How important are financial institutions?

Financial institutions offer consumers and business customers a wide range of services and different types of banking products. The importance of financial institutions to the economy as a whole is evident during market ups and downs. During economic ups, financial institutions provide the financing that fuels economic growth, and during downturns, banks reduce lending. This can exacerbate a country's financial problems and draw attention to the fact that economies are heavily dependent on the financial sector.

Lenders and insurers have been lending people money and insuring them against losses for centuries, but in the 20th century, governments around the world began to recognize the importance of financial institutions and passed laws that made it easier for more people to get financial products and services. . of these entities. In many countries, banks are encouraged or even required to lend money to homebuyers and small businesses. Available loans facilitate consumer spending, and such spending leads to economic growth.

Consumers are usually people with money looking for a return on their money or people with no money who need to borrow money to cover short-term expenses. Banks act as intermediaries between these two groups. People with money lend money at a nominal interest rate, and banks lend that same money to consumers at a much higher interest rate. The difference between the price a bank pays for the loan and the price it charges its own customers for the loan allows the bank to make a profit. In many cases, the importance of financial institutions is most vivid during recessions, when savers run out of money and banks don't have the money to finance consumer loans.

Financial institutions offer different types of insurance, from life insurance to mortgage contract insurance. Insurance companies and banks also insure other financial institutions. If a bank becomes insolvent, its losses are partially absorbed by the other institutions that insured it. In some cases, this can lead to systemic risk, which describes the danger that the collapse of a major bank will have a filtering effect on other banks and the economy at large.

When large banks and insurance companies become insolvent, government regulators are reminded of the importance of financial institutions to the economy and the dangers posed by systemic risk. Regulators in many countries regularly audit financial institutions to try to resolve short-term cash flow problems before these problems become major banking problems. In many countries, government regulators have set limits on the number of loans a bank can issue and the number of insurance policies any company can issue. Such measures aim to ensure that no bank becomes so important to the economy that its failure could jeopardize the health of the entire economy.

Go up

This website uses third-party cookies