ROLE OF FINANCIAL INSTITUTIONS IN FINANCIAL MARKETS 6
Roleof financial institutions in financial markets
Roleof financial institutions in financial markets
Afinancial market is an all-encompassing term that defines a marketplace where sellers, potential and actual buyers continuously partakethe trading of financial assets (Wilson, Casu & MacMillan, 2013).It involves the transfer of funds from lenders or savers who havesurplus units to borrowers and spenders who have deficit units owingto their present investing opportunities (Mishkin & Easkins,2014). These assets encompass currencies, bonds, equities, andderivative. In a nut shell, trading usually involves short termassets such as treasury bills to long term ranging assets such asbonds and long term liabilities. Financial markets are present invirtually every country worldwide. The major classifications ofsignificant financial markets include the money markets, the capitalmarkets, bond markets, stock markets, cash or spot markets, foreignexchange markets and interbank markets, derivative markets, primaryand secondary markets (Mishkin & Easkins, 2014).
Financialmarkets are outlined as containing internal and external marketforces that influence the prices of the securities involved,rudimentary regulations that govern the costs of trading and the feesinvolved, and transparent pricing (Bliss & Kaufman, 2013). Toensure these standards are adhered with, the financial markets haveput in place regulators, particularly for the protection of theinterests of the various players in the industry along withmaximizing shareholder’s value. As such, regulators have been putin place to govern commercial banks, investment banks, forex traders,insurance companies, underwriting stock or bond insurance, savingsand credit cooperative societies, pension funds, and mutual funds(Bliss & Kaufman, 2013). Majority of such institutions areregarded as financial intermediaries. This paper will focus on themain financial institutions, outlining the prime industry players ineach of them.
Financialinstitutions can be divided into two main categories depositoryinstitutions and nod-depository institutions (Wilson, Casu &MacMillan, 2013). Depository institutions are those that receivedeposits from persons with surplus units and subsequently delivercredit to persons with deficit units. The depository institutionsaccept deposits that are usually liquid except for fixed deposits,they accept the risk of loans and they also diversify their loans(Wilson, Casu & MacMillan, 2013). Their major sources of incomeare the interest that arises from offering credit, transaction fees,and income from other investments that they engage in. Majordepository institutions include commercial banks, savingsinstitutions, and credit unions (Wilson, Casu & MacMillan, 2013).
Commercialbanks display themselves as the prevailing depository institution.Commercial banks offer an assortment of financial services, notablytheir varied deposit accounts (Mishkin & Easkins, 2014). Theyconduct the function of offering loans to borrowers as well asengaging in acquisition of debt securities. Commercial banks arenondiscriminatory as they serve both the private and public sector.The Central Bank is the main regulatory institution of commercialbanks worldwide. Savings institutions consist of savings banks, andsavings and loan institutions, commonly referred to as S & Ls.These institutions are usually owned by the depositors, and theyfocus majorly on mortgages (Mishkin & Easkins, 2014). Creditunions, on the contrary, act as nonprofit organizations. They aremuch smaller compared to the other depository institutions and theirbusiness is strictly restricted to their individual members (Mishkin& Easkins, 2014).
Nondepository institutions are those that generate funds from othersources independent from deposits. Examples of these institutions arefinance companies, mutual funds, securities firms, insurancecompanies, and pension funds (Bliss & Kaufman, 2013). Financecompanies generate funds from the issuance of securities to thepublic. They also act as lenders, whereby they advance funds toindividual borrowers as well as small businesses (Bliss &Kaufman, 2013). Mutual funds engage in the selling of shares tosurplus units. He funds that are collected by mutual funds are usedto purchase a portfolio of securities that are to be distributed tothe surplus units. Mutual funds focus on both the capital markets andthe money markets (Bliss & Kaufman, 2013).
Securityfirms perform various functions, notably the broker function, thedealer function and the investment banking function (Bliss &Kaufman, 2013). The broker function consists of performingtransactions involving securities between two or more persons.Accordingly, they charge a certain fee which takes the form of abid-ask spread. As dealers, security firms are able to come up with amarket involving certain securities due to the altering of theirstock. The investment banking function involves the underwriting ofsecurities that have been newly issued (Bliss & Kaufman, 2013).
Insurancecompanies are responsible for the provision of insurance policies topersons, persons in this context referring to both individuals andcorporates alike. Such policies revolve around uncertainties such asdamage to property, injury, fire, illness, or death (Bliss &Kaufman, 2013). The insurance companies charge premiums that cover aperson for a certain period of time, and in case of damages involvingthe concerned cover, a person is liable for compensation. Apart fromissuance of insurance services, insurance companies also invest inother securities such as bonds and stocks that are issued by othercorporations where they earn investment income (Bliss & Kaufman,2013). For taxation purposes, however, such investment income issubject to corporation tax.
Pensionfunds arise from agreements made under irrevocable trust where themembers contribute funds and receive the funds back plus any otherinterests following their retirement from active employment (Bliss &Kaufman, 2013). Majority of Government agencies and corporations havea pension fund for their members, which can either take the form ofpension schemes or provident schemes. The funds are usually managedprior to their withdrawal from the retirement account. Holders ofpension funds invest in bonds and stock that are issued bycorporations, and they further invest in the securities that areissued by the Government (Bliss & Kaufman, 2013).
Bliss,R. R., & Kaufman, G. G. (2013). Financialinstitutions and markets: Current issues in financial markets. NewYork: Palgrave MacMillan.
Mishkin,F. S., & Easkins, S. G. (2014). Financialmarkets and institutions. Boston:Pearson Prentice Hall.
Wilson,J. O. S., Casu, B., & MacMillan, D. G. (2013). Contemporaryissues in financial institutions and markets. Volume I. London:Routledge.