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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, credit unions, trust companies, and mortgage loan companies);
2. Insurance companies and pension funds; and
3. Brokers, underwriters and investment funds.

Contents 1 Function 2 Corporate valuation 3 Governance 4 See also 5 References 6 External links

[edit] 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.

[edit] 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]

[edit] 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.

[edit] See also

• Bank
• Credit union
• Financial economics
• Savings and loan association
• Consumer Credit Act 1974 (UK law)

[edit] References

[edit] External links

• Council on Foreign Relations, IIGG Interactive Guide to Global Finance