Question

Explain the differences in the flow of funds in economies with and without Financial Institutions and Banks

Answer 1

The Financial Institution

A financial institution is basically an establishment that conducts financial transactions such as investments, loans and deposits.

There are five main types of financial institutions.

1.Commercial banks: commercial banks worked directly with businesses. Currently, the majority of large banks offer deposit accounts, lending and limited financial advice to both demographics.

2. Investment Banks:: Investment banks do not take deposits; instead, they help individuals, businesses and governments raise capital through the issuance of securities. Investment companies, more commonly known as mutual fund companies, pool funds from individual and institutional investors to provide them access to the broader securities market.5

Brokerage Firms: Brokerage firms assist individuals and institutions in buying and selling securities among available investors.

3. Insurance Company: Financial institutions that help individuals transfer risk of loss are known as insurance companies. Individuals and businesses use insurance companies to protect against financial loss due to death, disability, accidents, property damage, and other misfortunes

4. Mortgage: most mortgage companies serve the individual consumer market, some specialize in lending options for commercial real estate only.

5. Investment Company: Investment companies, more commonly known as mutual fund companies, pool funds from individual and institutional investors to provide them access to the broader securities market.

The primary role of financial institutions is to provide liquidity to the economy and permit a higher level of economic activity than would otherwise be possible.

According to the Brookings Institute, banks accomplish this in three main ways: offering credit, managing markets and pooling risk among consumers.

If you are familiar with GDP, the investment portion is heavily influenced by financial institutions, as they facilitate how much people save and invest in an economy, which is an ingredient for economic growth.

Without financial institutions, people wouldn’t be able to take advantage of rising and falling interest rates and there would be no saving of money, other than the stacks you stuff under your mattress

Capturing all the dimensions of the role of banks is out of my reach. I'll give you two ways in which banks improve the economy. Be sure, this is not even a tip of iceberg.

1. Credit: It is real hard for a business to thrive without credit. Banks give credit which can be used by entrepreneurs, companies etc. for investment. Most of the companies being benefitted from institutional credit is an evidence of this fact.
2. Saving: Surplus resources can be left idle only at the cost of development. So, if you earn surplus money and just put them in your vault without either spending or depositing in a bank. It is a resource wasted.

There is substantial literature available about the role banks can play in development of a region. Also, the emphasis by the now government on Jan Dhan Yojana is another example of how banks can help in the welfare of the nation(Direct Benefit Transfers)

As the institutions evolved, they are increasingly being involved in many other operations. Some if which are forex, equity trading, mutual funds, electronic payments, gold. Now, the system is complex for a lay man to specialise in its working.

In this developed corporate world banks and financial institutions places a crucial role