Financial institution
Encyclopedia
In financial economics
, a financial institution is an institution
that provides financial services
for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries
. Most financial institutions are highly regulated
by government
.
Broadly speaking, there are three major types of financial institutions:
become inverse, firms in this arena will offer additional fee-generating services including securities underwriting, and pre.
fds
Price/Equity
Price/Book Value
Use Equity Multiples (as opposed to Enterprise Multiples). To consider how valuing a Financial Institution's balance sheet is different from a non-Financial firm, consider how an industrial firm wields capital machinery (asset) and the loans (liabilities) it used to finance that asset. The line is blurred in Financial Institutions, which must hold deposit accounts (liabilities) to fuel the issuance of loans (assets). The same accounts are considered loans as they are held in ownership not of the bank, but of the individual client.
Dividend Discount Model :
Earnings-per-share
Dividends-per-share
Discounted Cash Flow (DCF) Model :
You'll need the FCFE (Free Cash Flow for Equity), which is the amount of money that is returned to shareholders. Calculate an FCFF (Free Cash Flow to the Firm):
EBIT
(1-tax rate) -Capital Expenditures+ (Depreciation & Amortization) - (Net increase in working capital)= FCFF
FCFF-Debt+Cash=FCFE
Use the Capital Asset Pricing Model, not the Weighted Average Cost of Capital (for the same reasons one uses Equity Multiples in relative valuation) to determine the cost of equity
(the return required by shareholders to make the decision to invest in a financial institutions)
Excess Return Model :
A model where valuation is expressed as the sum of capital invested currently in the firm and the present value of dollar excess returns that the firm expects to make in the future.http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/finfirm.pdf
in ordinary trades of some type. These agreements allow traders
to make faster trades since time used to settle the receiving agents is conserved. Limiting the trader to an SSI also lowers the likelihood of a fraud
.
Countries that have separate agencies include the United States
, where the key governing bodies are the Federal Financial Institutions Examination Council
(FFIEC), Office of the Comptroller of the Currency
- National Banks, Federal Deposit Insurance Corporation
(FDIC) State "non-member" banks, National Credit Union Administration
(NCUA) - Credit Unions, Federal Reserve
(Fed) - "member" Banks, Office of Thrift Supervision
- National Savings & Loan Association, State governments each often regulate and charter financial institutions.
Countries that have one consolidated financial regulator include United Kingdom
with the Financial Services Authority
, Norway with the Financial Supervisory Authority of Norway
, Hong Kong with Hong Kong Monetary Authority
and Russia with Central Bank of Russia. See also List of financial regulatory authorities by country.
Financial economics
Financial Economics is the branch of economics concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment"....
, a financial institution is an institution
Institution
An institution is any structure or mechanism of social order and cooperation governing the behavior of a set of individuals within a given human community...
that provides financial services
Financial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...
for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries
Financial intermediary
Financial intermediation consists of “channeling funds between surplus and deficit agents”. A financial intermediary is a financial institution that connects surplus and deficit agents...
. Most financial institutions are highly regulated
Financial regulation
Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system...
by government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
.
Broadly speaking, there are three major types of financial institutions:
- DepositDeposit accountA deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the...
-taking institutions that accept and manage deposits and make loanLoanA loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s, including bankBankA bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s, building societiesBuilding societyA building society is a financial institution owned by its members as a mutual organization. Building societies offer banking and related financial services, especially mortgage lending. These institutions are found in the United Kingdom and several other countries.The term "building society"...
, credit unionCredit unionA credit union is a cooperative financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift, providing credit at competitive rates, and providing other financial services to its members...
s, trust companiesTrust companyA trust company is a corporation, especially a commercial bank, organized to perform the fiduciary of trusts and agencies. It is normally owned by one of three types of structures: an independent partnership, a bank, or a law firm, each of which specializes in being a trustee of various kinds of...
, and mortgage loanMortgage loanA mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
companies - InsuranceInsuranceIn law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
companies and pension fundPension fundA pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
s; and - BrokerBrokerA broker is a party that arranges transactions between a buyer and a seller, and gets a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal...
s, underwritersUnderwritingUnderwriting refers to the process that a large financial service provider uses to assess the eligibility of a customer to receive their products . The name derives from the Lloyd's of London insurance market...
and investment fundsCollective investment schemeA collective investment scheme is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group...
.
Function
Financial institutions provide service as intermediaries of financial markets. They are responsible for transferring funds from investors to companies in need of those funds. Financial institutions facilitate the flow of money through the economy. To do so, savings arisk brought to provide funds for loans. Such is the primary means for depository institutions to develop revenue. Should the yield curveYield curve
In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...
become inverse, firms in this arena will offer additional fee-generating services including securities underwriting, and pre.
fds
Corporate valuation
Relative metrics :Price/Equity
Price/Book Value
Use Equity Multiples (as opposed to Enterprise Multiples). To consider how valuing a Financial Institution's balance sheet is different from a non-Financial firm, consider how an industrial firm wields capital machinery (asset) and the loans (liabilities) it used to finance that asset. The line is blurred in Financial Institutions, which must hold deposit accounts (liabilities) to fuel the issuance of loans (assets). The same accounts are considered loans as they are held in ownership not of the bank, but of the individual client.
Dividend Discount Model :
Earnings-per-share
Dividends-per-share
Discounted Cash Flow (DCF) Model :
You'll need the FCFE (Free Cash Flow for Equity), which is the amount of money that is returned to shareholders. Calculate an FCFF (Free Cash Flow to the Firm):
EBIT
Earnings before interest and taxes
In accounting and finance, earnings before interest and taxes is a measure of a firm's profit that excludes interest and income tax expenses. Operating income is the difference between operating revenues and operating expenses...
(1-tax rate) -Capital Expenditures+ (Depreciation & Amortization) - (Net increase in working capital)= FCFF
FCFF-Debt+Cash=FCFE
Use the Capital Asset Pricing Model, not the Weighted Average Cost of Capital (for the same reasons one uses Equity Multiples in relative valuation) to determine the cost of equity
Cost of equity
In finance, the cost of equity is the return a firm theoretically pays to its equity investors, i.e., shareholders, to compensate for the risk they undertake by investing their capital. Firms need to acquire capital from others to operate and grow...
(the return required by shareholders to make the decision to invest in a financial institutions)
Excess Return Model :
A model where valuation is expressed as the sum of capital invested currently in the firm and the present value of dollar excess returns that the firm expects to make in the future.http://pages.stern.nyu.edu/~adamodar/pdfiles/papers/finfirm.pdf
Standing settlement instructions
Standing Settlement Instructions (SSIs) are the agreements between two financial institutions which fix the receiving agents of each counterpartyCounterparty
A counterparty is a legal and financial term. It means a party to a contract. A counterparty is usually the entity with whom one negotiates on a given agreement, and the term can refer to either party or both, depending on context....
in ordinary trades of some type. These agreements allow traders
Trader (finance)
A trader is someone in finance who buys and sells financial instruments such as stocks, bonds, commodities and derivatives. A broker who simply fills buy or sell orders is not a trader, as they are merely executing instructions given to them. According to the Wall Street Journal in 2004, a managing...
to make faster trades since time used to settle the receiving agents is conserved. Limiting the trader to an SSI also lowers the likelihood of a fraud
Fraud
In criminal law, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation...
.
Regulation
Financial institutions in most countries operate in a heavily regulated environment as they are critical parts of countries' economies. Regulation structures differ in each country, but typically involve prudential regulation as well as consumer protection and market stability. Some countries have one consolidated agency that regulates all financial institutions while others have separate agencies for different types of institutions such as banks, insurance companies and brokers.Countries that have separate agencies include the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
, where the key governing bodies are the Federal Financial Institutions Examination Council
Federal Financial Institutions Examination Council
The Federal Financial Institutions Examination Council, or FFIEC, is a formal interagency body of the United States government empowered to prescribe uniform principles, standards, and report forms for the federal examination of financial institutions by the Board of Governors of the Federal...
(FFIEC), Office of the Comptroller of the Currency
Office of the Comptroller of the Currency
The Office of the Comptroller of the Currency is a US federal agency established by the National Currency Act of 1863 and serves to charter, regulate, and supervise all national banks and the federal branches and agencies of foreign banks in the United States...
- National Banks, Federal Deposit Insurance Corporation
Federal Deposit Insurance Corporation
The Federal Deposit Insurance Corporation is a United States government corporation created by the Glass–Steagall Act of 1933. It provides deposit insurance, which guarantees the safety of deposits in member banks, currently up to $250,000 per depositor per bank. , the FDIC insures deposits at...
(FDIC) State "non-member" banks, National Credit Union Administration
National Credit Union Administration
The National Credit Union Administration is the United States independent federal agency that supervises and charters federal credit unions...
(NCUA) - Credit Unions, Federal Reserve
Federal Reserve System
The Federal Reserve System is the central banking system of the United States. It was created on December 23, 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907...
(Fed) - "member" Banks, Office of Thrift Supervision
Office of Thrift Supervision
The Office of Thrift Supervision was a United States federal agency under the Department of the Treasury that charters, supervises, and regulates all federally- and state-chartered savings banks and savings and loans associations. It was created in 1989 as a renamed version of another federal agency...
- National Savings & Loan Association, State governments each often regulate and charter financial institutions.
Countries that have one consolidated financial regulator include United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
with the Financial Services Authority
Financial Services Authority
The Financial Services Authority is a quasi-judicial body responsible for the regulation of the financial services industry in the United Kingdom. Its board is appointed by the Treasury and the organisation is structured as a company limited by guarantee and owned by the UK government. Its main...
, Norway with the Financial Supervisory Authority of Norway
Financial Supervisory Authority of Norway
The Financial Supervisory Authority of Norway is a Norwegian government agency responsible for supervision of financial companies within Norway based on law and regulations from Storting, the Norwegian Ministry of Finance and international accounting standards...
, Hong Kong with Hong Kong Monetary Authority
Hong Kong Monetary Authority
The Hong Kong Monetary Authority or HKMA is Hong Kong's central banking institution . It is a government authority founded on 1 April 1993 via the consolidation of "Office of the Exchange Fund" and the "Office of the Commissioner of Banking"...
and Russia with Central Bank of Russia. See also List of financial regulatory authorities by country.
See also
- International financial institutionsInternational financial institutionsInternational financial institutions are financial institutions that have been established by more than one country, and hence are subjects of international law. Their owners or shareholders are generally national governments, although other international institutions and other organisations...
- BankBankA bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
- Credit unionCredit unionA credit union is a cooperative financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift, providing credit at competitive rates, and providing other financial services to its members...
- Financial economicsFinancial economicsFinancial Economics is the branch of economics concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment"....
- Savings and loan associationSavings and loan associationA savings and loan association , also known as a thrift, is a financial institution that specializes in accepting savings deposits and making mortgage and other loans...
- Consumer Credit Act 1974Consumer Credit Act 1974The Consumer Credit Act 1974 is an Act of the Parliament of the United Kingdom that significantly reformed the law relating to consumer credit within the United Kingdom....
(UK law) - Non-bank financial institutionNon-bank financial institutionA non-bank financial institution is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFIs facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market...