Roles Performed by Financial Institution

Financial institutions play a pivotal role in every economy. The central government organization regulates banking and non-banking financial institutions. In addition, these institutions help bridge the gap between idle savings and investment and its borrowers, i.e., from net savers to net borrowers.

The following is the list of roles performed by financial institutions: –

Key Takeaways

  • Financial institutions perform a critical role in the economy. The central government organization controls banking and non-banking financial institutions. Moreover, these institutions fill the gap between idle savings and investment and its borrowers, i.e., from net savers to borrowers.The roles such as money supply regulation, banking services, insurance services, capital formation, investment advice, brokerage services, pension fund services, trust fund services, financing small and medium-scale enterprises, and acting as a government agent for economic growth are played by the financial institutions.

  • Regulation of monetary supplyBanking servicesInsurance servicesCapital formationInvestment adviceBrokerage servicesPension fund servicesTrust fund servicesFinancing the small and medium-scale enterprisesAct as a government agent for economic growth

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Let us discuss each one of them in detail: –

#1 – Regulation of Monetary Supply

Financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more like the Central Bank help regulate the money supply in the economy to maintain stability and control inflation. For example, the Central Bank applies various measures like increasing or decreasing repo rate, cash reserve ratio Cash Reserve RatioCash Reserve Ratio refers to the share of a Bank’s total deposits that need to be maintained with the respective Country’s Central Bank to control financial supply in the economy. read more, and open market operationsOpen Market OperationsAn Open Market Operation or OMO is merely an activity performed by the central bank to either give or take liquidity to a financial institution. The aim of OMO is to strengthen the liquidity status of the commercial banks and also to take surplus liquidity from them.read more, i.e., buying and selling government securities, to regulate liquidity in the economy.

#2 – Banking Services

Financial institutions, like commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits.read more, help their customers by providing savings and deposit services. In addition, they offer credit facilitiesCredit FacilitiesCredit Facility is a pre-approved bank loan facility to businesses allowing them to borrow the capital amount as & when needed for their long-term/short-term requirements without having to re-apply for a loan each time. read more like overdraft facilities to the customers to cater to the need for short-term funds. Commercial banks also extend loans like personal loans, education loans, mortgages, or home loans to their customers.

#3 – Insurance Services

Financial institutions, like insurance companies, help to mobilize savings and investment in productive activities. In return, they assure investors against their life or some particular asset at the time of need. In other words, they transfer their customer’s risk of loss to themselves.

#4 – Capital Formation

Financial institutions help in capital formation, i.e., increase in capital stockCapital StockThe capital stock is the total amount of share capital (including equity capital and preference capital) that has been issued by a company. It is a way of raising funds by the company to meet its various business goals.read more like the plant, machinery, tools and equipment, buildings, transport, communication, etc. Moreover, they mobilize the idle savings from individuals in the economy to the investor through various monetary services.

#5 – Investment Advice

There are many investment options available at the disposal of individuals and businesses. But it is not easy to choose the best option in the current swiftly changing environment. Almost all financial institutions (banking or non-banking) have an investment advisory desk that helps customers, investors, and businesses to select the best investment option available in the market according to their risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation.read more and other factors.

#6 – Brokerage Services

These institutions provide their investors access to several investment options available in the market, ranging from stock bonds (common investment alternative) to hedge fundsHedge FundsA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques.read more and private equity investment (lesser-known alternative).

#7 – Pension Fund Services

Through their various kinds of investment plans, financial institutions help individuals plan their retirement. One such investment option is a pension fundPension FundA pension fund refers to any plan or scheme set up by an employer which generates regular income for employees after their retirement. This pooled contribution from the pension plan is invested conservatively in government securities, blue-chip stocks, and investment-grade bonds to ensure that it generates sufficient returns.read more. The individual contributes to the investment pool by employers, banks, or other organizations and gets the lump sum or monthly income after retirement.

#8 – Trust Fund Services

Some financial organizations provide trust fundTrust FundA trust fund is a legal entity formed as part of an estate planning tool which holds a grantor’s assets and duly distributes them to the inheritors after the grantor passes away.read more services to their clients. They manage the client’s assets, invest them in the best option available in the market, and take care of its safekeeping.

#9 – Financing the Small and Medium Scale Enterprises

Financial institutions help small and medium-scale enterprises set up themselves in their initial business days. They provide long-term as well as short-term funds to these companies. The long-term fund helps them form capital, and short-term funds fulfill their day-to-day working capital needs.

#10 – Act as A Government Agent for Economic Growth

The government regulates financial institutions on a national level. They act as a government agent and help grow the nation’s economy. For example, to help out an ailing sector, financial institutions, as per the guidelines from the government, issue a selective credit lineCredit LineA line of credit is an agreement between a customer and a bank, allowing the customer a ceiling limit of borrowing. The borrower can access any amount within the credit limit and pays interest; this provides flexibility to run a business.read more with lower interest rates to help the industry overcome the issues it is facing.

Conclusion

Financial institutions are the backbone of the economy. Without the help of these institutions, the economy will go down and cannot stand up. Due to their pivotal role in the development and growth of the economy, the government regulates these institutions through the central bank, insurance regulators, pension fund regulators, etc. Over the years, their role has expanded from accepting and lending funds to larger service areas.

This article is a guide to the Role of Financial Institutions. Here, we discuss the top 10 roles of financial institutions in economic development, including banking services, insurance services, trust fund services, etc. You may learn more about financing from the following articles: –

Financial institutions are essential because they offer a marketplace for money and assets. Therefore, they can efficiently allocate capital where it is most beneficial.

The financial sector performs a crucial role in financial operations through intervention. In other words, the financial industry is an intermediary between savers and borrowers. It takes funds from savers and grants them to those who need to borrow, whether they are households, businesses, or governments.

The financial institutions leading role is to facilitate liquidity in the economy and allow a higher level of financial movement. According to the Brookings Institute, banks may achieve this by offering credit, managing markets, and pooling risk among consumers.

Financial institutions provide financial transactions and play as a mediator in economic activities. There are different financial institutions’ roles which include monetary supply regulation, pension fund services, the economic growth of a nation, banking services, and capital formation.

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