Introduction to Financial Institutions
By the end of this section, students will be able to;
Describe the financial institutions
Explain the banking system
Elaborate the treasury bills
Analyze the roles of banks and treasury bills
What are institutions?
Institutions are norms that organise social, political and economic relations.
They are ‘the underlying rules of the game’ in any society or organization.
There are two forms of Institutions:
Formal and Informal.
Formal institutions include the written constitution, laws, policies, rights
and regulations enforced by official authorities.
Informal institutions, on the other hand, are the usually unwritten social
norms, customs or traditions that shape thought and behaviour.
What are financial Institutions?
Financial institutions are institutions that serve as financial intermediaries.
There are three major types of financial institutions:
I. Depositary Institutions: Deposit-taking institutions that accept and
manage deposits and make loans—example: banks and credit unions.
II. Contractual Institutions: These institutions collect funds on a
contractual basis, often with the promise of future payments. They
manage large pools of capital and invest them over long periods. Eg.
insurance companies and pension funds; and
III. Investment Institutes: these institutions facilitate the buying and
selling of securities, manage investments for clients, and/or assist
companies in raising capital. They connect investors with opportunities
and provide expertise in financial markets. Eg. Investment Banks,
underwriters, and brokerage firms.
Investment banks: They act as intermediaries between companies (issuers of
securities) and investors. They provide a wide range of financial services,
with a primary focus on helping corporations and governments raise capital.
Underwriters: Underwriting is a specific activity carried out by investment
banks (or sometimes other specialized firms). It involves guaranteeing the
sale of new securities issued by a company or government.
brokerage firms; Act as intermediaries between buyers and sellers of
securities. They execute trades on behalf of their clients (both individuals
and institutions).
The Banking Financial Institution
A bank is a financial intermediary that gives money (loan) to a borrower.
They also
accept deposits (savings) from depositors. The banking sector, being an
intermediary
in any economy, has a major role to play in enhancing development and
growth
through their activities of:
(a) Mobilizing saving,
(b) Identifying good investment and
(c) Exerting through sound corporate control, particularly during the early
stages of economic development and weak institutional environment.
Accordingly, the banks’ roles in an economy include;
I . Acquiring information about firms and managers and thereby improving
capital allocation and corporate governance.
II . Managing cross-sectional, inter-temporal and liquidity risk and thereby
enhancing investment efficiency and economic growth.
Cross-Sectional Risk: This refers to the risk associated with diversifying investments
across different borrowers, industries, and geographic locations at a single point in time.
Banks, by lending to a wide array of businesses and individuals, effectively pool these
risks. Instead of an individual investor putting all their eggs in one basket, the bank
spreads its loans across many different "baskets."
Inter-Temporal Risk: This refers to the risk associated with changes in economic
conditions over time that impact the value and performance of investments. This
includes macroeconomic factors like interest rate fluctuations, inflation, recessions, and
technological changes.
Liquidity Risk: This refers to the risk that a bank will not have enough readily available
cash to meet its obligations to depositors or other creditors when they are due.
As an institution, the efficiency of bank depends on following two key factors:
1) Degree of competition that exists among banks and,
2) The nature of the regulation to which banks are subject to.
It is believed that a competition among banks in the economy will result in:
Greater technical efficiency within deposit institutions,
Lower interest rates for borrowers,
Higher interest rates for depositors and
A greater variety of services
As an institution, the efficiency of a bank depends on the following two key
factors:
1) Degree of competition that exists among banks and,
2) The nature of the regulation to which banks are subject to.
It is believed that competition among banks in the economy will result in:
Greater technical efficiency within deposit institutions,
Lower interest rates for borrowers,
Higher interest rates for depositors and
A greater variety of services
The Non- Banking Financial institution
A non-bank financial institution (NBFI) is a financial institution that does not
have a full banking license or is not supervised by a national or international
banking regulatory agency.
NBFIs facilitate bank-related financial services- such as investment,
insurance, risk pooling, contractual savings, and market brokering.
Examples: insurance companies, pawn shops, cashier’s check issuers, check
cashing locations, payday lending, currency exchanges, and microloan
organizations.
Financial Service NBFI Example(s) Concise Explanation
Mutual funds, hedge
Investment Manage pooled investments
funds, private equity
Management in diverse assets for returns.
firms
Life, property, and Provide financial protection
Insurance casualty insurance against defined risks in
companies exchange for premiums.
Risk Pooling Insurance companies Spread risk among
policyholders, paying claims
from pooled premiums.
Certain life insurance
Offer savings plans with
policies, some
Contractual Savings fixed payment schedules
microfinance
and potential returns.
institutions
Facilitate short-term loans
Money Service Pawn shops, currency
(pawn shops), currency
Businesses (Market exchanges, money
conversion, and money
Brokering) transfer services
transfers.
Payday lenders,
Offer loans and credit
microloan
Lending/Credit products, often to
organizations, finance
underserved populations.
companies
"Fintech companies" refers to businesses that use technology to provide
financial services more efficiently and effectively than traditional financial
institutions. The term "fintech" is a combination of "financial" and
"technology." These companies might offer services such as online banking,
payment processing, investment management, lending, insurance, and
financial planning, often through user-friendly apps or platforms.
Fintech companies aim to improve the financial experience for consumers
and businesses by making transactions faster, more accessible, and less
costly. Some well-known examples include mobile payment apps like PayPal
and Venmo, peer-to-peer lending platforms, robo-advisors for investment,
and digital wallet services. Overall, fintech is transforming the financial
landscape by leveraging innovative technologies.
