Understanding the Financial Intermediaries | Types of Financial Institutions
Financial institutions that accept money from savers and use that funds to make loans and other financial investments in their name are called Financial Intermediaries. They include commercial banks, savings institutions, Insurance companies, pension funds, finance companies, and mutual funds.
The flow of funds from savers to investors in real assets can be direct; if there are financial intermediaries in an economy the flow can also be indirect. These intermediaries come between ultimate borrowers and lenders by transforming direct claims into indirect claims. Financial intermediaries purchase direct (or primary) securities and in turn, issue their own indirect (or secondary) securities to the public.
For example, a life insurance company purchases corporate bonds (primary securities) and issues life insurance policies (secondary securities) to the public. Intermediaries help to facilitate the flow of funds in the financial marketplace.
Types of Financial Institutions
1. Commercial Banks
The primary purpose of commercial banks is to take in business deposits and lend funds to businesses. Commercial banks are the most important source of funds for business firms in aggregate. Banks acquire deposits from individuals, companies, and the government and in turn make loans and investments. Besides performing a banking function, commercial banks also invest in corporate bonds and stocks.2. Savings and Loans
Savings and loans’ primary purpose is to take in deposits from households and to lend funds for home and consumer loans.3. Credit Unions
Credit Unions are owned by depositors (actually share owners) who are individuals, not businesses. Credit Unions take in funds and primarily make personal loans.4. Finance Companies
Non-bank firms that borrow funds to make short and medium-term loans to higher-risk borrowers. These companies raise capital through stock issues as well as through borrowing some of which are long term but most of it comes from commercial banks, in turn, financial companies make loans.5. Insurance Companies
Receive premiums for insurance policies. This pool of funds is used to reimburse policyholders who incur losses that are covered under the policy.Life Insurers: Insure against financial hardship caused by death.
Property and Casualty: Insure against damage to person and property (health, autos, homes, theft, earthquake, etc.)
Property and casualty insurance companies invest in municipal bonds which offer tax-exempt interest income, to a lesser extent they also invest in stocks and bonds. Life insurance companies invest in long-term securities.
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