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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 bodies. Broadly speaking, there are three major types of financial institution[1]:

  1. Deposit-taking institutions that accept and manage deposits and make loans (this category includes banks, building Societies, credit unions, trust companies, and mortgage loan companies);
  2. Insurance companies and pension funds; and
  3. Brokers, underwriters and investment funds.

Contents

Function

Financial institutions provide service as intermediaries of the capital and debt markets. They are responsible for transferring funds from investors to companies, in need of those funds. The presence of financial institutions facilitate the flow of money through the economy. To do so, savings are pooled to mitigate the risk brought to provide funds for loans. Such is the primary means for depository institutions to develop revenue. Should the yield curve become inverse, firms in this arena will offer additional fee-generating services including securities underwriting, and prime brokerage.

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 (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.[1]

Governance

Governance is a critical issue for financial institutions as they operate in a substantially regulated environment. Some of the key governing bodies are: In the United States: FFIEC, Comptroller of the Currency- National Banks, FDIC-State "non-member" banks, 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. In Norway, Financial Supervisory Authority of Norway. In Hong Kong, Hong Kong Monetary Authority. In Russia, Central Bank of Russia.

See also

== * Bank

==

References

  1. ^ Siklos, Pierre (2001). Money, Banking, and Financial Institutions: Canada in the Global Environment. Toronto: McGraw-Hill Ryerson. p. 40. ISBN 0-07-087158-2. 

External links

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In financial economics, a financial institution 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:[1]

  1. Deposit-taking institutions that accept and manage deposits and make loans, including banks, building societies, credit unions, trust companies, and mortgage loan companies
  2. Insurance companies and pension funds; and
  3. Brokers, underwriters and investment funds.

Contents

Function

Financial institutions provide service as intermediaries of the capital and debt 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 are pooled to mitigate the risk brought to provide funds for loans. Such is the primary means for depository institutions to develop revenue. Should the yield curve become inverse, firms in this arena will offer additional fee-generating services including securities underwriting, and prime brokerage.

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 (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.[1]

Standard settlement instructions

Standard Settlement Instructions (SSIs) are the agreements between two financial institutions which fix the receiving agents of each counterparty 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.

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 other have separate agencies for different types of institutions such as banks, insurance companies and brokers.

Countries that have separate agencies include the United States, where the key governing bodies are the Federal Financial Institutions Examination Council (FDIC), 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.

See also

References

  1. ^ Siklos, Pierre (2001). Money, Banking, and Financial Institutions: Canada in the Global Environment. Toronto: McGraw-Hill Ryerson. p. 40. ISBN 0-07-087158-2. 

External links


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