Financial Institutions,

Financial Instruments,
and the financial
market
LESSON 2
Your best quote that reflects your
approach… “It’s one small step for
man, one giant leap for mankind.”

- NEIL ARMSTRONG
Financial Institutions - also called financial intermediaries, is an organization that
handles financial transactions for individuals, groups. And other organizations---
profit, nonprofit, private, or government-owned. Some financial institutions are
smaller than others like community- based rural banks over large urban-based
commercial banks.

2 Different Types of Financial Institutions

• Depository Institution –manages money that is deposited by individuals and
organizations. Example of depository institutions are banks, credit unions, and
savings and loan associations.
• Nondepository Institution– does not handle deposits. Instead, such institutions serve
as intermediaries between savers and demanders of funds, or individuals, households,
and other businesses who need additional funds to support personal needs or business
operations.

The most common types of financial institutions are as follows:

1. Commercial Banks
2. Savings and Loans
3. Credit Unions
4. Investment Banks
5. Insurance Companies
6. Brokerage
7. Investment Companies
• Banks
Banks provide mechanism where savers can put their excess funds through
deposits. Banks give the depositors interest on the money deposited to them. To
cover for the interest given to the depositors, banks lend the money to borrowers
after performing a credit investigation.

A commercial bank functions for credit creation and thereby helps in

the sustainable growth of the economy.
• It provides a fiscal advantage to both the creditors and the borrowers. These
banks provide all core banking services.
• They accept deposits in accounts such as savings and recurring
accounts and fixed deposits.
• They also provide internet banking facilities and allow clients to invest
in mutual funds and insurance schemes. They, therefore, earn huge profits on the
client’s money.
• They grant loans to big businesses and act as the trustee of the client’s money.
For doing this, they create an account for the borrower. This account
automatically leads to deposit creation.
However, there is no security of funds in these banks as they grant loans to any
person. This leads to banking fraud.

Non-commercial banks usually have no credit earnings.

• They provide fewer banking facilities to the people by sticking
to traditional banking rules.
• They generally do not provide internet banking and other facilities to the
clients.
• The only services they provide are accepting deposits, lending small amounts to
borrowers along with few others.
Co-operative banks operate in semi-urban areas and provide services primarily to
small businesses. They have low rates of interest for borrowers to support new
entrepreneurs.
Rural banks have revolutionized the livelihoods of people living in villages. They
have educated the rural masses in undertaking saving practices.

Main Differences Between Commercial and

Non-Commercial Bank

1.Commercial banks work for earning profits, whereas non-commercial

banks have little to no credit earnings.
2. Commercial banking offers many services and facilities to clients, whereas non-
commercial banking has limited scope in providing services.

3.·Commercial banks are widespread in urban areas. On the other hand, non–
commercial banks have limited existence in rural and semi-urban areas only.

4.Due to the high profits earned, commercial banks spend more on

infrastructure. Non-commercial banks do not gain much to spend on infrastructure.

5.Commercial banks are at high risk of losing the client’s money due to loose
restrictions in operation. Non-commercial banks work under the guidelines of the
state government and have no such issue.
Example: Commercial banks- RCBC, BPI, BDO, PNB, METROBANK
Rural Banks: BOF, Bank of Mexico, GM Bank

• Insurance Companies
Insurance companies offer different products. Insurance companies can be broadly
categorized into life insurance products and non-life insurance products. Life
insurance products protect the insured from loss of life while non-life insurance
products protect the insured from the loss of or damaged to properties.

Example of Insurance Companies:

Life:Sunlife, Prulife, AXA,Manulife
Non-Life: AIG, Malayan, Insurance, Prudential and Guarantee Insurance
• Stock Exchange
The Philippine Stock Exchange (PSE) provides a system for the trading of equity
securities of publicly listed companies. These equity securities are common stocks
and preferred stocks. An individual who wants to invest and trade in the stock
market cannot go directly to PSE to buy and sell stocks. He has to open account
with an accredited stock brokerage firm where he can channel his buy and sell
orders of equity securities.

• Stock Brokerage Firms

Investing in the stock market has to be coursed through stock brokerage firms. At
present, there are online brokers and live brokers. With online brokers, one can
trade in the stock market through Internet. With live brokers, one need a telephone
to call brokers and place orders.
• Mutual Funds
• Mutual funds are owned by investment companies that enable small investors to
enjoy the benefits of investing in a diversified portfolio of securities purchased on
their behalf by professional investment managers.
• When mutual funds use money from investors to invest in newly issued debt or
equity securities, they finance new investment by firms. Conversely, when they
invest in debt or equity securities already held by investors, they are transferring
ownership of the securities among investors.

Example: PAG-IBIG, and other Insurance companies

• Other Financial Institutions

Other financial institutions include pension funds like Government Service Insurance
System (GSIS) and Social Security System (SSS), investment banks, and credit
unions, among others.
 Financial Instrument – also called financial products, a document which
signifies a legal or binding agreement between two parties. Financial
instruments typically have monetary values associated with them. A personal
check is an example of financial instrument.

2 Major Categories in Financial Instruments

1. Common Stocks and Preferred Stocks

• Preferred Stock has priority over a common stock in terms of claims over the
assets of a company. This means that if a company were to be liquidated and its
assets have to be distributed, no asset will be distributed to common stockholders
unless all the claims of the preferred stockholders have been given. Moreover,
preferred stockholders have also priority over common stockholders in cash
dividend declaration. Dividends to preferred stockholders are usually in a fixed
rate. No cash dividends will be given to common stockholders unless all the
dividends due to preferred stockholders are paid first. (Cayanan, 2015)
• Holders of Common Stock on the other hand are the real owners of the company.
If the company’s growth is spurring, the common stockholders will benefit on the
growth. Moreover, during a profitable period for which a company may decide to
declare higher dividends, preferred stock will receive a fixed dividend rate while
common stockholders receive all the excess.

2. Debt Securities
• Debt Securitiesrefers to a debt instrument, such as a government bond,
corporate bond, certificate of deposit (CD), municipal bond, or preferred
stock, that can be bought or sold between two parties and has basic terms
defined, such as notional amount (amount borrowed), interest rate, and
maturity and renewal date.
 Financial Market – is a means for the buying and selling of stocks, bonds, and
other financial instruments. Stocks are shares of a corporation sold to investors
while bonds are money loaned.

2. Comparative Groups of Financial Markets

1. Primary Vs. Secondary Markets
• To raise money, users of funds will go to a primary market to issue new securities
(either debt or equity) through a public offering or a private placement.

• The sale of new securities to the public is referred to as a public offering and the
first offering of stock is called an initial public offering. The sale of new securities
to one investor or a group of investors (institutional investors) is referred to as a
private placement.
 • However, suppliers of funds or the holders of the securities may decide to sell
the securities that have previously been purchased. The sale of previously
owned securities takes place in secondary markets
• The Philippine Stock Exchange (PSE) is both a primary and secondary market.

2. Money Markets vs. Capital Markets

• Money markets are a venue wherein securities with short-term maturities (1 year
or less) are sold. They are created because some individuals, businesses,
governments, and financial institutions have temporarily idle funds that they wish
to invest in a relatively safe, interest-bearing asset. At the same time, other
individuals, businesses, governments, and financial institutions find themselves in
need of seasonal or temporary financing.

• On the other hand, securities with longer-term maturities are sold in Capital
markets. The key capital market securities are bonds (long-term debt) and both
common stock and preferred stock (equity, or ownership).