Role of Financial Institutions in Financial Markets (Essay Sample)

Role of Financial Institutions in Financial Markets
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Role of financial institutions in financial markets
A financial market is an all-encompassing term that defines a market place where sellers, potential and actual buyers continuously partake the trading of financial assets (Wilson, Casu & MacMillan, 2013). It involves the transfer of funds from lenders or savers who have surplus units to borrowers and spenders who have deficit units owing to their present investing opportunities (Mishkin & Easkins, 2014). These assets encompass currencies, bonds, equities, and derivative. In a nut shell, trading usually involves short term assets such as treasury bills to long term ranging assets such as bonds and long term liabilities. Financial markets are present in virtually every country worldwide. The major classifications of significant financial markets include the money markets, the capital markets, bond markets, stock markets, cash or spot markets, foreign exchange markets and interbank markets, derivative markets, primary and secondary markets (Mishkin & Easkins, 2014).
Financial markets are outlined as containing internal and external market forces that influence the prices of the securities involved, rudimentary regulations that govern the costs of trading and the fees involved, and transparent pricing (Bliss & Kaufman, 2013). To ensure these standards are adhered with, the financial markets have put in place regulators, particularly for the protection of the interests of the various players in the industry along with maximizing shareholder’s value. As such, regulators have been put in place to govern commercial banks, investment banks, forex traders, insurance companies, underwriting stock or bond insurance, savings and credit cooperative societies, pension funds, and mutual funds (Bliss & Kaufman, 2013). Majority of such institutions are regarded as financial intermediaries. This paper will focus on the main financial institutions, outlining the prime industry players in each of them.
Financial institutions can be divided into two main categories; depository institutions and nod-depository institutions (Wilson, Casu & MacMillan, 2013). Depository institutions are those that receive deposits from persons with surplus units and subsequently deliver credit to persons with deficit units. The depository institutions accept 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 income are the interest that arises from offering credit, transaction fees, and income from other investments that they engage in. Major depository institutions include commercial banks, savings institutions, and credit unions (Wilson, Casu & MacMillan, 2013).
Commercial banks display themselves as the prevailing depository institution. Commercial banks offer an assortment of financial services, notably their varied deposit accounts (Mishkin & Easkins, 2014). They conduct the function of offering loans to borrowers as well as engaging in acquisition of debt securities. Commercial banks are nondiscriminatory as they serve both the private and public sector. The Central Bank is the main regulatory institution of commercial banks worldwide. Savings institutions consist of savings banks, and savings and loan institutions, commonly referred to as S & Ls. These institutions are usually owned by the depositors, and they focus majorly on mortgages (Mishkin & Easkins, 2014). Credit unions, on the contrary, act as nonprofit organizations. They are much smaller compared to the other depository institutions and their business is strictly restricted to their individual members (Mishkin & Easkins, 2014).
Non depository institutions are those that generate funds from other sources independent from deposits. Examples of these institutions are finance companies, mutual funds, securities firms, insurance companies, and pension funds (Bliss & Kaufman, 2013). Finance companies generate funds from the issuance of securities to the public. They also act as lenders, whereby they advance funds to individual borrowers as well as small businesses (Bliss & Kaufman, 2013). Mutual funds engage in the selling of shares to surplus units. He funds that are collected by mutual funds are used to purchase a portfolio of securities that are to be distributed to the surplus units. Mutual funds focus on both the capital markets and the money markets (Bliss & Kaufman, 2013).
Security firms perform various functions, notably the broker function, the dealer function and the investment banking function (Bliss & Kaufman, 2013). The broker function consists of performing transactions involving securities between two or more persons. Accordingly, they charge a certain fee which takes the form of a bid-ask spread. As dealers, security firms are able to come up with a market involving certain securities due to the altering of their stock. The investment banking function involves the underwriting of securities that have been newly issued (Bliss & Kaufma...