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Financial Institutions

Learning Goals

- Explain how financial institutions serve as intermediaries between investors and firms.

- Provide an overview of financial markets.

- Explain how firms and investors trade money market and capital market securities in the financial markets in order to satisfy their needs.

- Describe the major securities exchanges.

- Describe derivative securities and explain why firms and investors use them.

- Describe the foreign exchange market.

financial institution

An intermediary that channels the savings of individuals,

businesses, and governments into loans or investments.

Financial institutions serve as intermediaries by channeling the savings of individuals, businesses, and governments into loans or investments. They are major players in the financial marketplace, with more than $12 trillion of financial assets under their control. They often serve as the main source of funds for businesses and individuals. Some financial institutions accept customers' savings deposits and lend this money to other customers or to firms. In fact, many firms rely heavily on loans from institutions for their financial support. Financial institutions are required by the government to operate within established regulatory guidelines.

Key Customers of Financial Institutions

The key suppliers of funds to financial institutions and the key demanders of funds from financial institutions are individuals, businesses, and governments. The savings that individual consumers place in financial institutions provide these institutions with a large portion of their funds. Individuals not only supply funds to financial institutions but also demand funds from them in the form of loans. However, individuals as a group are the net suppliers for financial institutions: They save more money than they borrow.

Firms also deposit some of their funds in financial institutions, primarily in checking accounts with various commercial banks. Like individuals, firms also borrow funds from these institutions, but firms are net demanders of funds. They borrow more money than they save.

Governments maintain deposits of temporarily idle funds, certain tax payments, and Social Security payments in commercial banks. They do not borrow funds directly from financial institutions, although by selling their debt securities to various institutions, governments indirectly borrow from them. The government, like business firms, is typically a net demander of funds. It typically borrows more than it saves.

The different types of financial institutions are described in Table 1. The most important financial institutions that facilitate the flow of funds from investors to firms are commercial banks, mutual funds, security firms, insurance companies, and pension funds. Each of these financial institutions is discussed in more detail below.

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