Banking Financial Institutions
In today's financial services the financial institutions are created to provide a wide variety of deposits, lending and deposit procedures are required to be carried out to facilitate the individuals, businesses or the both. Financial Institutions focus on providing the services and accounts for the general public, while others serve specific consumers with specialised offerings.
Financial institutions are developed to appropriate the needs of the society and thus it is important to understand the difference between the types of institutions which will be more appropriate to serve their individual needs.
There are different types of financial institutions from non-banking ones to banking ones and they are as follows:
Central banks: These are responsible for overseeing as well as managing all the other banks. No individual consumer has direct contact with a central bank because other big institutions tend to work with the Federal Reserve Bank for providing the general public with various products and services.
Retail and commercial banks: These tend to offer products and services like savings accounts, checking accounts, personal loans, mortgage loans, credit cards, etc.
Credit unions: A credit union is owned by their members and they tend to operate for their personal benefit.
Internet banks: These are further classified as digital banks and neo banks, wherein the former is online-only platforms and the latter are strictly digital native banks, holding no affiliation with any other bank but themselves.
Investment banks and companies: These are known to help individuals and businesses to raise their capital through the issuance of securities.
Savings and loan associations: Individuals take the help of savings and loan associations for mortgage lending, personal loans, and deposit accounts. And these financial institutions don’t lend more than 20% when it comes to businesses.
Brokerage firms: This helps both businesses as well as individuals to buy and sell securities if there are any available investors.
Insurance companies: An insurance company is one that helps out an individual to transfer the risk of loss.
Mortgage companies: Most mortgage companies are focused on serving the individual consumer market. However, there are a chosen few whose lending options are specialised in commercial real estate only.
The Difference Between a Bank and a Financial Institution
Commercial Bank
Banks, more precisely termed as retail or the commercial banks, fall under the category known as the banking financial institutions. A bank is actually a financial intermediary, they act as a middleman between the suppliers of funds or the depositors and the borrowers. The major task of the bank is to accept the deposits and use the funds which will later on to offer loans to the customers. Yet another duty of a bank is to act as a payment agent, that is done by offering a payment. A bank makes money by investing the deposits in the financial securities and assets, but they mostly make money by lending the funds further to its customers. The primary reasons that the public deposits the money in banks are for convenience, safety and to gain interest income.
Financial Institutions
While financial institutions include all the categories of banks – banks, investment banks, insurance companies, investment funds and other categories of money sector corporates. Except for banks, all are known as non-banking financial institutions who provide financial services to the public but that differs from those of a bank.
The main difference between other financial institutions and banks is that other financial institutions cannot accept deposits into savings and demand deposit accounts, while the same is the core business for banks.
Advantages of a Commercial Bank
The Advantages of Commercial Banks are as follows:
1. Location
The commercial banks are large companies thus, these companies are to be found all over the town, state or country. Some of these commercial banks have businesses in other foreign countries as well and hence their location facilitates the people. Commercial banks are literally located anywhere even inside of malls or retail stores, the ability to access money and account information can be done from almost any location.
2. Discounts
Commercial banks also serve the customers with low prices. Like wholesale companies, the commercial banks buy in bulk and sell to the public at a discount. These discounts may offer free checking, no fees while opening savings or checking accounts. They also provide the customers with low interest rates on real estate loans.
3. Product Offerings
Commercial banks offer more products and service offerings. Commercial banks offer every banking service which a small banking company would offer also CDs, investment accounts, commercial real estate loans, even mortgage plans and the option to have a debit card, credit card or both.
4. Online Banking
With the increasing growth of technology, commercial banks also offer their services online. Customers can keep track of their checking and savings accounts, transfer money to either of their accounts, also pay bills or apply for a loan over the internet itself.
5. Electronic Banking
By using the 24-hour ATMs, customers can withdraw or deposit money and also can access their account information or transfer their funds.
Limitations of Financial Services
The limitations with these financial institutions are as follows:
Restriction on dividend payment which is imposed on the powers of the borrowing capacity of financial institutions.
These institutions come under the government criteria hence, they follow rigid rules for granting these loans.
Too many formalities are attached which is indeed time consuming.
Financial institutions have their nominees on the Board of Directors of the borrowing company thereby restricting the powers of the company to borrow funds.
FAQs on Commercial Banks and Financial Institutions: Role and Importance
1. What is a financial institution, and what are some common types?
A financial institution is a company that provides financial services to clients, such as individuals and businesses. They are essential for managing money and helping the economy function smoothly. Some common types include:
- Commercial banks: Offer everyday banking like deposits and loans.
- Investment banks: Help large companies raise money.
- Insurance companies: Provide protection against financial loss.
- Credit unions: Member-owned institutions that function like banks.
- Brokerage firms: Help people buy and sell stocks and bonds.
2. What exactly is a commercial bank and who are its main customers?
A commercial bank is a type of financial institution that provides services like accepting deposits, offering checking and savings accounts, and making loans. Its main customers are the general public and small businesses. It's the place most people go for their day-to-day banking needs.
3. What are the primary functions of a commercial bank?
Commercial banks perform several crucial functions in an economy. The most important ones are:
- Accepting Deposits: Taking money from people and businesses and keeping it safe in different types of accounts.
- Providing Loans: Lending money for various needs, such as home mortgages, car loans, and business expansion.
- Credit Creation: A unique function where banks lend more than their cash reserves, effectively creating new credit in the economy.
- Transfer of Funds: Making it easy to move money using services like cheques, online transfers, and debit cards.
4. How do commercial banks contribute to a country's economic growth?
Commercial banks are vital for economic growth because they act as a bridge. They collect savings from households and channel that money to businesses that need funds for investment. This process, known as capital formation, helps create new jobs, increase production of goods and services, and encourage trade, which fuels the overall economy.
5. What is the main difference between a commercial bank and an investment bank?
The key difference is their target customer. A commercial bank mainly serves the general public with everyday banking needs like savings accounts and personal loans. In contrast, an investment bank works with large corporations and governments, helping them with complex finance like raising money from the stock market or managing mergers.
6. What are some real-world examples of commercial banks in India?
In India, there are many examples of commercial banks that people use every day. Some of the largest and most well-known are the State Bank of India (SBI), HDFC Bank, ICICI Bank, and Punjab National Bank (PNB). These banks offer a wide range of services to millions of individuals and businesses across the country.
7. Why do banks have such strict rules and procedures for giving out loans?
Banks use strict rules to manage risk and protect the money of their depositors. When a bank lends money, it's taking a risk that the borrower might not repay it. By checking a borrower's credit score, income, and collateral, the bank can better predict their ability to repay. These rules are also often required by the country's central bank, like the Reserve Bank of India (RBI), to ensure the entire financial system remains stable and secure.
8. What is the basic difference between a savings account and a current account?
A savings account is designed to help you save money. You deposit funds and earn a small amount of interest, but there may be limits on withdrawals. A current account (also known as a checking account) is meant for daily transactions. It allows for unlimited withdrawals and deposits, making it ideal for businesses, but it typically offers little to no interest.
9. How does a bank actually “create” credit in the economy?
Banks create credit through a process called the fractional reserve system. When you deposit money, the bank is only required to keep a small fraction of it as a cash reserve. It can lend the remaining amount to someone else. When that loan is spent and deposited in another bank, that second bank can also lend out a fraction of it. This lending cycle repeats, multiplying the initial deposit's impact and effectively creating new credit.
