LECTURE 4 OTHER FINANCIAL INSTITUTIONS

Financial institution

An entity in the economy that provides services related to financial or monetary needs for individuals, businesses, or governments, playing a key role in indirect financing by channeling funds from savers to borrowers

Types of financial institutions

Deposit-accepting institutions, non-bank financial companies, insurance companies, pension funds, mutual funds, hedge funds, brokers, and underwriters

Deposit-accepting institutions

Institutions that accept deposits and use them to provide capital for loans or investments, operating under a banking license

Building societies

Member-owned institutions that collect savings and provide mortgage lending

Credit unions

Cooperative institutions offering financial services only to their members, guided by the motto “Profit is not a priority

Trust companies

Institutions that manage financial assets for clients and can be owned by banks

Non-bank financial institutions (NBFIs)

Financial entities that offer financial services but lack a banking license and cannot accept deposits

Role of NBFIs

Increase financial inclusion and diversify funding sources but face higher liquidity and credit risks due to lighter regulation

Development finance institutions

Organizations that finance development projects, often on a non-profit basis (e

Leasing companies

Provide the rental of assets such as buildings, equipment, or vehicles through financial or operational leasing

Home finance companies

Offer financing services to meet household and individual financial needs

Venture capital companies

Provide funding to startups and early-stage firms in exchange for equity (private equity financing)

Discount and guarantee houses

Financial institutions involved in discounting bills or providing guarantees; follow the formula PV = FV × (1 − d × t)

Corporate development companies

Support existing firms in expansion, strategic growth, and competitiveness

Pension funds

Organizations that offer clients long-term retirement savings and pay pensions; major institutional investors that stabilize markets by providing long-term capital

Types of pension funds

Private, public, or hybrid (private with state support or tax benefits)

Collective investment

The pooling of funds from small investors to invest in markets, enabling access to larger, diversified portfolios

Advantages of collective investment

Professional management, economies of scale, and diversification

Mutual funds

Financial vehicles that pool investors’ money to buy securities and are managed by professionals

Open-end mutual funds

Funds with unlimited investors; must repurchase shares from investors; value set daily as NAV (Net Asset Value)

Closed-end mutual funds

Funds with a fixed number of shares traded on secondary markets; no obligation to buy back shares

Hedge funds

Private investment funds with few restrictions on strategies (derivatives, leverage, speculation); high-risk, high-return; limited to qualified investors

Famous hedge funds

Bridgewater (Ray Dalio), Soros Fund Management, Renaissance Technologies, Citadel

Insurance market

Market where supply and demand for insurance meet; insurance companies act as institutional investors, using premiums to invest in bonds, stocks, and real estate

Types of insurance

Life insurance (life or death coverage) and nonlife insurance (property, liability, accidents, commercial health)

Brokerage firms

Intermediaries between buyers and sellers trading in securities

Underwriters

Institutions, often investment banks, that assess risks and help issue securities on the primary market (eg., IPOs).

Flow of funds step 1 – where money comes from

Individual investors (banks, mutual funds), policyholders (insurance premiums), and employees/employers (pension fund contributions)

Flow of funds step 2 – what institutions do

Banks lend deposits, mutual funds and pension funds invest in securities, insurance companies invest premiums

Flow of funds step 3 – where money goes

Firms receive financing through loans or the sale of securities for operations and growth

Overall role of financial institutions

Complement banks by offering alternative saving and investment channels, improving financial system efficiency and stability