Financial institutions allocate the economy’s money to many different people for many different purposes. This groups includes banks, asset management firms, insurance companies, and more. Their actions provide capital to those who want to use it.
Financial institutions primarily lend money. Banks loan large amounts of money into the economy. Banks, as do other financial institutions, create new money when they originate loans. This is because of fractional reserve banking. This expands the money supply, providing stability and liquidity for the economy.
Money is earned by financial institutions in the form of interest. Interest is that cost of borrowing money. Lenders use interest payments to cover expenses, and are left with a profit. There are also financial institutions that earn money in the form of investment returns. This includes hedge funds, venture capital funds, segments of investment banks, and certain insurance company investments.
Wall Street firms and similar companies are categorized as financial institutions. This group includes Goldman Sachs, Credit Suisse, and many more. Such firms are beneficial to the economy. They provide liquidity to companies looking to borrow money and transfer risk to those willing to take it. There is a wide array of financial instruments that can be used to carry out those functions.
Free enterprise benefits these institutions by allowing them to allocate capital with little restriction. This allows them to find the most profitable opportunities to fund, which expands the economy.
The free enterprise system creates an economic environment for financial institutions to thrive in. As a result, consumers, businesses, and governments all have better access to financing. A proper financial system is important for a growing economy.