with these types of financial institutions if you have a checking or savings account. Examples of depository institutions include commercial banks and credit unions. Commercial banks are for-profit entities that provide a number of services to their account holders. These types of financial institutions usually operate at the local, regional or national level, have large advertising budgets, and charge higher fees than a credit union. Credit unions are non-profit entities owned by accountholders, also called members. You must be affiliated with a certain organization or live within a certain proximity to the credit union to be a member. Fees are usually lower at credit unions. They're typically found at the local level.
It's relatively easy to understand how financial intermediation works at depository institutions because customers deposit money in accounts, and the institutions loan that money to borrowers. Now let's see how non-depository institutions play a role in this process.
As you may have already guessed, non-depository institutions do not allow customers to deposit money. However, they're considered financial institutions because they transfer funds from savers to borrowers by investing the funds they receive. Insurance companies are non-depository institutions. Insurance companies provide customers with policies that protect them from risk, for which they charge them monthly premiums. Only a small percentage of the premiums collected are paid out in losses. Insurance companies invest the rest of the premiums in securities, like stocks, bonds, and other commodities, such as cattle, gold, and silver. Sometimes, insurance companies purchase securities and commodities directly from an entity. Other times, there's a middleman involved: an investment firm.
Investment banks are also financial institutions in that they play a role in the financial intermediation process by channeling funds from savers to borrowers. Unlike commercial banks, they usually don't provide services to the public. Areas of focus include initial public offerings (IPOs), mergers, share offerings, and underwriting. Investment banks may also function as brokers, provide financial advice to corporations, or serve as the middlemen between investors and securities issuers. Examples of investment banks include Citigroup, Goldman Sachs, Lehman Brothers, and Morgan Stanley. Regulatory bodies, like the Securities and Exchange Commission (SEC) and the U.S. Treasury, oversee the activities of investment banks.
Let's review. Financial intermediation is the process by which financial institutions transfer funds from those who save money to those who borrow money. There are three main types of financial institutions. Depository institutions allow customers to deposit money in an account and then loan the money to borrowers. Non-depository institutions do not allow customers to deposit money, however, they use monies received from the services they provide to invest in securities and commodities. Investment firms are financial institutions, like Goldman Sachs and Morgan Stanley, that act as the middlemen and facilitate the channeling of funds from borrower to savers. Instead of providing services to the public, they're typically involved in corporate mergers, IPOs, share offerings, and underwriting activities.
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GACE Economics (538): Practice & Study Guide26 chapters | 234 lessons | 21 flashcard sets
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