Discuss the role of depository & non depository institutions for contributing in growth of financial
institution
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Answer:
Depository institutions (aka banks), which includes commercial banks, savings and loans, and credit unions, receive money from depositors to lend out to borrowers. Nondepository institutions, such as finance companies, rely on other sources of funding, such as the commercial paper market. Because depository institutions receive funds from the public for safekeeping and are major sources of credit and the main providers of a payment system, these institutions are more heavily regulated than nondepository institutions.
Depository institutions provide 4 important services to the economy:
they provide safekeeping services and liquidity;
they provide a payment system consisting of checks and electronic funds transfers;
they pool the money of many savers and lend it out to people and businesses; and
they invest in securities.
The 1st 3 services are so important in any economy that when banks fail, the economy suffers. The Great Recession of2008 and 2009 underscored the primary importance of banks and why governments all over the world propped up their banks with trillions of dollars. A bank receives money from the deposits of its customers and from the fees that it charges for its services, and from borrowing either from other banks or by selling securities in the financial markets. It uses the money to make loans and to buy securities. A bank profits from the interest rate spread of what it earns on its assets and what it pays in liabilities, and from banking fees. Most of the assets of banks can be grouped into 4 categories:
cash,
securities,
loans,
other assets, which includes real property, such as equipment, buildings, land, and repossessed collateral from borrowers who have defaulted.
Most of a bank's assets are in the form of loans with a large portion in securities, since these are the main sources of income for a bank.
Cash is obviously an asset to a bank, but it's an expensive asset in terms of opportunity cost because it earns no interest — therefore, banks try to minimize the amount of cash that they hold. They have to keep some cash to conduct business which includes being able to meet withdrawal requests and to meet reserve requirements that are set by the Federal Reserve to help prevent insolvency.
Before there were ATM machines or the Federal Reserve, banks kept almost all their cash in their vaults, and, for this reason, it is called vault cash. Nowadays, vault cash also includes cash kept at the bank's account at the Federal Reserve and in the bank's ATM machines. Cash kept in vaults and ATM machines allows banks to give customers cash in the form of coin and currency. Cash kept in its account at the Federal Reserve is used to clear and settle checks and electronic funds transfers. Required reserves is the amount of cash that must be held by law and includes vault cash and cash held in the bank's account at the Federal Reserve and is equal to a percentage of a bank's liabilities.
Banks also hold securities to earn additional returns. While banks in other countries can own stocks, banks in the United States are restricted to bonds, most of which are Treasuries or municipal bonds, although they also held a good portion in mortgage-backed securities which contributed to the 2008 - 2009 Great Recession. Banks could also own corporate bonds, but since corporate bonds increase their reserve requirements just as loans, banks would earn more money lending to corporations rather than buying their bonds. Because government bonds can be quickly sold in the secondary financial markets to raise cash, securities are also called secondary reserves.
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