Financial institutions offer a wide range of services and different types of banking products to consumers and commercial customers. The importance of financial institutions to the overall economy is evident during market booms and recessions. During booms, financial institutions provide the financing that supports economic growth. During recessions, banks restrict lending. This can worsen the financial problems of a country. It can draw attention to economies’ heavy dependence on the financial sector.
Moneylenders and insurance companies have been lending people money and insuring against losses for centuries. In many countries, they encourage or even force banks to lend money to homebuyers and small businesses. Easy credit encourages consumer spending, and that spending drives economic growth. Customers who are once approved for a personal loan can easily apply for loans.
Consumers for personal loans
Consumers are often either people with cash looking to get back on their money or people without cash who need to borrow money to cover their short-term expenses. Banks perform as mediators between these two groups. People with cash lend money back at a nominal interest rate. Banks lend the same money to consumers at a much higher interest rate. The difference between the price a bank pays to borrow and the price it charges its own customers to borrow allows the bank to make a profit. In many cases, the importance of financial institutions is most evident during a recession, when savers are short of cash and banks lack the money to finance consumer loans.
Financial institutions offer different types of loans
Financial institutions offer different types of insurance ranging from life insurance to insurance on mortgage contracts. Insurance companies and banks also cover other financial institutions. If a bank defaults, its losses are partially covered by the other institutions that insured them. In individual cases, this can lead to systemic risk. This describes the danger that the collapse of a major bank will affect other banks and the economy as a whole.
When large banks and insurance companies default, government regulators are reminded of the importance of financial institutions to the economy. Regulators in many countries regularly scrutinize financial institutions. They try to solve short-term cash flow problems before these problems become major problems in the banking industry.