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MGT411 - Money & Banking - Lecture Handout 07

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  • Financial Institutions
  • Structure of Financial Industry
  • Time Value of Money

Financial Institutions

  • Financial institutions are the firms that provide access to the financial markets;
  • They sit between savers and borrowers and so are known as financial intermediaries.
  • Banks, insurance companies, securities firms and pension funds
  • A system without financial institutions would not work very well for three reasons
  • Individual transactions between saver-lenders and borrower-spenders would be extremely expensive.
  • Lenders need to evaluate the creditworthiness of borrowers and then monitor them, and individuals are not equipped to do this.
  • Most borrowers want to borrow long term, while lenders favor short-term loans

Role of Financial Institutions

  • Reduce transactions cost by specializing in the issuance of standardized securities
  • Reduce information costs of screening and monitoring borrowers.
  • Curb information asymmetries, helping to ensure that resources flow into their most productive uses
  • Make long-term loans but allow savers ready access to their funds.
  • Provide savers with financial instruments (more liquid and less risky than the individual stocks and bonds) that savers would purchase directly in financial markets

Flow of funds through Financial Institutions

The simplified Balance Sheet of a Financial Institution
Assets Liabilities
Real estate
Insurance policies

The structure of the financial industry

The structure of the financial industry:

  • Financial institutions or intermediaries can be divided into two broad categories
    Depository institutions - take deposits and make loans.
  • (Commercial banks, savings banks, and credit unions)
    Nondepository institutions
  • Insurance companies, securities firms, mutual fund companies, finance companies, and pension funds
    Insurance companies
  • Accept premiums, which they invest in securities and real estate in return for promising compensation to policyholders should certain events occurs (like death, property losses, etc.)
    Pension funds
  • Invest individual and company contributions into stocks, bonds and real estate in order to provide payments to retired workers.
    Securities firms
  • They include brokers, investment banks, and mutual fund companies
  • Brokers and investment banks issue stocks and bonds to corporate customers, trade them, and advise clients.
  • Mutual fund companies pool the resources of individuals and companies and invest them in portfolios of bonds, stocks, and real estate.
    Government Sponsored Enterprises:
  • Federal credit agencies that provide loans directly for farmers and home mortgages, as well as guarantee programs that insure the loans made by private lenders.
  • HBFC, ZTBL, Khushhali bank, SME Bank
  • The government also provides retirement income and medical care to the elderly (and disabled) through Social Security and Medicare.
    Finance Companies:
  • Raise funds directly in the financial markets in order to make loans to individuals and firms.
  • The monetary aggregates are made up of liabilities of commercial banks, so clearly the financial structure is tied to the availability of money and credit.

Related Content: MGT411 - VU Lectures, Handouts, PPT Slides, Assignments, Quizzes, Papers & Books of Money & Banking