Financial institutions have been very popular from the very beginning where transfers of funds were being facilitated from lenders to borrowers. It faced remarkable challenges such as economic and industrial depression, regulatory barriers, technological and financial innovations, and environmental changes which tested it to stand strong and firm no matter how stiff those challenges are. These are only some proofs that financial institutions have special role in the financial system. Direct funds transfers are common among individuals and small businesses and in economies where financial markets and institutions are less developed. But large countries in developed economies generally find it more efficient to enlist the services of financial institutions (e.g banks, credit unions, pension funds, insurance companies, mutual funds, hedge funds) when it comes time to raise capital from those with excess fund to those with scarcities of funds. These services include the following:
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- aggregating funds to gather information about customers’ profile including their actions
- providing financial claims to customers with greater capability to settle currently maturing obligations when they fall due and with lower price risk
- reducing transaction costs leading to efficiency of FIs operations;
- serving as pass-through entities between central’s bank monetary policy actions and financial system and economy;
- financing particular sector of the economy such as agricultural, small business, and residential real estate;
- channeling funds of savers from one generation to the next;
- offering efficient payment services to depository institutions; and
- allowing investors to write checks against their accounts.
FIs remain to be very significant in the efficient operations of economy because of its diverse functions. Some of which are as follows:
- FIs serve as “MONITORS” on behalf of depositors and investors through their “insider information and act as rating agencies and examiners;
- FIs serve as “BROKERS” to different companies e.g. Merrill Lynch, Bank of America, Deutsche Bank, UBS;
- FIs reduces transaction costs and increases higher percentage of savings among savers;
- FIs were great “TRANSFORMERS” of resources and financial risks; and
- FI were expert “DIVERSIFIERS” of risks faced by the parties involved and provide payment services (FedWire and Clearing House Interbank Payments System , CHIPS) and also have active participation in maturity and denomination intermediations.
FIs are business organizations that receive funds in one form and repackage them for the use of those who need funds. Without FIs, transactions between net savers and net borrowers will not be facilitated; level of funds flow weakens, liquidity lessens, and price risk increases. External factors which cause the downfall of FIs, extraordinary services provided, its traditional roles such as money transmission, deposit taking and credit system are what make some FIs special than others, thereby, it deserve to be given a special regulatory attention. There are six (6) types of regulations granted to FIs to secure enhancement of their net social welfare benefits. These include the inclusion of customers’ value, segregation of credit, monetary policy, safety and soundness internally and externally, protection of investors, and entry and chartering regulation. Each regulation covers multitude aspects of business. Safety and Soundness regulation is more concerned with increase in diversification to no more than 10 percent of equity to single borrower, minimum capital requirements for Troubled Asset Relief Program (TARP), ECB asset-buying and Capital Purchase Program, guaranty funds of Deposit Insurance Fund and Securities Investors Protection Fund, and monitoring and surveillance. For Monetary policy, it covers the direct controls over the inside (deposits) and outside (notes and coins) money as well the reserve requirements to facilitate transmission. Under Credit allocation regulation, important sectors such housing and farming were being supported. It covers minimum requirement of assets or maximum interest rates or fees as well as the Qualified Thrift Lender Test (QTL). To protect consumer, different regulations were also implemented such as Community Reinvestment Act (CRA) and Home Mortgage Disclosure Act (HMDA). In addition to these two (2), Consumer Financial Protection Agency (2009) was materialized to protect and support consumer from unfair, deceptive, fraudulent and abusive practices across financial sectors. Protection against inside trading, lack of disclosure and the like were the concerns of Investor Protection regulations. Key legislation under which are Securities Act of 1933 and 1934, Investment Company Act of 1940, and Wall Street Reform and Consumer Protection Act (passed July 2010). Under entry regulation, Financial Services Modernization Act of 1999 defines scope of permitted activities.
Despite of the special regulatory attention given to FIs, they’re still subject to risk and financial crisis. Such risk and financial crisis include large financial losses, delinquent accounts rose, downfall of business, Lehman Brothers failure, and the like. To resolve this crisis, Federal Reserve, TARP, American Recovery and Reinvestment Act, and other central banks came to rescue.
Through FIs, the interest of savers and borrowers are met, resources are allocated more effectively, and the real output of the economy is thereby increased.