FINANCIAL MARKETS AND INSTITUTIONS
Other Lending Institutions
1. Central Banks
Central banks are the financial institutions responsible for the oversight and management of all other
banks. In the United States, the central bank is the Federal Reserve Bank (Fed), which is responsible
for conducting monetary policy and supervision and regulation of 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.
A central bank, reserve bank or monetary authority, is an entity responsible for the monetary policy
of its country or of a group of member states, such as the European Central Bank (ECB) in the
European Union, the Federal Reserve System in the United States of America, State Bank in
Pakistan. Its primary responsibility is to maintain the stability of the national currency and money
supply, but more active duties include controlling subsidized-loan interest rates, and acting as a
"bailout" lender of last resort to the banking sector during times of financial crisis (private banks
often being integral to the national financial system).
A commercial bank accepts deposits from customers and in turn makes loans, even in excess of the
deposits; a process known as fractional-reserve banking. Some banks (called Banks of issue) issue
banknotes as legal tender.
A central bank, reserve bank or monetary authority, is an entity responsible for the monetary policy
of its country or of a group of member states, such as the European Central Bank (ECB) in the
European Union or the Federal Reserve System in the United States of America.
Its primary responsibility is to maintain the stability of the national currency and money supply, but
more active duties include controlling subsidized-loan interest rates, and acting as a "bailout" lender
of last resort to the banking sector during times of financial crisis (private banks often being integral
to the national financial system). It may also have supervisory powers, to ensure that banks and
other financial institutions do not behave recklessly or fraudulently. A central bank is usually headed
by a governor, but the titles are president, chief executive, and managing director respectively for the
European Central Bank the Hong Kong Monetary Authority and the Monetary Authority of
Singapore.
In most countries the central bank is state owned and has a minimal degree of autonomy, which
allows for the possibility of government intervening in monetary policy.
An "Independent central bank" is one which operates under rules designed to prevent political
interference; examples include the US Federal Reserve, the Bank of England (since 1997), and the
Bank of Canada, the Reserve Bank of Australia, the Banco de la República de Colombia, and the
European Central Bank.
Activities and responsibilities
Functions of a central bank (not all functions are carried out by all banks):
Implementing the basis of monetary policy
Monopoly on the issue of banknotes
Controls the nation's entire money supply
The Government's banker and the bankers' bank ("Lender of Last Resort")
Manages the country's foreign exchange and gold reserves and the Government's stock
register
Regulation and supervision of the banking industry
BY: MEHTAB ISMAIL KUMBHAR
FINANCIAL MARKETS AND INSTITUTIONS
Setting the official interest rate - used to manage both inflation and the country's exchange
rate - and ensuring that this rate takes effect via a variety of policy mechanisms.
Monetary Policy
Central banks implement a country's chosen monetary policy. At the most basic level, this involves
establishing what form of currency the country may have, whether a fiat currency, gold-backed
currency, currency board or a currency union. When a country has its own national currency, this
involves the issue of some form of standardized currency, which is essentially a form of promissory
note: a promise to exchange the note for "money" under certain circumstances.
Historically, this was often a promise to exchange the money for precious metals in some fixed
amount. Now, when many currencies are fiat money, the "promise to pay" consists of nothing more
than a promise to pay the same sum in the same currency.
Many central banks are "banks" in the sense that they hold assets (foreign exchange, gold, and other
financial assets) and liabilities. A central bank's primary liabilities are the currency outstanding, and
these liabilities are backed by the assets the bank owns. Unusually, however, central banks in
jurisdictions with fiat currencies may "create" new money to back its own liabilities, to theoretically
unlimited amounts.
In many countries, the central bank may use another country's currency either directly (in a currency
union), or indirectly, by using a currency board. In the latter case, local currency is directly backed
by the central bank's holdings of a foreign currency in a fixed-ratio; this mechanism is used, notably,
in Hong Kong and Estonia.
In countries with fiat money, monetary policy may be used as a shorthand form for the interest rate
targets and other active measures undertaken by the monetary authority.
Central or National
There is no standard terminology for the name of a central bank, but many countries use the "Bank
of Country" form (e.g., Bank of England, Bank of Canada, and Bank of Russia). Some are styled
national banks, such as the National Bank of Ukraine. In other cases they may incorporate the word
"Central" (e.g. European Central Bank, Central Bank of Ireland).
In many countries, there may be private banks that incorporate the term national. Many countries
have state-owned banks or other quasi-government entities that have entirely separate functions,
such as financing imports and exports.
In some countries, particularly in some Communist countries, the term national bank may be used to
indicate both the monetary authority and the leading banking entity, such as the USSR's Gosbank
(state bank). In other countries, the term national bank may be used to indicate that the central bank's
goals are broader than monetary stability, such as full employment, industrial development, or other
goals.
Limits of Enforcement Power
Contrary to popular perception, central banks are not all-powerful and have limited powers to put
their policies into effect. Most importantly, although the perception by the public may be that the
"Central bank" controls some or all interest rates and currency rates, economic theory, (and
substantial empirical evidence) shows that it is impossible to do both at once in an open economy.
Robert Mundell's "Impossible Trinity" is the most famous formulation of these limited powers, and
postulates that it is impossible to target monetary policy (broadly, interest rates), the exchange rate
(through a fixed rate) and maintain free capital movement.
BY: MEHTAB ISMAIL KUMBHAR
FINANCIAL MARKETS AND INSTITUTIONS
Since most Western economies are now considered "Open" with free capital movement, this
essentially means that central banks may target interest rates or exchange rates with credibility, but
not both at once. Even when targeting interest rates, most central banks have limited ability to
influence the rates actually paid by private individuals and companies.
Even the US must engage in buying and selling to meet its targets. In the most famous case of policy
failure, George Soros arbitraged the pound sterling's relationship to the ECU and (after making $2B
himself and forcing the UK to spend over $8B defending the pound) forced it to abandon its policy.
Since then he has been a harsh critic of clumsy bank policies and argued that no one should be able
to do what he in fact did.
The most complex relationships are those between the yen and the US dollar, and between the Euro
and its neighbors. The situation in Cuba is so exceptional as to require the Cuban peso to be dealt
with simply as an exception, since the US forbids direct trade with Cuba. US dollars were ubiquitous
in Cuba's economy after its legalization in 1991, but were officially removed from circulation in
2004 and replaced by the Convertible peso.
2. Retail and Commercial Banks
Traditionally, retail banks offered products to individual consumers while commercial banks worked
directly with businesses. Currently, the majority of large banks offer deposit accounts, lending, and
limited financial advice to both demographics.
Products offered at retail and commercial banks include checking and savings accounts, certificates
of deposit (CDs), personal and mortgage loans, credit cards, and business banking accounts.
3. Internet Banks
A newer entrant to the financial institution market is internet banks, which work similarly to retail
banks. Internet banks offer the same products and services as conventional banks, but they do so
through online platforms instead of brick-and-mortar locations.
Under internet banks, there are two categories: digital banks and neobanks. Digital banks are online-
only platforms affiliated with traditional banks. However, neobanks are pure digital native banks
with no affiliation to any bank but themselves.
4. Credit Union
A credit union is a type of financial institution providing traditional banking services and is created,
owned, and operated by its members. In the recent past, credit unions used to serve a specific
demographic per their field of membership, such as teachers or members of the military. Nowadays,
however, they have loosened the restrictions on membership and are open to the general public.
Credit unions are not publicly traded and only need to make enough money to continue daily
operations. That’s why they can afford to provide better rates to their customers than commercial
banks.
Important: While members can access better rates, credit unions may provide fewer services than
traditional banks and have fewer brick-and-mortar locations than most banks, which can be a
drawback for clients who like in-person service.
Credit unions (CUs) are not-for-profit depository institutions mutually organized and owned by their
members (depositors). They were established in the United States in the early 1900s as self-help
organizations. The first credit unions were organized in the Northeast, initially in Massachusetts..
Members paid an entrance fee and put up funds to purchase at least one deposit share. Members
were expected to deposit their savings in the CU, and these funds were lent only to other members.
BY: MEHTAB ISMAIL KUMBHAR
FINANCIAL MARKETS AND INSTITUTIONS
This limit in the customer base of CUs continues today as, unlike commercial banks and savings
institutions, CUs are prohibited from serving the general public. Rather, in organizing a credit union,
members are required to have a common bond of occupation (e.g., police CUs), association (e.g.,
university-affiliated CUs), or cover a well-defined neighborhood, community, or rural district. CUs
may, however, have multiple groups with more than one type of membership.
Each credit union decides the common bond requirements (i.e., which groups it will serve) with the
approval of the appropriate regulator (see below). To join a credit union an individual must then be a
member of the approved group(s). The primary objective of credit unions is to satisfy the depository
and borrowing needs of their members. CU member deposits (called shares, representing ownership
stakes in the CU) are used to provide loans to other members in need of funds. Earnings from these
loans are used to pay interest on member deposits. Because credit unions are not-for-profit
organizations, their earnings are not taxed.
This tax-exempt status allows CUs to offer higher rates on deposits and charge lower rates on some
types of loans compared to banks and savings institutions, whose earnings are taxable. This is shown
in Figure 14–4 for the period 1991–2010.
5. SAVINGS INSTITUTIONS
Savings institutions comprise two groups of depository institutions: savings associations and savings
banks. Historically, the industry consisted of only savings associations (referred to as savings and
loan (S&L) associations). However, in the 1980s, federally chartered savings banks appeared in the
United States. 2 These two types of institutions have the same regulators and regulations as the
traditional savings and loans. Together they are referred to as savings institutions.
6. FINANCE COMPANIES
In 2010, the finance company industry assets stood at $1,840.8 billion . The three major types of
finance companies are
(1) sales finance institutions,
(2) personal credit institutions, and
(3) business credit institutions.
Sales finance institutions
Finance companies specializing in loans to customers of a particular retailer or manufacturer. sales
finance institutions Finance companies specializing in loans to customers of a particular retailer or
manufacturer.
Personal credit institutions
Finance companies specializing in installment and other loans to consumers.
Business credit institutions
Finance companies specializing in business loans.
7. Savings and Loan (S&L) Associations
Financial institutions that are mutually owned by their customers and provide no more than 20%
of total lending to businesses fall under the category of savings and loan associations. They
provide individual consumers with checking and accounts, personal loans, and home mortgages.
Unlike commercial banks, most of these institutions are community-based and privately owned,
although some may also be publicly traded. The members pay dues that are pooled together,
which allows better rates on banking products.
8. Investment Banks
BY: MEHTAB ISMAIL KUMBHAR
FINANCIAL MARKETS AND INSTITUTIONS
Investment banks are financial institutions that provide services and act as an intermediary in
complex transactions—for instance, when a startup is preparing for an initial public offering (IPO),
or in mergers. They can also act as a broker or financial advisor for large institutional clients such as
pension funds.
Investment banks do not take deposits; instead, they help individuals, businesses, and governments
raise capital through the issuance of securities. Investment companies, traditionally known as mutual
fund companies, pool funds from individuals and institutional investors to provide them access to
the broader securities market. Global investment banks include JPMorgan Chase, Goldman Sachs,
Morgan Stanley, Citigroup, Bank of America, Credit Suisse, and Deutsche Bank. Robo-advisors are
the new breed of such companies, enabled by mobile technology to support investment services
more cost-effectively and provide broader access to investing by the public.
9. Brokerage Firms
Brokerage firms assist individuals and institutions in buying and selling securities among
available investors. Customers of brokerage firms can place trades of stocks, bonds, mutual
funds, exchange-traded funds (ETFs), and some alternative investments.
8. Insurance Companies
Financial institutions that help individuals transfer the risk of loss are known
as insurance companies. Individuals and businesses use insurance companies to protect against
financial loss due to death, disability, accidents, property damage, and other misfortunes.
10. 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.
BY: MEHTAB ISMAIL KUMBHAR
