UNIT : 1

FINANCIAL INSTITUTIONS
What is Financial Institution (FI)?
Financial Institutions are businesses that offer
various types of financial services to customers.
These organizations provide many services, such as
accepting deposits, making investments, advancing
loans, offering foreign exchange services, etc.

Financial Institutes are not limited to banks, as

credit unions, insurance companies, investment
banks, and brokerage firms are also part of FIs.
These organizations play a crucial role within a
capitalistic economic system, as they regulate the
economy, ensure fair financial practices, connect
savers and spenders and facilitate prosperity to
facilitate transactions.

As financial institutions have an imperative role in

our economy, regulating their activities has become
a part of governmental authorities. As a result, the
government makes myriad laws and regulations to
oversee and regulate financial institutions’ activities.

Choosing the most suitable financial institution to

meet a specific need is necessary; thus, let’s
understand the various types of financial institutions
and the purpose they solve.

Check out- Scope of Financial Management As a

Career

Types of Financial Institutions

Commercial Banks
A commercial bank is a financial institution that
accepts money from individuals and businesses and
provides loans to those in need. They offer services
such as loans, savings, certificates of deposits, bank
accounts, bank overdrafts, etc., to their customers.
These organizations earn money by granting loans
to individuals and gaining interest on loans.
Business loans, house loans, personal loans, car
loans, and education loans are the different types of
loans offered by commercial banks.
Investment Banks
Investment banking helps individuals, organizations,
governments, and other institutions raise capital and
provide financial consultancy advice. They don’t deal
with customer deposits but rather assist with
financing through securities such as bonds and
stocks.
They are a type of financial institution that provides
services that specialize in facilitating business
operations, such as financing and offerings of capital
expenditure and equity, mergers and acquisitions,
and new issues of initial public offerings (IPOs).
They also commonly act as market makers for
trading exchanges, provide brokerage services for
investors, and other corporate restructurings.
Credit Unions
A credit union is a financial institution similar to a
commercial bank. But it is a non-profit institution
created, owned, and operated by its members. They
provide traditional banking services only to their
members, such as account opening, issuing credit
cards, loans, etc. Credit unions charge interest and
account fees just like a bank, but they reinvest those
profits into the products they offer; however, banks
provide these profits to their shareholders.
Historically, credit unions only serve a particular
demographic as per their field of membership, such
as military members, teachers, etc. Although,
nowadays, they have liberated the restrictions on
membership and provide their services to the
general public.
Insurance Companies
Insurance companies are familiar kinds of non-bank
financial institutions. They offer insurance services
to both individuals and organizations. The insurance
can be related to the protection against financial
risk, life insurance, health, home, shop, company,
products, vehicles, etc. These institutions put the
money from insurance premiums into a pool to fund
the policy coverage. Insurance companies can be
necessary for the stability of financial systems
mainly because they are significant investors in
financial markets. As a result of the growing links
between insurers and banks, insurers are insuring
the risks of households and firms to guarantee their
financial stability.
Brokerage Firms
A brokerage firm or company is a middleman who
connects the buying and selling parties to facilitate
the transaction. They assist in the dealing of
securities such as stocks, mutual funds, shares,
bonds, options, and other financial instruments.
Once the transaction is completed, brokers receive
both parties’ brokerage (commission). Some
brokerage companies also provide financial advice
and act as consultants.
Central Banks
Central banks are the financial institutions
responsible for overseeing and managing all other
banks. In the United States, the central bank is the
Federal Reserve Bank (Fed), which is responsible for
conducting monetary policy and supervising and
regulating financial institutions.
Individual consumers do not have direct contact
with a central bank. Instead, large financial
institutions work directly with the Fed to provide
products and services to the general public.
Savings and Loan (S&L) Associations
Savings and loan associations provide individual
consumers with checking accounts, personal loans,
and home mortgages. Financial institutions are
owned by their customers or community. A savings
and loan is a type of thrift that is required by law to
produce a certain number of loans secured by
residential real estate, but the aim of most savings
and loans is to lend for residential mortgages.
Mortgage Companies
Financial institutions that specialize in originating or
funding mortgage loans are mortgage companies.
While most mortgage companies serve the
individual consumer market, some specialize in
lending options for commercial real estate only.
Mortgage companies focus exclusively on originating
loans and seek funding from financial institutions
that provide the capital for the mortgages.Many
mortgage companies today operate online or have
limited branch locations, which allows for lower
mortgage costs and fees.

Roles Performed by Financial

Institutions
1. Economic Growth of the Nation
At the national level, financial institutions are
subject to government regulation. They serve as an
agent of the government and develop the country’s
economy. For instance, following government
regulations, financial institutions may extend a
selective credit line with lower interest rates to
assist a struggling industry in resolving its problems.
2. Capital Formation
Financial institutions offer financial services to
investors who require external cash to raise their
capital stocks by accepting individual savings.
Investors may want financial services to carry out
development plans by setting up new machinery,
tools, and equipment; constructing a new facility;
and purchasing new transport vehicles, among other
things. Financial institutions contribute to the
creation of capital in this way.
3. Regulate Monetary Supply
The financial institution assists in controlling the
amount of money in the economy. These
organizations keep the money supply stable and
manage inflation. The Federal Reserve Bank
regulates the nation’s liquidity in several ways,
including adjusting repo rates, participating in open
markets, and setting cash reserve ratios. To control
liquidity, financial institutions participate in the
purchasing and selling of government assets.
4. Banking Services
Commercial banks and other financial institutions
assist their clients by offering savings and deposit
services. Additionally, they provide their clients with
credit options, including overdraft facilities, to meet
their short-term funding needs. Additionally,
commercial banks offer their clients loans such as
house loans, mortgages, personal loans, and loans
for schooling.
5. Pension Fund Services
Financial institutions assist people in retirement
planning through the different types of investment
plans they offer. A pension fund is one of these
investing possibilities. Employers, banks, or other
institutions contribute to the investment pool on
behalf of the individual, who then receives a lump
sum or monthly income upon retirement.

Functions of Financial Institution

Financial institutions perform several key functions
essential to the economy and financial system. Here
are the primary functions of financial institutions:
Intermediation
Financial institutions act as intermediaries between
savers and borrowers. They collect funds from
individuals and businesses as deposits and then lend
them to borrowers who need capital for various
purposes, such as starting a business or purchasing a
home.
Depository Services
Financial institutions provide depository services by
accepting deposits from individuals and businesses.
They offer checking accounts, savings accounts, and
other deposit products where customers can
securely store their money. These deposits may also
earn interest.
Credit Provision
Financial institutions extend credit to individuals
and businesses through loans and credit lines. They
evaluate the creditworthiness of borrowers,
determine interest rates, and provide financial
support for various needs, such as personal loans,
mortgages, business loans, and working capital.
Investment Services
Financial institutions offer investment services to
help individuals and businesses manage and grow
wealth. They provide access to investment products
such as stocks, bonds, mutual funds, and other
securities. They also offer advisory services to guide
clients in making informed investment decisions.
Risk Management
Financial institutions assist individuals and
businesses in managing financial risks. They provide
insurance products, such as life insurance, health
insurance, property insurance, and liability
insurance, to protect against potential losses and
unforeseen events.
Payment and Settlement Services
Financial institutions facilitate payment transactions
between individuals and businesses. They provide
payment and settlement services such as processing
electronic fund transfers, issuing credit and debit
cards, and managing payment systems to enable
smooth and secure transactions.
Asset Management
Financial institutions offer asset management
services, where they manage investment portfolios
on behalf of clients. They provide expertise in
selecting investment options, diversifying portfolios,
and monitoring market conditions to optimize
returns and meet clients’ financial goals.
Financial Advisory
Financial institutions provide financial advisory
services to individuals and businesses. They offer
guidance on financial planning, retirement planning,
tax planning, estate planning, and overall wealth
management. They assist clients in making informed
financial decisions based on their goals and risk
tolerance.

Advantages of Financial Institutions

1.Procurement of Funds
Financial institutions are crucial because they make
it possible for people to receive money when they
need it. For instance, even though banks do various
tasks, they primarily collect deposits from those who
have money, pool them, and then lend them to
individuals who need money. Banks act as
middlemen between depositors (who provide the
bank with funds) and borrowers (to whom the bank
lends money).
2. Offer Safety
Even though you can keep your money at home or in
your wallet, depositing money with a financial
institution guarantees its security. You also have an
additional layer of protection because government
laws provide some protection for your deposits in
case of a bank failure. Individuals can use financial
institutions to earn interest on a deposit account
(cash deposits, money market, or savings).
Alternatively, one can buy stocks and bonds through
a brokerage.
3. Financial Consultation
Financial institutions provide people with finances
and guide them with the right investment plans and
policies. Investment banks inform businesses and
individuals about the proper techniques for
generating profits. They help their clients raise
capital, issue new IPOs, etc. Similarly, insurance
companies help individuals and businesses by
suggesting the right plan for their future welfare.
4. Employment Creation
Starting or expanding a business requires financial
resources, and bank loans are one of the easiest
ways to get them. Financial institutions provide
credit not only to individuals but businesses also.
Startups and small businesses can start their
venture by seeking long and medium-term credit
from these institutions. This will lead to the opening
of new employment opportunities and economic
growth. The business owners also have the option to
take a loan against their existing property either for
a new venture opening or for the expansion and
diversification of an existing one.
5. Ensure Regional Balance
The government set up financial institutes in rural
and backward areas to help local people, small
farmers, artisans, household workers, etc., with
loans and credits. These institutions also provide
government-approved schemes such as NABARD,
Agricultural loans, interest at low rates to Self Health
Groups (SGHs), etc., to help uplift these areas.

Disadvantages of Financial
Institutions
1. Complex and Lengthy Process
These organizations follow strict guidelines for
giving loans since they must meet government
standards. The individual or company seeking
financing requires a detailed examination involving
many formalities and paperwork, making the
process time-consuming.
2. Security Deposit
One has to keep any security and bear due to other
restrictions set by them to take a loan from these
financial institutions. Also, loans are given at high-
interest rates, which burdens individuals and
businesses. This is the reason why many worthy
individuals fail to receive credit.
3. Hidden Risk Involved
If the management of the financial institution
defaults, then the customers will have to deal with
even worse situations. They might not be able to get
their invested money back. The principal amount is
only sometimes guaranteed to be recovered because
the government may declare a specific amount to be
reimbursed in the event of default. The amount the
government declares to be repaid is typically
substantially lower than the principal amount of the
investment made.
4. Limitation on the Borrower
The financial institutions are entitled to have a
representative on the borrowing company’s board of
directors, which limits the company’s authority.
Additionally, they may directly influence the
borrowing company’s dividend distribution choice.

Conclusion
Financial institutions are the base of any strong
economy. These institutions are necessary for the
economy to thrive and recover. The government
oversees these institutions through the central bank,
insurance regulators, investment banks, pension
fund regulators, etc. In earlier days, their role was
limited to providing traditional banking services, but
now they are an integral part of the development
and growth of the economy. In conclusion, financial
institutions are pivotal to the functioning of the
modern economy, providing essential services that
facilitate economic growth, risk management, and
wealth creation. Their diverse roles and functions
contribute to the overall stability and development
of the financial system.
 Indian Financial System
The Indian financial system is a complex network of
financial institutions, markets, instruments, and
services that facilitate the flow of funds between
savers and investors. It comprises various entities
such as banks, non-banking financial companies
(NBFCs), insurance companies, stock exchanges,
mutual funds, pension funds, and other financial
intermediaries.The Indian Financial System plays a
crucial role in mobilizing savings, allocating capital,
and facilitating economic growth and development
in the country.
Indian Financial System Structure
The Indian Financial System is made up of various
components that work together to facilitate the flow
of funds between savers and investors. The
structure of the Indian financial system can be
broadly divided into two parts: the organized sector
and the unorganized sector.
The organized sector includes formal financial
institutions such as banks, insurance companies,
NBFCs, mutual funds, stock exchanges, and pension
funds. These institutions are regulated by the
Reserve Bank of India (RBI) and other regulatory
bodies such as the Securities and Exchange Board of
India (SEBI), the Insurance Regulatory and
Development Authority of India (IRDAI), and the
Pension Fund Regulatory and Development
Authority (PFRDA).
The unorganized sector, on the other hand, includes
informal financial intermediaries such as
moneylenders, chit funds, and other unregulated
entities that cater to the financial needs of the
unbanked and underserved sections of society.

Indian Financial System

Components
The Indian Financial System is composed of various
components, including:
Components of Indian Financial System
1. Banks: Banks are financial institutions that
accept deposits from customers and provide loans
and other financial services. In India, banks can be
classified into public sector banks, private sector
banks, and foreign banks.
2. Non-Banking Financial Companies (NBFCs):
NBFCs are financial institutions that provide
banking services without holding a banking license.
They offer a wide range of financial services, such as
loans, leasing, hire purchase, and investment
advisory services.
3. Insurance Companies: Insurance companies
offer a range of life and non-life insurance products,
including health insurance, motor insurance, and
property insurance. They are regulated by the
Insurance Regulatory and Development Authority of
India (IRDAI).
4. Capital Markets :The capital markets in
India comprise the stock exchanges, such as the
Bombay Stock Exchange (BSE) and the National
Stock Exchange (NSE), and other capital markets
intermediaries such as brokers, depositories, and
registrars. They provide a platform for companies to
raise capital through the issuance of equity and debt
instruments.
5. Mutual Funds: Mutual funds are investment
vehicles that pool money from various investors and
invest in a diversified portfolio of stocks, bonds, and
other securities. They are regulated by the Securities
and Exchange Board of India (SEBI).
6. Pension Funds: Pension funds in India offer
retirement solutions to individuals and are
regulated by the Pension Fund Regulatory and
Development Authority of India (PFRDA).

Indian Financial System Code

The Indian financial system is governed by various
laws, regulations, and codes issued by different
regulatory bodies. For example, the Reserve Bank of
India Act, of 1934 governs the functioning of the
Reserve Bank of India, while the Securities and
Exchange Board of India (SEBI) Act, of 1992
regulates the securities market in India. There have
been proposals in the past to introduce a
comprehensive financial code, but they are still in
the drafting stages and have not been implemented
yet.

Features of Indian Financial System

The Indian financial system is a complex and
interconnected network of institutions, markets, and
instruments that facilitate the flow of funds between
savers and borrowers. It plays a vital role in the
economic development of the country by mobilizing
savings and allocating them to productive
investments. The Indian financial system is
characterized by the following features:
  Dual structure system consisting of a formal
sector and an informal sector.
 Intermediated, meaning that financial
institutions play a key role in mobilizing savings
and allocating them to borrowers
Increasingly market-based
Regulated by the government through a number of
regulatory bodies
Promote financial inclusion, through the Pradhan
Mantri Jan Dhan Yojana and the Pradhan Mantri
Mudra Yojana etc.
Promoting economic growth
Indian Financial System Functions
The Indian financial system has several functions
that help to meet the financial needs of individuals
and businesses. Here are some of the key functions
of the Indian financial system:

Mobilization of Savings: The Indian financial system

helps to mobilize savings from various sectors of the
economy and channel them towards productive
investments. This is achieved through various
financial intermediaries such as banks, mutual
funds, and insurance companies.
Allocation of Credit: The Indian financial system also
plays a key role in allocating credit to different
sectors of the economy. Banks and other financial
institutions provide loans and credit facilities to
businesses and individuals to help them meet their
financial needs.
Payment System: The financial system provides a
safe and efficient payment mechanism to facilitate
transactions between different individuals and
businesses. This is achieved through various
payment systems such as NEFT, RTGS, and IMPS.
Risk Management: The financial system helps to
manage risks associated with financial transactions.
Financial intermediaries such as insurance
companies provide risk management products such
as life insurance, health insurance, and property
insurance.
Price Discovery: The Indian financial system also
helps in the discovery of prices of financial assets
such as stocks, bonds, and commodities. This is
achieved through various financial intermediaries
such as stock exchanges and commodity exchanges.
Economic Development: The financial system plays a
critical role in the economic development of the
country. It provides financial resources for
investment in infrastructure, industries, and other
productive sectors of the economy.
Financial Inclusion: The Indian financial system also
strives to promote financial inclusion by providing
access to financial services to individuals and
businesses in remote and underdeveloped areas of
the country.... Read more at:
https://www.studyiq.com/articles/indian-financial-
system/