Chapter Three

Financial Institutions in the

Financial System
 Introduction

•Business entities include nonfinancial and financial

enterprises.
•Nonfinancial enterprises manufacture products (e.g., cars,
steel, computers) and/or provide nonfinancial services
(e.g., transportation, utilities, computer programming).
•On the other hand, financial enterprises, more popularly
referred to as financial institutions, provide services
related to one or more of the following:
 Cont’d
A.Transforming financial assets acquired through the market
from depositors to borrowers.
B.Exchanging of financial assets on behalf of customers.
C.Exchanging of financial assets for their own accounts.
D.Assisting in the creation of financial assets for their
customers, and then selling those financial assets to other
market participants.
E.Providing investment advice to other market participants.
F. Managing the portfolios of other market participants.
 Cont’d
•Financial intermediaries / institutions may be
classified in a variety of ways.
•One of the most important distinctions is
between Depository and Non-Depository
Intermediaries.
•Below is their basic distinction:
 Cont’d
1. Depository Intermediaries
 They are the most commonly recognized intermediaries
because most people use their services on a daily basis.
 Depository institutions issue a variety of checking or
savings accounts and time deposits and they use the
funds to make consumer, business and mortgage loans.
 In other words, they accept deposits from individuals
and firms and use these funds to participate in the debt
market, making loans or purchasing other debt
instruments.
 Cont’d
 There are several types of depository intermediaries:
commercial banks and nonbank thrift institutions
(near banking institutions) or simply “thrifts” that
comprises saving institutions and credit unions.
 Saving institutions include: savings and loan
associations and mutual savings banks.
 Mutual savings banks are similar to S&Ls except that
they have more diversified uses of funds.
 Cont’d
 Whereas commercial banks concentrate on commercial
(business) loans, savings institutions concentrate on
residential mortgage loans.
 Credit unions differ from commercial banks and savings
institutions in that they (1) are nonprofit and (2) restrict
their business to credit union members, who share a
common bond (such as a common employer or union).
 In addition to accepting deposits, these institutions make
loans and provide other financial services.
 Depository institutions are highly regulated because of
the important role that they play in the financial system.
 Cont’d
2. Non-Depository Intermediaries
 It includes contractual institutions (like insurance companies
and pension funds) and investment institutions (like
investment companies or mutual funds, finance companies,
and real estate investment trusts).
 Contractual institutions attract funds by offering legal
contracts to the public in order to protect the savers against
potential risks. (like insurance companies and pension funds)
 Investment institutions sell shares to the public and invest the
proceeds in stocks, bonds, and other securities. (like
investment companies or mutual funds, finance companies,
and real estate investment trusts).
 Group Assignment (20%-2&3)
1. Discuss about depository and non-depository
financial institutions in Ethiopia
2. Discuss about the following non-depository
financial institutions
A. Investment companies or mutual funds
B. Finance companies and
C. Real estate investment trusts
3. Discuss about the current opportunities and
challenges of the Ethiopian financial institutions.