The types and functions of financial institutions and markets (article) | Khan Academy (2024)

In our world of money and finance, there are special organizations that help us save, invest, and manage our money. These organizations are called financial institutions. They include banks, credit unions, insurance companies, and brokerage firms. Financial institutions play a big role in our lives, helping us do things like save for college, buy a car, or even start a business.

Imagine you want to buy or sell things like stocks, bonds, or other financial assets. To do this, you need a place where buyers and sellers can come together to trade these assets. That place is called a financial market. There are different types of financial markets, such as stock markets, bond markets, and money markets. These markets are essential for the smooth functioning of our economy and play a key role in helping businesses and governments raise money.

Financial institutions, like banks and credit unions, can be really helpful. They help you manage your money, build your credit, and get more money over time. Here are some ways they can benefit you:

Imagine two friends, Alex and Jamie. They both work hard and make the same amount of money. But there's a big difference in how they handle their money. Alex saves money under the mattress, has no bank account, and cashes their paycheck at a local check-cashing place. Jamie, on the other hand, has a bank account and uses financial institutions and markets for his own benefit.

Alex always carries cash because they don't have a bank account. This can be risky and inconvenient. When they need to pay a bill, Alex has to go to the post office or the store to pay in person. Jamie, however, has a bank account, which makes it easy to pay bills online or with a debit card. Plus, if Jamie ever loses his wallet, he can contact the bank to cancel the card and protect his money.

Since Alex keeps all their money under the mattress, they don't earn any interest on their savings. This means that if Alex saves $\mathrm{\$}\mathrm{1,000}$‍ for a year, it will still be worth only $\mathrm{\$}\mathrm{1,000}$‍. Jamie, however, has a savings account at a bank. This account earns interest, so if Jamie saves $\mathrm{\$}\mathrm{1,000}$‍ for a year, he might earn $\mathrm{\$}30$‍ in interest, making the total $\mathrm{\$}\mathrm{1,030}$‍.

Both Alex and Jamie want to grow their money, but they have very different approaches. Alex doesn't know much about investing, so they stick to saving money under the mattress. Jamie, on the other hand, knows that investing can help him build wealth faster. Jamie uses financial institutions and markets to invest in stocks or bonds, which can potentially provide higher returns than just saving money in a bank account.

Alex's method of keeping money under the mattress is not only outdated, but it's also risky. If there's a fire or a burglary, Alex could lose all their savings. Jamie's money, on the other hand, is protected by the bank's security measures and federal insurance. Even if the bank gets robbed or if the bank goes out of business, Jamie's money is insured up to $\mathrm{\$}\mathrm{250,000}$‍ by the Federal Deposit Insurance Corporation (FDIC).

In the future, both Alex and Jamie might need to borrow money, maybe for college or to buy a car. Alex will have trouble getting a loan because they don't have a bank account or a credit history. Jamie, however, has a relationship with a bank and has built a credit history by using a credit card responsibly. This makes it easier for Jamie to get a loan with a good interest rate.

As you can see, financial institutions and markets play a crucial role in our lives and, if you take advantage of them, you can make your money work for you.

Let's look at some examples of financial institutions and markets and how they serve different saving and investing needs.

Banks are a popular choice for people who want to save money in a secure place and earn interest. They also provide loans and credit cards to help people finance large purchases, like homes and cars. Banks may also offer investment products and services, such as stocks and mutual funds. In reality, your bank might be a one-stop-shop, where you can take care of all your financial needs.

Lenders are institutions that lend money to people and businesses. While most banks and credit unions do this, there are some companies who only lend money and do not provide any other services, like checking or savings account. They charge interest on the borrowed amount, which is their main source of income.

Credit unions are similar to banks, but they are member-owned and you typically have to qualify to become a member. For example, there are teacher credit unions, or town credit unions (you have to live in a certain town to be a member). Credit unions usually offer better interest rates on savings and lower interest rates on loans. They also provide a range of financial services, just like banks.

These companies help people invest their money in stocks, bonds, and other financial assets. They often charge fees or commissions for their services. For example, you might open an account with a brokerage firm to invest $\mathrm{\$}\mathrm{1,000}$‍ in a stock or mutual fund.

Insurance companies provide protection against financial losses due to accidents, natural disasters, and other unexpected events. They collect premiums from policyholders and use the money to pay out claims when needed. For example, you might buy homeowners insurance to protect your house from damage due to a fire.

Some financial institutions, like financial advisers and wealth managers, provide advice to help people make informed decisions about saving, investing, and managing their money. They may charge fees for their services, or earn commissions based on the products they recommend.

Financial markets are where financial trades happen, but most people don't actually go there to trade stocks, bonds, or other securities. Instead, they rely on financial institutions, like banks or investment firms, to act on their behalf. So even though you might buy stocks or invest in a mutual fund, you're not actually the one making the trades- the financial institution is doing that work for you.

Stock markets are places where people can invest in shares of companies, like Apple or Amazon. They allow investors to buy and sell stocks, which represent ownership in the company, and potentially earn profits as the company grows.

Bond markets are where people can invest in bonds, which are loans made to companies or governments. Investors who buy bonds receive regular interest payments and get their principal amount back when the bond matures.

Money markets are a type of financial market where people can invest in short-term debt securities, like Treasury bills and certificates of deposit.

Understanding financial institutions and markets is essential for making smart decisions about saving and investing your money. By exploring the different types and functions of these organizations, you can identify the best options for your needs and preferences. Whether you're saving for a rainy day, investing in your future, or borrowing money for a big purchase, financial institutions and markets are there to help you achieve your financial goals.