Introduction to Finance

Financial intermediation
is the 
process by which individual savings are accumulated in depository institutions and, in 
turn, lent or invested.
Figure 3.1
shows the major types of fi nancial intermediaries grouped into four categories—
depository institutions, contractual savings organizations, securities fi rms, and fi nance 
companies. 
Depository institutions
accept deposits or savings from individuals and then 
lend these pooled savings to businesses, governments, and individuals. Depository institu-
tions include commercial banks, savings and loan associations (S&Ls), savings banks, and 
credit unions. 
Contractual savings organizations
collect premiums on insurance policies 
and employee/employer contributions from pension fund participants and provide retirement 
fi nancial intermediation 
process 
by which savings are accumulated 
in fi nancial institutions and then 
lent or invested
depository institutions 
accept 
deposits from individuals and then 
lend pooled deposits to businesses, 
governments, and individuals
contractual savings organizations 
collect premiums and contributions 
from participants and provide 
retirement benefi ts and insurance 
against major fi nancial losses

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C H A PT E R 3 Banks and Other Financial Institutions
benefi ts and insurance against major fi nancial losses. Insurance companies and pension funds 
are the two important forms of contractual savings organizations.
Securities fi rms
accept and invest individual savings and also facilitate the sale and trans-
fer of securities between investors. In addition to pooling individual savings and investments, 
securities fi rms receive funds from other fi nancial intermediaries. Investment companies (mutual 
funds), investment banking fi rms, and brokerage fi rms are the primary types of securities 
fi rms that we will cover. 
Finance fi rms 
provide loans directly to consumers and businesses, 
as well as help borrowers obtain mortgage loans on real property. Our emphasis will be on 
fi nance companies and mortgage banking fi rms when discussing fi nance fi rms. 
Few of today’s fi nancial intermediaries existed during the American colonial period. Only 
commercial banks and insurance companies (life and property) can be traced back prior to 1800. 
Savings banks and S&Ls began developing during the early 1800s. Investment banking fi rms 
(and organized securities exchanges) also can be traced back to the fi rst half of the 1800s. No 
new major fi nancial intermediaries evolved during the last half of the nineteenth century. Credit 
unions, pension funds, mutual funds, and fi nance companies began during the early part of the 
1900s. Thus, throughout much of the 1900s and into the twenty-fi rst century, emphasis has been 
on redefi ning and restructuring existing fi nancial intermediaries rather than introducing new ones.
Depository Institutions
When we refer to banks and the banking system in the United States, we primarily think in terms 
of commercial banking.