Financial institutions are organizations that deals with transaction of financial claims and financial assets. They issue financial claims against themselves for cash and use the proceeds from this issuance to purchase primarily the financial assets of others. Financial institutions primarily collect saving from people, business and government by offering accounts and by issuing securities. The savings are lent to the user of the funds. They also work as the intermediaries between issuer of securities and the investing public. Thus, financial institutions are the specialized firms that facilitate the transfer of funds from savers to borrowers. They offer accounts to the savers and in turn the money deposited are used to buy the financial assets issued by other forms. Similarly, they also issue the financial claims against themselves and the proceeds are used to buy the securities of other firms. Since financial claims simply represent the liability side of balance sheet for an organization, the key distinction between financial institution and other types of organizations involves what is on the assets side of the balance sheet.
For example, a typical commercial bank issues financial claims against itself in the form of debt (for instance, checking and saving accounts) and equity; and so does a typical manufacturing firm. However, structure of assets held by a commercial bank reveals that most of the bank's money is invested in loans to individuals, corporations, and government as well. On the other hand, typical manufacturing firm invest primarily in real assets. Accordingly, banks are classified as financial institutions and manufacturing firms are not. Besides commercial banks, other example of financial institutions are finance companies, insurance companies, credit unions, pension funds, mutual funds savings and loan associations, and so on.
