Study on the Types of Financial Institutions Finance Essay

2.0 Introduction

Financial Institutions are very important in our society today. This institutions let individuals and firms to borrow money and pay back later in time. Financial Institutions are institutions that provide financial services for its clients and members it also acts as financial intermediaries of the capital market and debt markets. This institution is responsible for transferring funds from investors to companies and vice versa who are in need of those funds. Financial institutions also facilitate the flow of money through the economy. This institution must take the risk when offering funds and loans to clients. This institution responsibility is to make sure that every client or company involved are satisfied by the services they offer and avoid mistakes and risks when unexpected circumstances occur. There are 3 ways to transfer funds which are; Direct Transfer, Indirect Transfer through Investment Banking House and Indirect Transfer through Financial Intermediaries. These 3 ways are the most common and mostly used way to transfer money.

2.1 Types of Financial Institutions

The first way is through direct transfer, direct transfer of money and securities occurs when a business sells its stocks or bonds to savers without going to financial institutions. Whereas, the business delivers the securities to savers and can get the payment immediately. Second way is through indirect transfer through investment banking house. Investment bank is a type of financial institution that assists individuals, corporations and governments in raising capital through underwriting or acting as the client's agent in issuing of securities. Compared to commercial banks and retail banks, an investment banks do not take deposits. Investment bank can be categorized into private and public functions with a Chinese wall that separates the two in preventing the information from crossing to each other. The private areas of the bank deals with the private insider information that is not to be publicly disclosed, and the public areas such as stock analysis are dealt with public information. Other large service investment banks offer all of the lines of businesses, such as both sell side and buy side. The smaller ones sell side investment firms such as boutique investment banks and small broker-dealers focus more on investment banking and sales, trading and research. Investment banks offer services to both investors buying securities and corporations issuing securities. For corporations, investment bankers are the one who provide information about when and how to place their money to an investment bank's reputation. So, investment bankers play a very important role in issuing new security offerings and making sure that the company is in good state. The third way to transfer funds is through indirect transfer through financial intermediaries. Some people do not enter financial markets directly but they use financial intermediaries or middlemen. Commercial banks are part of financial intermediary, mutual funds, pension funds, credit unions, savings and loan associations, and to some insurance companies is also part of financial intermediaries. For example, when people deposit money in a bank, the bank uses the funds to make loans to home buyers for mortgages, to students so they can pay for their education, and to anyone else who needs to borrow. A person who has extra money could, seek out borrowers himself and bypass the intermediary. By not having the middleman, the saver could get a higher return. But still, people use financial intermediaries. Financial intermediaries provide important advantages to savers. First, is lending through financial intermediary is usually less risky than lending directly. The major reason for reducing risk is that a financial intermediary can diversify. On the other hand, an average saver could directly make only a few loans, and having bad loans would substantially affect his wealth. Financial intermediaries also insure its depositors from substantial losses. By making many loans, financial intermediaries can reduce risk; they learn how to predict a better forecast which of the people who wants to borrow money will be able to repay it in the future. People who do not specialize in this kind of lending may be in a poor judge of who loans are worth making and which are not, sometimes, even specialists can make mistakes. Another advantage of financial intermediaries give savers is liquidity. Liquidity refers to the ability to convert assets into a spendable form which is money. House is an illiquid asset; selling one can take a lot of time. If an individual saver has borrowed money directly to another person, the loan can also be an illiquid asset. But if the lender suddenly needs cash, he must force the borrower to repay quickly, which is not be possible, or he must find someone else who will buy the loan from him, which is very difficult. So it is better to borrow money in financial intermediaries because it is safe and fast and it is legal compared to other unauthorized people because they may cheat you.

2.2 Conclusion

This diagram summarizes the flow of funds in the market. The first one is; Direct transfer which shows that the stocks and bonds goes directly from the business to savers and the payment of the savers goes directly to the business itself. The second one is; Indirect transfer through investment banks which shows that the securities sold by the business go first to the investment baking house then to the savers and the payments made by the savers go first to the investment banking house and hands over to the business. In short, the investment banking house serves as the client's agent for this transactions and they take over the risks. The third one is; Indirect transfer through financial intermediaries which is same as the indirect transfer through investment banking house the only difference is that financial intermediaries have diffent forms in which the savers can choose from. The securities bought and payments will go through the financial intermediaries first and then to the business and savers and they act as middleman. As a summary, Financial institutions are very important in our society now adays because thay help people and business to have a legal transactions. People engaged in this kind of transactions must know the risk that they are going through and financial institutions must be held liable if anything happen. In my opinion, each flow of funds has its own advantages and disadvantages whether it is direct or indirect. But for me, the best way is through indirect transfer thorugh investment banking house because savers may feel secure when they engage in this kind of transaction. The investment banks will act as the client's agent in all of this and they will make sure that the transaction between savers and business will go smoothly without any delay. And with that savers may feel that investments bank are reliable when it comes to this kind of matters. People may have different perception when it comes to this, they may choose the direct transfer or indirect transfer through financial intermediaries. but still, savers has the assurance that their money is in good hands. They must never fall for illegal transactions like the loan sharks who offers high interest but cheat people.

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