The Financial Institutions Group (FIG) is a group of professionals that provide advisory services to financial institution clients. Some of the services that the FIG offers include mergers and acquisitions, recapitalization, capital raising, financial restructuring, corporate valuations, expert financial opinions, and other advisory services.
Companies that may represent prospective FIG clients include investment banks and companies that provide financial services to businesses, banks, asset management companies, brokerages, and insurance companies. Investment banks sometimes categorize their areas of expertise under the FIG into a financial services group and an insurance group, with the aim of providing tailored services to their clients.
Unlike other companies that profit from selling physical products, FIG companies make money by borrowing money cheaply and lending it expensively. Companies in the Financial Institutions Group are in the business of moving money around in the form of deposits, loans, and money markets; hence, a significant proportion of their revenues and expenses are in the form of interest income and interest expense, respectively.
For example, the profit and loss account for a deposit bank comprises large values of interest expense and interest income, and little or no entries for the cost of goods sold or depreciation. Since Financial Institutions Group capital mainly comes from individual clients, there are restrictions on the type of assets and their quantities that can be held.
Types of FIG clients
Depending on the exact nature of its business, the Financial Institutions Group (FIG) works with the following types of companies:
Banks are institutions that accept cash deposits from the public through saving accounts, current accounts, money market accounts, certificates of deposit, and call deposit accounts. Banks hold the deposits and pay a little interest. They then use the deposits to lend out loans to borrowers at a significantly higher interest rate than the rate offered to depositors.
For example, a bank might offer depositors an average interest rate of 2%, while charging borrowers an average rate of 7%. On average then, the bank would make a 5% profit (7-2=5). This is, of course, a very simplified example, not taking into account the costs of doing business, the exact difference between the total amount of money the bank loans out and the total of deposit accounts, and varying interest rates paid out or earned on different types of loans and accounts.
Apart from customer deposits, banks may also fund their lending activities using wholesale funding from the government, capital markets, and other financial institutions. The government lends to banks through central banks, while large institutional customers – such as endowment funds and pension funds – may provide long-term funding in return for higher annual interest earned.
Most banks shy away from wholesale funding because it is a sign that the bank is not as competitive as other banks and may be going through financial distress. Also, wholesale funding is more expensive than other sources of revenue, and the bank will need to settle for a reduced interest spread.
Another source of revenue for banks is share equity. Banks raise equity capital by selling shares to outside investors and paying a dividend in return. Since equity capital is expensive, it is typically only issued when the bank is in financial trouble or needs funds for an expansion or acquisition. Banks may make the shares callable so they can repurchase them at some point in the future when their capital position has strengthened or improved.
Interest income from loans makes up 50% to 70% of the total revenues earned by banks. Other interest-earning assets that banks invest in may include mortgages, stocks and bonds, commercial financings, and proprietary trading.
Non-interest income makes up 25%-50% of total revenues and is mostly comprised of fees charged for services. For example, some banks charge lending and deposit fees, ATM use fees, and ledger fees. Banks often generate considerable revenues from interest and fees charged on credit cards it issues.
Insurance companies make money in two primary ways – earning premiums from selling various types of policies to individuals and businesses and investing the premiums they receive in interest-generating assets. The difference between the amount of money collected when selling policies and the amount paid out as insurance claims is the underwriting income.
For example, if an insurance company collects $1 million in premiums and pays out $600,000 in insurance claims, it makes a profit of $400,000. However, if the claims amount to $1.2 million, the company will have incurred a loss of $200,000. In normal circumstances, insurance companies collect huge sums of money annually, and they may not have to pay claims on those policies for years.
Insurance companies also earn investment income by investing the money they get from selling insurance products before paying for claims. They use the revenue they receive to invest in bonds or equities so they can make a profit before having to pay for claims.
Sometimes, insurance companies can charge their products competitively so they can receive more premiums than their competitors and then invest those funds in the stock market. The proceeds from invested funds allow insurers to continue insurance operations even when underwriting losses may occasionally exceed the premiums collected.
The most common financial instruments that insurance companies invest in include Treasury bills, high-grade corporate bonds, and interest-generating cash equivalents.
3. Asset Management
Asset management companies earn income by investing money for individuals and institutional investors such as pension funds and university endowment funds, in return for a fee. They allow investors to have more diversified investment options than they would if they made the investments themselves. By pooling assets, investors can avoid minimum capital requirements that are placed for individual investors, and invest in large sets of investments with a smaller amount of capital.
Asset managers charge two types of fees – management fees and performance fees. The management fees are paid as a percentage of the total assets under management, irrespective of the performance of their investments. Performance fees are calculated as a percentage of the returns earned by the asset manager beyond a specifically predetermined benchmark.
For example, assume that ABC manages assets worth $10 million and charges a management fee of 2%. ABC will earn $200,000 from this. If the value of assets under management (AUM) rises to $12 million as a result of ABC’s investments, then ABC will additionally receive a performance fee of $40,000 (performance fees are typically 20% of profits). In total, ABC will earn $240,000 from the client.
Asset managers review the AUM figure to quickly determine whether or not the assets are growing or shrinking. Whether the AUM is growing or shrinking is determined by the investment gains/losses, organic flow, and acquired flows. Organic flow is the value of assets taken out of the asset manager’s control by the client, while acquired flows represent the assets added or acquired from other asset managers.
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