A financial institution is a channel that transferring the funds between the savers and the borrowers. Financial institution is only focuses on the financial transaction such as loan, bonds, debentures, insurance, investment and other various types of financial activities. The financial institutions are included insurance companies, banks, credit unions, stock brokerage firms, non banking financial institutions, building societies, and asset management firms.
There are three different ways for transferring capital or fund from savers to borrowers in the financial market are direct transfers of money and securities, investment banking house, and financial intermediaries.
2.1 Three ways for transferring capital or fund
Direct transfer of money and securities is the easier way to transferring the capital or fund from both borrower and saver. The borrowers no need to go through the investment bankers or any financial intermediaries. The scenario of direct transfer of money and securities will only occur when the businesses sell the shares or bonds to the savers directly in the financial market without go through any financial institution. The securities of the company will straight away sell to the seller exchange with money to the borrower. This direct transfer of money and securities is only suitable for the small firms and procedure is raised by a small amount of capital.
The concept is the business deliver the securities to savers in return its give the firm the money it needs.
For example, a person needs capital to starting his new business but he is lack of capital. So his uncle lends him money to raise fund in order to starting business. So his uncle direct transfer the money to that person.
Investment banking house
For investment banking house, if the company needs to raise up the capital faster so the company will prefer to go through the investment banking house to established new investment securities in order to help the company to obtain financing. For example, ABC company is temporary lacking in capital so ABC company need to sell the shares or bonds to the investment banking house in order to raise fund quickly. The purpose implements the investment banking house in order to exchange the securities into cash faster than the business sell the securities itself. But the investment might use the prices that lower than the market price to purchase these shares or bonds of the company.
When the firms sell their securities to the investment banking house, the investment banking house will resell the securities to the savers. So, the investment banking house is the middleman between the business and the savers. However, the investment banking house will buy in bulk of the securities or the bonds from the business and slowly resell to the seller who are willing to purchase those securities and bonds. The primary market transaction is corporation receives the proceeds of the sale and new securities are involved.
Financial intermediaries
Financial intermediaries are institutions which are between savers and investors and moving funds between both of them. The types of intermediaries included banks, credit unions, insurance companies, pension funds, mutual fund, broker and building societies. Banks are one type of intermediary, it receiving money from small savers and provide loan to borrowers to purchase homes, vacations, and so on to businesses and government units.
In this indirect transfer through a financial intermediary, the financial intermediaries will collect the money from the savers that wish to invest or the savers purchase the intermediary’s securities. After that, the financial intermediary will use this amount of money to provide financial service such as provide loans to the borrowers to start up the business.
There are three main functions which are risk transformation, maturity transformation, and convenient denomination.
For risk transformation, lending money through an intermediary is having less risky than lending money directly. The main reason it is less risky is because a finance intermediary can be diversify and it lends to multiple borrower which can spread the risk become risk-free.
For maturity transformation, the borrower can be converting the short-term liabilities into their long term asset. The third function is convenience denomination. Convenience denomination is matching a small amount of deposits with large loans and large amount of deposits with small loans.
There are also having advantages by using the financial intermediaries which are cost advantage and market failure protection. Financial intermediaries are having cost advantage over the direct lending. For market failure protection, there might be a conflicting between the borrowers and the savers, so the financial intermediaries can be preventing the market failure by become the middleman because the securities or shares are under the financial institution’s name. This is because the borrowers sell the securities or bonds to the financial intermediaries. After that, the financial intermediaries buy the securities or bonds and resell the securities to the saver by using their own name which become as the intermediaries securities or bonds.
Classes of financial intermediaries
The seven major classes of intermediaries are commercial banks, saving and loan associations (S&Ls), mutual savings banks, credit unions, life insurance companies, mutual funds and pension funds.
Commercial banks
Commercial banks is a finance department which provide loan, saving, money market account and connect with customer that having capital deficits and capital surpluses. So that commercial bank is the financial intermediaries that balance the capital in the financial market. For example, a customer goes to a commercial bank to deposit worth RM 10,000 into his own saving account. After that the bank will take these amounts of money to provide loan to the customer or purchase the securities from the business.
On the other hand, commercial bank also provides brokerage services and insurance. Commercial bank is different from the investment bank because commercial bank is normally provide loan services to the customer but the investment bank is help the companies raise up funds from other parties in order to start up the business. Larger banks are generally part of financial services corporations. This kind of bank primarily is dealing with deposit and loans from corporations or large businesses. Commercial banking may also be seen as distinct from retail banking, which involves the provision of financial services direct to consumers. Many banks offer both commercial and retail banking services.
Savings and loan association (S&Ls)
Savings and loan association (S&Ls) is a financial institution that specializes served in accepting saving deposits, mortgage and loans. Savings and loan association also takes the funds that collect from the savers and lend these amounts of fund to the borrower. For saving and loan association, they are expert in analyzing credit and how much of loan is available for each borrower as well as expanding the availability of the fund to provide the borrower to take a loan. S&Ls can be benefit to the savers because they are able to invest in more liquid, better managed and have less risk asset.
Mutual Saving Bank
A mutual saving bank is a financial institution that provides a safe place to accept savings primarily from individuals and lend mainly on a long-terms basis as well as the mortgages, loans, bonds, stocks and others.
Credit Unions
Credit union is a type of non-profit financial institution which is owned and operates by its members. The purpose of this credit union financial institution is promoting thrift, provide credit at a reasonable rate, and provide financial service to the credit union’s member. Once the people deposits the money in the credit union, they will be automatically become the member of credit union. The money that deposit by the member of the credit union will only loaned to other members. So that the borrowers are able to take a loan once they become the member and use for their home mortgages, and home improvement loans.
Life insurance companies
Life insurance companies are a financial institution that is registered under Life Insurance Act 1995. Life insurance companies are mainly provided the service such as providing insurance against death and operate superannuation funds as well as furnishing life insurance protecting. The participants of the life insurance have to buy policies in order to guarantee the payment to designated beneficiaries at the time the policyholder’s death.
Mutual funds
Mutual funds are a type of investments that collection of stocks or bonds. The investor who interested on mutual funds will invest their money to the mutual funds institution in order to achieve the return. Some of the investors are willing to take a high risk to invest in order to get higher return. However, the mutual funds institution has designed different funds to meet the objectives of different types of savers such as bond funds and stock funds are designed for different investors. Some of the funds are used as money market funds.
Pension funds
Pension fund is a fund that launched retirement plans to the people who are retire and these pension funds is funded by corporations or government agencies. For corporations, the corporations will provide pension funds to the employees who are contribute good performance on their work.
