Functions of Financial Institutions

Financial Institutions play a significant role in the economy of every country. Their primary role is to act as intermediaries between those who have surplus and those who have shortage of money, they between savings and investments; those who want to save and those who want to borrow; lenders and borrowers; consumers and borrowers. Those who need money for consumption will need to borrow money from those who want to invest their idle money. However, it is very difficult for those who have surplus to know or trust those who genuinely need money. Financial institutions come in to link the two parties to ensure constant supply of money. The major functions of financial institutions include:

  • Regulating money supply: Financial institutions help in regulating money supply and ensure stability in the economy. For example, the Central Bank of Kenya uses monetary policy to regulate the amount of money in circulation and control inflation.
  • Providing banking services: Another function of financial institutions such as commercial banks is to provide banking services such as taking deposits and providing loans.
  • Providing insurance services: financial institutions also provide insurance to cover for losses of life and property. They manage and minimize risks through insurance and risk management. This function of financial institutions benefits both households and companies by protecting them against uncertainties.
  • Capital formation: Financial institutions also play the role of capital formation by facilitating the trade in shares and bonds in the capital market. For example, the Nairobi Stock Exchange helps companies to access equity capital by engaging in the trade of shares in the primary and secondary market.
  • Investment advice: financial institutions also provide financial consultancy and advisory services. For instance, stock brokers provide advice to investors regarding their shares. Investment banks play the role of advising companies on various investment options.
  • Brokerage services: providing access to investment options in the market is also the role of financial brokerage firms. Some investment options include stock bonds, hedge funds, mutual funds, and private equity investments.
  • Pension fund services: Financial institutions also have several investment plans or portfolios that can help individuals to develop pension funds for their retirement. Individuals contribute to an investment pool held by financial institutions such as banks and they can be able to get lump sum or monthly income after retirement.
  • Financing SMEs: Financial institutions such as SACCOs and microfinance institutions facilitate the financing of small and medium sized businesses. They provide loans or credit for businesses to fund their investments and operations.
  • Agent for economic growth: All the above functions of financial institutions contribute to economic growth. Financial institutions act as agents of economic growth by facilitating economic transactions, investments, financial management, and risk management. Examples of financial institutions that provide pension funds are: Zimele Asset Management Company, Absa Asset Management Ltd, Old Mutual Investment Group, CIC Asset Management Ltd, etc.

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