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The Role of Financial Institutions in Financial Markets Essay

The Role of Financial Institutions in Financial Markets

Financial institutions refer to the business organizations that act as savings depositories and mobilisers as well as sources of credit or finance (Bhole, 2004). They also engage in the provision of various financial services to the society as whole. Financial institutions are different from the non-financial (commercial and industrial) business organizations in terms of what their products comprise of. For instance, while the industrial sector deal in equipment, real estates, machinery, stocks of goods, and so on, the commercial sector deal in financial assets which include securities, loans, deposits, and so on. Activities of different financial institutions may either be specialized or can at times overlap, and in most cases they overlap. Classification of financial institutions is therefore critical and can only be done on the basis of their primary activity that they engage in, the manner in which they were created, or the extent of their specialization in relation to the buyers or savers they regularly deal with. In general, a large number of financial institutions are usually classified in terms of their functional or sectoral scope of activity or otherwise in their type of ownership (Bhole, 2004).

            The Commercial banks, for

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instance, are a good example of these financial institutions. One possible and very crucial market for Commercial banks is the microfinance. Microfinance has for the last 15 years moved from an almost unfamiliar independent tool to one of the most important topics in the development work of economics (Harper & Arora, 2005).  Its approach has clearly shown that there are varied and more commercially-minded means to help the poor. It is though this approach, of treating the poor as clients and not as beneficiaries that they have managed to reach a vast number of people mostly located at the bottom of the pyramid. But why should commercial banks be interested in microfinance? It is apparent that financial services that are efficient and profitable are necessary for sustainable economic development. These services should then be available for the elite and the general public as well.  It would make no sense for the government and other institutions who wish to extend financial services to the underprivileged in society, or the unreached, use up so much money and resources to build up new institutions while all the while there are thousands of banking outlets all over the world. This is where the commercial banks come in. Most commercial banks are already being replaced by automatic teller machines and are using these services to reach people of all walks of life. For those with no prior experience of formal institutions, personal contact is proving very crucial and it is for this reason that the banks are engaging themselves in the microfinance market (Harper & Arora, 2005).

            Next are the insurance products. One notable and upcoming market for the insurance products is the electronic market. The successful sale of an insurance policy basically depends on how well the policy terms have been matched with the insurer’s requirements (Kowalczyk 2003). Though the reception of e-commerce has not been received as expected, it is having a great impact in the insurance industry. Insurance business is all about selling a particular service at a certain risk. Insurers are required to make the premiums high in such a way that they are able to cover the forecast level of claims and at the same time should keep them low in order to keep them attractive in a market that is increasingly competitive. For any insurance business to be successful, it is fundamental to maintain the balance between profit and risk. Traditionally, most insurance companies fragmented their policy holders into split lines of business like life, business and auto markets, each segment carrying its own claims and marketing strategies. This made it hard to get a comprehensive view of the varied relationships a customer might have with one single company. The insurance company basically informs its customers through advertising. Advertisements are further simplified when using channels such as the newspapers, radio, television, magazines, etc.  E-insurance uses the internet to reach its customers through advertising and it does it more effectively since it joins together the traditional passive as well as active channels of advertisement into one. While passive media is replaced by email notifications, coupons, and advertisement banners, the human counterparts are on the other hand replaced by the software agents. Therefore, the electronic market provides a facility that will facilitate a two way exchange of information.

            When it comes to investment banks, mortgage markets are among the possible markets for the bankers. According to Williamson (1988), mortgage investments range from the sale of loans to collateralized mortgage obligations. Among them include pass-through securities, mortgage pay-through bonds, and mortgage-backed bonds. In the securitization process, the investments banks usually act as conduits. In the case of whole loans, the investment banks purchase the loans, or loan interest for that matter, and then resell it the same way it is, or as a securitized form. When it comes to mortgage pass-throughs, investment banks pool the particular mortgages and then sell the pass-through certificate. In addition to this, investment banks underwrite and then distribute both the pay-through bonds and the mortgage-backed bonds. However, in as much as the investment banks are important to the process of mortgage securitization, they are equally important to the investment banks, and are becoming more important by the day. For instance, the mortgage period of trading of 1983-1985, profits comprised of 20 to 30 per cent just for underwriting and sales. As the instruments of mortgage continue to grow and as mortgages are increasingly becoming important financial tools, investment banks are now starting to not only build but expand departments to accommodate these transactions. It is apparent this is one area that can not clearly be taken lightly.


Bhole, L. M., (2004). Financial institutions and markets: structure, growth and

            innovations. Tata McGraw-Hill, Noida.

Harper, M., & Arora, S.S. (2005). Small customers, big market: commercial banks in

            microfinance. (S.Arora., M. Harper, Ed). TERI Press, New Delhi.

Kowalczyk, R. (2003). Agent-technologies, infrastructures, tools, and applications for E-

            Services. (R.Kowalczyk, Ed). Springer, New York.

Williamson, J.P., (1988). The Investment banking handbook. Wiley professional banking

            and finance series Volume 11 of Frontiers in Finance Series. John Wiley and

            Sons, New York.


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