Chapter Two
II. Financial Institutions in the Financial System
Leaning Objectives
At the end of the chapter students/learners will be
able to.
Recognize financial institutions and capital
transfer
Appreciate the function of financial institutions
Realize the roles of financial intermediaries
Differentiate the classification of financial
institutions
Discriminate the types of risk in financial industry
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2.1. Financial Institutions and Capital Transfer



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A financial institution is an organization that facilitates
financial transactions and is a key player in financial
intermediation.
They are involved in handling transactions such
advancing loans, receiving deposits, and currency
changes.
A Funds Transfer is a sequence of events that results in
the movement of funds from the remitter to the
beneficiary.
Funds Transfers can also be classified as customer
transfer, bank transfer and bank transfer for own
account.
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2.2. Functions of Financial Institutions
Banking
Service
Ensure
economic
growth
Capital
Formation
Function
of FIs
Pension
Fund
Service
Money
Supply
Regulation
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2.3. Financial Intermediaries and their Roles
Lending and borrowing involve both transactions
costs, like the cost of writing a loan contract, and
information costs. Financial institutions exist to
reduce these costs.
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2.4. Classifications of Financial Institutions
Broadly speaking financial institutions are categorized in
to two major parts, as:
a) Depository financial institutions; which include
commercial banks, savings and loan associations,
mutual savings banks, and credit unions
b) Non-depository
financial institutions; which
comprises of contractual savings institutions
(insurance companies and pension funds); investment
institutions (finance companies, mutual funds, money
market mutual funds, stock brokerage firms,
investment banks etc).
 There are several governmental financial institutions
assigned with regulatory and supervisory functions.
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Financial Institutions Classification
Depository Financial Institutions
Non-Depository Financial Institutions
Commercial Banks
Insurance
Saving and Loan Association
Pension Fund
Saving Bank
Mutual Fund
Credit Union
Investment Bank
Finance Companies
Money Market Mutual Fund
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---Cont….
Depository institutions are popular financial
institutions for the following reasons:
They offer deposit accounts
They provide loan facilities
They accept the risk on loans provided
They have more expertise
They diversify their loans among
numerous deficit units
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Advantage of Mutual Funds
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
Mutual Fund: - A mutual fund (in US) or unit trust (in UK and India)
raise funds from the public and invests the funds in a variety of
financial assets, mostly equity, both domestic and overseas and also in
liquid money and capital market.
Advantage of Mutual Funds
 Mobilizing small saving
 Professional management
 Diversified investment/ reduced risks
 Better liquidity
 Investment protection
 Low transaction cost (economy of scale)
 Economic Developments

The investors’ return in the mutual fund includes capital appreciation
(capital gain from price appreciation of the underlying assets), and the
income generated by the assets of the fund.
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2.7. Risks in Financial Industry
Credit
Liquidity
Operational
Types of
Risks in
Financial
Industry
Solvency
Market
Interest
rate
Fxc
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----Cont…..

Risk-taking is an inherent element of
banking and, indeed, profits are in part the
reward for successful risk taking. In
contrary, excessive, poorly managed risk
can lead to distresses and failures of
banks. Risks are, therefore, warranted
when
they
are
understandable,
measurable, controllable and within a
bank’s capacity to withstand adverse
results.
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---End---
Thank you!
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Abebe Tilahun(Ass. Prof.)
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