Why are banks called financial institutions? Significant differences between banks and financial institutions
Banks and financial institutions are two terms often used interchangeably. However, a common query, or rather a confusion here, is why banks are addressed as financial institutions. Well, the answer is simple, banks are organizations that manage various financial activities. It acts as a financial intermediary and accepts capital in the form of deposits and savings. Then it uses these deposits and begins various lending activities in the market. This lending can either be direct to the debtors or through capital markets.
So, calling banks financial institutions is not an issue in the larger scheme of things. To learn more, you can complete a PGDM in financial management.
What Else Does a Bank Do?
Banks connect capital deficits and capital surpluses through customers. So, the cash flow can be redirected to people who need it the most. But that is not the sole function of the bank. They can also issue letters of credit and also issue travelers’ cheques and perform other activities of a similar nature.
Along with that, they also offer locker facilities that help to keep valuable items and documents safe and secure.
Banks also provide foreign exchange dealings for customers. They also assist in the underwriting of market tools like shares and debentures.
What Are Financial Institutions, And What Do They Do?
Financial institutions are organizations that serve as channels between borrowers and servers. A financial institution collects money and invests assets like stocks, bank deposits, bonds, or loans. Institutions like these are considered to be financial institutions. But it is a non-deposit financial institution. A financial institution accepts the customer’s cash deposits but strictly uses them for investment or security, and then it returns the revenue to the investor. The entire amount may be returned on maturity or when the account is terminated.
Financial institutions interact directly with banks and governments. But when they are dealing with clients, they do not collect the customer’s deposits and provide them with deposit accounts while handling their cash. The only source of return is a fixed rate of simple interest. Banks can do both of these, and so, banks are financial institutions, but vice versa is not true.
If you wish to learn more then, you can enroll in financial services and capital markets course.
Differences between Banks and Financial Institutions
Now, a financial institution is a broader term; it includes banks, NBFCs, Co-operatives, and other organizations that deal under the guidance of RBI. To be specific, RBI is the apex bank of India, and it draws the framework and guidelines for these organizations to work.
However, you should not confuse it with the share market and mutual fund distributors; they come under the scope of SEBI (Securities and Exchange Board of India).
So, to decide the difference between banks and other financial institutions, let’s take up a few pointers –
The definition of a bank is more precise when compared to financial institutions. Financial institutions will include the definition of NBFCs, modern-age payments banks, etc.
Banks operate under the specific Banking Regulation Act of 1949, and they need a separate banking license from the RBI to operate in India.
Banks are free to accept demand deposits, but other financial institutions that do not have a banking license cannot accept them. Furthermore, banks can offer the whole suite of banking services, but for other financial institutions, there are limitations in place.
As per Indian laws, foreign companies can invest up to 74% in Indian banks. Whereas, in the case of all other financial institutions, there are no such restrictions in place.
Maintaining reserve ratios
Banks in India need to maintain a reserve ratio as per RBI’s instruction. Moreover, this is mandatory for every bank to keep this ratio. Whereas, for other financial institutions, there are no such provisions.
Payment and settlement system
Banks are a crucial part of the country’s payment and settlement system. In contrast, non-banking financial institutions are not.
These are some of the main differences between banks and financial institutions.
Hopefully, now you have an idea of why banks are called financial institutions and how banks stand out from other financial institutions. But if you wish to learn more, then there is plenty of study material available across the internet.
However, if you are planning a career in this domain, then completing a Post Graduate Program in Banking and Finance from Imarticus Learning can be a great idea.