The Role of Depository Financial Institutions

Depository financial institutions, also known as deposit-taking financial organizations, specialize in depository lending.The financial services that these institutions offer are different from other institutions with the financial service functions. The depository financial institutions accept deposits from the surplus units and provide credit to other units with deficits. This is facilitated through loans and purchases of securities. Depository financial institutions are made up of commercial banks, savings and loan associations, credit loans and mutual saving banks. Although they have particular roles in the money markets, their roles are broadly interrelated.

Role of Depository Financial Institutions

As the name suggests, depository financial institutions are often very open to financial deposits from other units and financial institutions operating at a surplus levels.This enhances regulation of monetary circulation in the economy especially from the non-deposit financial institutions. This implies that the financial institutions and units that have monetary base beyond their normal operational limits can deposit the extra moneys and currencies to the depository financial institutions .

The depository financial institutions serve as providers of financial credit to deficit units. Madura  cited that these units are able to access the credits through loans and securities that they purchase from the depository financial institutions. The purchase of these securities thus enables the units under financial deposits to access more loans from other lending institutions. Commercial banks, savings and loan associations thus support businesses and individuals by issuing credits and loans. Besides, the provision of credit services enables these units to maintain financial stability even during economic depression. 

The depository financial institutions function to offer deposit accounts that can accommodate the amount and the liquidity characteristics that the surplus units actually need.  Without these depository financial institutions, each surplus unit would have the challenge of identifying a deficit unit that is in need of borrowing the exact amount of money that is available within the particular period in which the funds are available. This implies that such surplus units would have to also perform credit evaluation and be ready to incur the risk of default. The depository institutions therefore bridge this gap by acting as a link of transactions between the surplus and the deficit units.

As a result of the credit risks and risks of default that are associated with transactions between surplus and deficit units, many surplus units would most often hold their funds instead of channeling them to the deficit financial units. This has significant implications. First, the flow of funds from the surplus to the deficit units would be greatly disrupted. Secondly, the disruption of the normal flow of funds between these two units would greatly affects the lending and borrowing activities in the financial services industry of any economy. Therefore, the depository financial institutions function to enhance effective and undisrupted flow of funds from the surplus to the deficit units.

Repackaging of funds is another significant role of the depository institutions. They repackage the proceeds that have been received from individuals so as to facilitate a variety of investment initiatives. All the funds that are received from deposits are used by the depository financial institutions to provide loan facilities according to the size and maturity schedules as desired by the deficit monetary units.

Depository financial institutions accept all the risks that are associated with the loans that are provided to the deficit units. These risks cannot be admissible by other financial institutions including the non-depository institutions. However, the depository financial institutions are able to undertake credit evaluations and risk assessment to precisely determine the risks that is associated with the loans issued to the deficit units. The readiness of the depository institutions to incur the risk thus helps the deficit units to benefit from fund deposits from the surplus units that would have otherwise been inaccessible.

Determination of credit worthiness of the deficit units is a financial strategic initiative that requires high level of expertise. Many financial institutions thus are limited when it comes to the accurate and strategic evaluations and assessment of the credit worthiness of the deficit units. Madura cited that the depository financial institutions are capable of executing this mandate effectively. This is because the depository financial institutions have more expertise than the individual surplus units to evaluate the credit worthiness of the deficit units.

Depository financial institutions especially the commercial banks facilitate transfer of deposited funds to deficit units through provision of direct loans. They also achieve this by purchasing of the debt securities. In this way, the commercial banks serve both the public and the private sectors. This is because their deposits and lending services are commonly utilized by households, businesses and government agencies.

Credit unions such as the Navy Credit Union, State Employees Credit Union of North Carolina are examples of depository institutions that help their members to access loans. Much of the revolving funds at these depository institutions are utilized by the unions to provide loans to their members. This therefore makes it easier and convenient for the members of such depository institutions to access loans at rates that are relatively lower than the commercial rates existing in other financial institutions at any given time.

The depository financial institutions, especially the commercial banks, hold most of the reserve balances at the Federal Reserve Banks and further plays a significant role in intermediation. Besides, these institutions facilitate payments of large dollars over the electronic transfer network for the Federal Reserve. Therefore whereas the Federal Reserve exists to fashion and implement financial policies, it greatly depends on the behavior of the depository institutions especially the commercial banks to effectively execute its strategic functions.

The technical bench that is involved in the development and formulation of the monetary policy in any given economy greatly relies on the operations of the depository institutions especially the commercial banks in order to realize a strategic financial system in the economy. Commercial banks play a significant role in providing backup credit lines to commercial paper issuers in the financial market. They then place the paper as an agent for the issuer. Through this, the depository institutions have progressively developed to become key players in the regulation of the financial services industry throughout the global economy.

Depository institutions promote economic growth by making capital available for various productive activities within an economy (Ryan 21). However, this role heavily depends on the willingness of the lenders to hold deposits at any given time. For example, in times of economic uncertainty, most lenders often withdraw their deposits. This may force the depository institutions to reduce their lending so as to remain liquid. This regulatory role of the depository institutions is known as disintermediation. For example, during the Great Depression, disintermediation resulted from economic uncertainty. This uncertainty was quickly responded to by depository institutions through restricted lending.

From the borrowers’ perspective, the depository institutions provide an alternative to the issuance of securities in the public. In this manner, they cushion the borrowers from costly or sometimes difficult conditions of securing loans. Ryan asserts that the securities are considered convenient especially when the borrowing entities are well known and the borrowing involves large amounts for a long period of time. The depository institutions utilize such borrowing to justify the cost of such issuance.

The depository financial institutions in the US played critical role in commercial banking. All the funds that the institutions collect are in turn utilized to meet the demands of other organizations. They thus help other businesses, individuals and organizations to meet their credit requirements conveniently and constantly. Depository institutions also prevent development of monopolies in the financial markets (Cohen and Mazzeo 63). This is affected through the use of unit banking system. Therefore, the depository institutions, especially the commercial banks, regulate monopolistic operations in the financial services sector in the United States.

The role of depository institutions in providing ownership for financial claims can never be ignored. Besides, these institutions are responsible for maintaining liquidity in the market and in the management of risks associated with price changes in the financial market. In this regard, the depository financial institutions help in the provision of opportunities for investment and help many businesses in an economy to generate funds that they need for various business strategic purpos.

Convenient payment system is very critical to the realization of successful business operations. Depository institutions offer convenient payment system for operators in the financial/monetary markets.  These institutions facilitate monetary transfer through checks, electronic transfer of funds, or by use of credit and debit cards. This helps in eliminating the risks associated with carrying large amounts of cash at hand. Such payment systems also serve as proof that a transaction actually took place.


Depository financial institutions play a very significant role in the monetary and financial service sector of every economy. Generally the active role of these institutions is in facilitating transactions involving deposits from the surplus to the deficit units. They also play a critical role in the provision of loans and purchase of securities in the financial and monetary market. 

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