Financial Institutions
Banks and other financial firms
The Different Kinds of Banks
1. Commercial Banks – they have a number of primary roles
1) Accept savings
2) Lend to individuals and firms
3) To move funds from lenders to borrowers (financial intermediary)
4) To allow payments from one person/firm to another
However, they also offer other products e.g. insurance and financial advice products.
Retail banking – providing banking services to individuals and small firms. Also known as High Street Banks.
Wholesale banking – dealing with the greater for financial services from large firms.
2. Investment Banks – they don’t take deposits from customers
They deal with shares and bonds and other types of asset
Arrange share and bond issues
Buy and sell securities on behalf of clients
Offer investment advice to individuals and for firms planning expansion e.g. a merger
Act as market makers to make trading securities easier
They engage in higher risk activity when compared to commercial banks. They even invest their own money by buying and selling shares.
Commercial banks and investment banks are not mutually exclusive.
A commercial bank can also have an investment bank division e.g. Barclays Bank has two sides two their company, commercial side and investment side.
This is particularly risky because the investment bank side could technically use deposits from the commercial bank side to engage in risky activity. They could lose people’s deposits through bad investments. This is why we need regulation of the banking sector.
Other Financial Institutions
Pension funds – people put money into a pension fund. The pension manager invests this money into securities. The hope is that in the end, there will be a sizeable return on initial investment.
Insurance firms – these firms provide cover against unexpected events e.g. a car crash. It is important for insurance products to be there, otherwise people would be more scared to spend their money.
Hedge funds – They take investors’ money and put it into a pool. They invest this money in different markets looking for returns for the people who invested in the first place. They do present sizeable risks for investors.
Private equity firms – They invest in businesses. They are looking to hold shares in businesses, so they can make a return with the profits they make. They can also sell their shares in these businesses for a profit if the businesses become successful.
However, they can be criticised for being inhumane at times – they’re only focused on the money returned. People losing jobs doesn’t bother them.
Shadow Banking System
These are unregulated institutions. Hedge funds and private equity firms are often considered part of this system as it is unregulated activity.
The shadow banking system has grown in size in recent years. Because they are unregulated, there is less protection against risk than in other regulated financial markets.
In summary, we have learned:
The different kinds of financial institution within the finance industry
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