What is a Financial Institution?

What Is a Financial Institution (FI)?

A financial institution (FI) is a company engaged in the business of dealing with financial and monetary transactions such as deposits, loans, investments, and currency exchange. Financial institutions include a broad range of business operations within the financial services sector, including banks, insurance companies, brokerage firms, and investment dealers.

Virtually everyone living in a developed economy has an ongoing or at least periodic need for a financial institution's services.

Key Takeaways

A financial institution (FI) is a company engaged in the business of dealing with financial and monetary transactions such as deposits, loans, investments, and currency exchange.
Financial institutions are vital to a functioning capitalist economy in matching people seeking funds with those who can lend or invest it.
Financial institutions encompass a broad range of business operations within the financial services sector including banks, insurance companies, brokerage firms, and investment dealers.
Financial institutions vary by size, scope, and geography.

Understanding Financial Institutions (FIs)

Financial institutions often match savers' or investors' funds with those seeking funds, such as borrowers or businesses seeking to trade shares of ownership for funds. Typically, this leads to future payments from the borrower or business to the saver or investor. The tools for matching all of these parties up include products such as loans, and markets, such as a stock exchange.

At the most basic level, financial institutions allow people to access the money they need. For example, although banks do many things, their primary role is to take in funds—called deposits—from those with money, pool the deposits, and lend the money to others who need funds. Banks are intermediaries between depositors (who lend money to the bank) and borrowers (who the bank lends money to).

This works well because while some depositors need their money at any given moment, most do not. So banks can use deposits to make long-term loans. This applies to almost every entity and individual in a capitalist system: individuals and households, financial and nonfinancial firms, and national and local governments.

Without financial institutions, businesses could not grow. And households could only buy goods, education, and housing that the families have cash for today.

Financial institutions serve most people in some way as a critical part of any economy—whether in banking, insurance, or securities markets. Individuals and companies rely on financial institutions for transactions and investing. For example, the health of a nation's banking system is a linchpin of economic stability. Loss of confidence in a financial institution can easily lead to a bank run.

The Function of Financial Institutions in Capital Markets

Capital markets are important for functioning capitalist economies because they channel savings and investments between suppliers and those in need. Suppliers are people or institutions with capital to lend or invest. Suppliers typically include banks and investors. Those seeking capital are businesses, governments, and individuals.

Financial institutions play an important role in capital markets, directing capital to where it is most useful. For example, a bank takes in deposits from customers and lends the money to borrowers, ensuring capital markets' efficient function.

Regulation

Governments oversee and regulate banks and financial institutions because the institutions play an integral economic role. Bankruptcies of financial institutions, for instance, can create panic. Federal and state agencies can regulate financial institutions. Sometimes, multiple agencies regulate the same institution.

Federal Depository Regulators

Federal depository regulators oversee commercial banks, thrifts (savings associations), and credit unions accepting customer deposits.

U.S. Federal Reserve (The Fed): Regulator of Federal Reserve System member state banks, foreign banking organizations operating in the United States, and financial holding companies.
Office of the Comptroller of the Currency (OCC): The OCC is responsible for seeing that national banks and federal savings associations operate safely, provide equal access to financial services, treat customers fairly, and comply with applicable laws and regulations. It also regulates U.S. federal branches of foreign banks and federally chartered thrift institutions.
Federal Deposit Insurance Corporation (FDIC): The FDIC regulates federally insured depository institutions, state banks that aren't members of the Federal Reserve System, and state-chartered thrift institutions.
National Credit Union Administration (NCUA): NCUA supervises and insures federally chartered or insured credit unions.

The FDIC insures deposits in state-chartered banks and federal savings associations if a bank fails. The FDIC insures regular deposit accounts of up to $250,000 per depositor per institution. Offering this insurance reassures individuals and businesses regarding the safety of their finances with financial institutions. Like the FDIC, the NCUA insures deposit amounts of up to $250,000.

Federal Securities Markets Regulators

Two federal institutions regulate products, markets, and market participants for securities such as stocks, bonds, and derivatives.

Securities and Exchange Commission (SEC): The SEC regulates securities exchanges, broker-dealers, and corporations selling securities to the public; investment funds, including mutual funds; investment advisers, including hedge funds with assets over $150 million; and investment companies.
Commodities Futures Trading Commission (CFTC): The CFTC regulates futures exchanges, futures commission merchants, commodity pool operators, commodity trading advisors, derivatives, clearing organizations, and designated contract markets.

Government-Sponsored Enterprise (GSE) Regulators

These dedicated regulators exclusively oversee government-sponsored enterprises, which are quasi-governmental entities established to enhance the flow of credit to specific sectors of the U.S. economy.

Federal Housing Finance Agency: The FHFA supervises, regulates, and performs oversight of the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan Bank System.
Farm Credit Administration: This agency regulates Farm Credit System institutions and Farmer Mac, credit sources for eligible persons in agriculture and rural America.

Consumer Protection Regulator

Currently, the Consumer Financial Protection Bureau (CFPB) is the only national consumer entity tasked with exclusively regulating consumer products. CFPB's purview includes nonbank mortgage-related firms, private student lenders, payday lenders, and other large “consumer financial entities,” as determined by the CFPB. CFPB is the rulemaking consumer protection authority for all banks and has supervisory authority for banks with more than $10 billion in assets.

State Regulators

States may regulate financial institutions in addition to or instead of federal regulators. For example, there is minimal federal oversight of the insurance industry. Each state government has a department that licenses and regulates insurance companies and any company selling insurance products. States may also regulate banking, securities, and consumer protections in addition to federal regulators who work in those areas.

Types of Financial Institutions

Financial institutions offer various products and services for individual and commercial clients. The specific services offered vary widely between different types of financial institutions. Here are some of the types consumers are most likely to use:

Banks, Credit Unions, and Savings & Loans

These financial institutions accept deposits and offers checking and savings account services; make business, personal, and mortgage loans; and provides basic financial products like certificates of deposit (CDs). They may also act as payment agents via credit cards, wire transfers, and currency exchange.

These types of financial institution can include:

Commercial or private banks
Savings and loans associations
Credit unions
Foreign banks
Savings banks, industrial institutions, thrifts

Investment Companies, Advisors, and Brokers

Investment companies issue and invest in securities (stocks, bonds, mutual funds and ETFs or exchange-traded funds). Mutual funds are one example of a product offered by an investment company, where many investors' money is pooled and invested in stocks, bonds, money market instruments, other securities, or even cash in an ongoing manner.

Other examples of investment-related financial institutions include investment advisors and brokers. Brokers accept and carry out orders to buy and sell investments (such as securities) for customers.

Insurance Companies

Among the most familiar non-bank financial institutions are insurance companies. Providing insurance for individuals or corporations is one of the oldest financial services. Protection of assets and protection against financial risk, secured through insurance products, is an essential service that facilitates individual and corporate investments that fuel economic growth.

Insurance is primarily regulated at the state level, but the U.S. Treasury's Federal Insurance Office (FIO) does monitor the industry and plays an advisory role.

Why Are Financial Institutions Important?

Financial institutions are essential because they provide a marketplace for money and assets so that capital can be efficiently allocated to where it is most useful. For example, a bank takes in customer deposits and lends the money to borrowers. Without the bank as an intermediary, any individual is unlikely to find a qualified borrower or know how to service the loan. Via the bank, the depositor can earn interest as a result. Likewise, investment banks find investors to market a company's shares or bonds to.

What Are the Different Types of Financial Institutions?

The most common types of financial institutions include banks, credit unions, insurance companies, and investment companies. These entities offer various products and services for individual and commercial clients, such as deposits, loans, investments, and currency exchange.

Which Agency Oversees Banking Operations in the United States?

Several agencies oversee banking operations in the U.S., including the Federal Reserve, Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (NCUA).

What's the Difference Between a Commercial and Investment Bank?

A commercial bank, where most people do their banking, is a type of financial institution that accepts deposits, offers checking account services, makes business, personal, and mortgage loans, and offers basic financial products like certificates of deposit (CDs) and savings accounts to individuals and small businesses.
Investment banks specialize in providing services designed to facilitate business operations. This might include raising money through financing and equity offerings, including initial public offerings (IPOs). They also commonly offer brokerage services for investors, act as market makers for trading exchanges, and manage mergers, acquisitions, and other corporate restructurings.

Which Agency Regulates Investment Banking Firms?

The Securities and Exchange Commission (SEC) oversees the operations of investment banks as these banks deal with securities.

The Bottom Line

Financial institutions help keep capitalist economies running by matching people who need funds with those who can lend or invest it. They offer a wide range of business operations within the financial services sector including banks, credit unions, insurance companies, and brokerage firms. Regulatory agencies such as the OCC, the SEC, the FDIC, and the Federal Reserve oversee the operations of financial institutions in the United States.