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Comparison of the Key Financial Institutions

A comparison of the most important types of financial institutions that provide funding to firms appears in Figure 1. The financial institutions differ in the manner by which they obtain funds, but all provide credit to firms by purchasing debt securities the firms have issued. All of these financial institutions except commercial banks and savings institutions also provide equity investment by purchasing equity securities issued by firms.

Securities firms are not shown in Figure 1 because they are not as important in actually providing the funds needed by firms. Yet they play a crucial role in facilitating the flow of funds from financial institutions to firms. In fact, each arrow representing a flow of funds from financial institutions to firms may have been facilitated by a securities firm that was hired by the business firm to sell its debt or equity securities. A securities firm also sells the debt and equity securities

to individual investors, which results in some funds flowing directly from individuals to firms without first passing through a financial institution.

Consolidation of Financial Institutions

There has recently been a great deal of consolidation among financial institutions, and a single financial conglomerate may own every type of financial institution. Many financial conglomerates offer commercial banking services, investment banking services, brokerage services, mutual funds, and insurance services. They also have a pension fund and manage the pension funds of other companies. The most notable example of a financial conglomerate is Citigroup Inc., which offers commercial banking services through its Citibank unit, insurance services through its Travelers' insurance unit, and investment banking and brokerage services through its Salomon Smith Barney unit.

In recent years, many commercial banks have attempted to expand their offerings of financial services by acquiring other financial intermediaries that offer other financial services. Some banks even serve in advisory roles for firms that are considering the acquisition of other firms. Thus, much of the bank expansion is focused on services that were traditionally offered by securities firms. In general, the expansion of banks into these services is expected to increase the competition among financial intermediaries and therefore lower the price that individuals or firms pay for these services.

Globalization of Financial Institutions

Financial institutions not only have diversified their services in recent years but also have expanded internationally. This expansion was stimulated by various factors. First, the expansion of multinational corporations encouraged expansion of commercial banks to serve these foreign subsidiaries. Second, U.S. commercial banks had more flexibility to offer securities services and other financial services outside the United States, where fewer restrictions were imposed on commercial banks. Third, large commercial banks recognized that they could capitalize on their global image by establishing branches in foreign cities.

Financial institutions located in foreign countries facilitate the flow of funds between investors and the firms based in that country. During the 1997-1998 period, many Asian firms experienced poor performance and were cut off from funding by local banks and foreign banks. Before this time, some banks had been too willing to extend loans to Asian firms without determining whether the funding was really necessary and feasible. The crisis made some foreign banks realize that they should not extend credit to firms just because those firms had performed well during the mid-1990s. The crisis also caused Asian firms to realize how dependent they were on banks to run their businesses. As a result, Asian firms are expanding more cautiously, because they must now justify their request for additional funding from banks.

REVIEW QUESTIONS

RQ-1 Distinguish between the role of a commercial bank and that of a mutual fund.

RQ-2 Which type of financial institution do you think is most critical for firms?

 
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