https://www.youtube.com/watch?

v=XeZ3IUV6_Hk

Two of the largest types of financial institutions are neither banks nor direct
depository institutions. Many times, neither of these will immediately come to
mind if the layman is asked to name a large sophisticated financial
intermediary. The reason for this lapse is that both institutions devote
themselves to a different type of savings and investment function than do banks
or building associations. Life insurance companies and pension funds cater to
another sort of financial need than do banks that serve as depositories for
current needs. Both invest for the individual on a future basis; seeking to
protect his future needs for wealth and protection rather than serve more
immediate concerns covered by depository institutions.

A pension fund, also known as a superannuation fund in some countries, is

any plan, fund, or scheme that provides retirement income. Pension funds are
pooled monetary contributions from pension plans set up by employers,
unions, or other organizations to provide for their employees' or members'
retirement benefits. Pension funds are the largest investment blocks in most
countries and dominate the stock markets where they invest. When managed
by professional fund managers, they constitute the institutional investor sector
along with insurance companies and investment trusts. Typically, pension
funds are exempt from capital gains tax and the earnings on their investment
portfolios are either tax-deferred or tax exempt.
Pension funds provide retirement income through annuities to employees covered by a pension plan.
Funds are obtained through contributions from employees or employers. Pension funds differ in method
of payment although the purpose remains the same. The first method of payment— known as defined
benefit plan— guarantees payments of benefits that are not tied to contributions but based on a
prescribed formula. Under this type of plan, the sponsor shoulders risk of shortfall in investment
returns. The other type of plan—defined contribution plan—both the employee and the employer
contribute specific amounts to the plan periodically. Under the defined contribution plan, the employee
bears the risk of accumulated funds not meeting replacement income goal. The Government Service
Insurance System (GSIS) and the Social Security System serve as the largest pension funds in the
Philippines. These two government administered funds invest in government securities, the stock
market, commercial paper, and property development. Their income usually comes from salary and
housing loans, interest income in investments, dividends, and foreign exchange gains. Apart from GSIS
and SSS, there is another smaller government administered fund: the Armed Forces of the Philippines
Retirement Separation and Benefits System (AFP-RSBS). These three public pension funds all fall under,
mandatory defined benefit plan. At present, GSIS and SSS experience difficulty in meeting their
redistribution goal. Specifically, benefits paid to member have outpaced the amount of contributions of
members. Meager returns on investments, poor compliance and enforcement in payment of premiums,
low collection rate on loans, huge losses from housing programs, and the lack of regulatory institution
threaten the viability of the two government administered pension funds. Nonetheless, there have been
initiatives to reform the country’s pension system and enhance its role in capital market development.

Roles as financial intermediaries:

http://citeseerx.ist.psu.edu/viewdoc/download;jsessionid=A6C30651BE0DFA2
CF27C829B795FE2D4?doi=10.1.1.460.9298&rep=rep1&type=pdf

http://article.sapub.org/10.5923.j.ijfa.20130207.04.html

Regulatory aspects:
The old age system of protection in the Philippines is now evolving into a four-tiered system of
protection. The first tier is more of a social assistance scheme wherein different departments of
government, notably the Department of Social Welfare and Development (DSWD), Department of
Health (DOH) and Department of Labor and Employment (DOLE), implement various social assistance
programs for the benefit of the very poor in our society. The second tier is a mandatory defined benefit
scheme which is provided for by the Social Security System (SSS) for the private sector workers and the
Government Service and Insurance System (GSIS) for the public sector employees. The third tier includes
the mandatory deposits maintained at the PAG-IBIG Fund which become available at retirement and, for
workers in the private sector, the mandatory retirement pay provided for under Republic Act 7641.
Public sector workers receive from GSIS a benefit that is more generous than the benefit paid under SSS
in part because it is a combination of both the second layer and the third layer. The fourth tier is a
voluntary tier, and this is where individuals, on their own, buy pension plans and other pre-need
products to provide for the many contingencies in life.

The second tier is a mandatory defined benefit scheme which is provided for by the Social Security
System (SSS) for the private sector workers and the Government Service and Insurance System (GSIS) for
the public sector employees. The third tier includes the mandatory deposits maintained at the PAG-IBIG
Fund which become available at retirement and, for workers in the private sector, the mandatory
retirement pay provided for under Republic Act 7641. Public sector workers receive from GSIS a benefit
that is more generous than the benefit paid under SSS in part because it is a combination of both the
second layer and the third layer.

The fourth tier is a voluntary tier, and this is where individuals, on their own, buy pension plans and
other pre-need products to provide for the many contingencies in life.

http://www.actuary.org.ph/wp-content/uploads/2013/10/Private-Retirement-Plans-in-the-
Philippines.pdf

http://www.nomurafoundation.or.jp/en/wordpress/wp-content/uploads/2019/03/NJACM3-2SP19-
05.pdf
https://silo.tips/download/session-5-the-role-of-regulators

RISKS

Investment or market risk: risk of losses due to adverse movements in interest rates and other market
prices - leading to underfunding in DB plans and low balances in DC accounts. The problem may
materialise due to ‘concentration risk’ (i.e. the risk that the investment portfolio is not sufficiently
diversified and is too concentrated on one asset or issuer). The risk may also arise due to investment in
unregulated/ unlisted products. In developing economies the range of investments available to pension
funds may be highly limited (due to under-developed capital markets and / or restrictions on overseas
investments). In such cases the investment portfolio as a whole would be far from ideal and the
supervisory authority should consider investment risk for all supervised entities within the high risk
category. Investment risk can also be systemic in nature when all pension plans are affected by financial
meltdowns or other economic catastrophes (as was the case in 2008/9).¹ ‘Concentration’ risk is also
possible – i.e. risk that the pension fund’s portfolio is not adequately diversified and too exposed to one
asset or issuer.

Counterparty default risk / credit risk: risk of loss from the failures of a counterparty to meet its
obligations (this might arise if derivative instruments are being used for “liability driven investment”).
Credit risk arises from an obligor’s failure to meet the terms of any contract with the institution or
otherwise fail to perform as agreed, including the possibility of restrictions on or impediments to the
transfer of payments from abroad.

Funding and solvency risk: the risk that a pension fund does not have sufficient assets to meet its
liabilities.

Liquidity Risk: the risk that an institution will not be able to meet its payment obligations as they fall
due without excessive cost or the total inability to recover funds or only with significant delay.

Mismatch risks: risk arising from volatility in investment returns in relation to those necessary to meet
liabilities, for example, adverse movements in interest rates, bond prices, stock and commodity prices,
or exchange rates having a differential effect on assets and liabilities (for example a drop in interest
rates which increases the value of liabilities by more than the increase in the value of assets – naively, an
increase in asset value would otherwise be considered a positive development, but not if liabilities
increase even more).

Actuarial risk: including inappropriate actuarial valuation methods and assumptions (e.g. mortality,
longevity, disability, inflation, liquidity) as well as insurance type risks within the pension plan. This can
have a considerable impact on actuarial liabilities. If not assessed accurately there is a danger of
overestimating, or more problematically, underestimating the value of the liabilities. Likewise
inappropriate methods (departing from market value) that consistently over-estimate the values
ascribed to assets could lead to actuarial risk. Again inconsistent or inaccurate assumptions may be a
systemic problem within developing economies and this risk may need to be placed in the highest
category for all entities which pension supervisory authorities in such jurisdictions oversee. Insurance
underwriting risk is the risk that insurance cover will not be available as expected when needed (which
might occur if there are significant life insurance or disability benefits in the pension plan that should be
reinsured, but for which no market might exist in the country). Also under this heading would be various
guarantees, such as relative or absolute rates of return for defined contribution plans

Agency risks: these could otherwise be described as ‘competition risk’ or ‘competition failure’. Issue
include excessive fees, conflicts of interest, fraud misappropriation and misallocation. Agency risk can
arise from simple ignorance of law and best practices, unwillingness to adopt best practices, or through
wilful negligence and corrupt practices. One significant risk in both defined benefit and defined
contribution plans is that of non-payment of contributions.

Operational Risk: the risk of losses resulting from inadequate internal processes, people and systems –
whether these are internal to the regulated entity or in a service provider. Operational risk arises from
failures in transactions with counterparties, ineffective decision making, and inadequate or insufficient
human and technical resources. Examples include transaction processing (correct, complete and in
time), outsourcing and cooperation (assessment of mandates), expenses (levy in premium), staff (quality
and quantity) information management, product development (innovation) material: (pre-) acceptance
(transfer of pension rights), payment & settlement. More serious risks may also be involved, such as the
risk of fraud and general natural disaster risks (e.g. damage to buildings due to fire or natural disasters,
burglary or theft of fund property). Causes include internal fraud, external fraud, employment practices,
clients, products and business practices, damage to physical assets, business disruption and system
failure or process management.

IT Risk: IT risk is the risk arising from inadequate information technology and processing in terms of
manageability, exclusivity, integrity, infrastructure, controllability and continuity IT risk also arises from
an inadequate IT strategy and policy and from inadequate use of the information technology.

External and strategic risk: these are the inherent risks with regard to the sensitivity of the fund to
external factors. These risks arise from adverse strategic decisions, improper implementation of
decisions or lack of responsiveness to changes in surrounding environment. These include risks related
to demographics, competition, technology, reinsurance, conjuncture, interested parties, infection, and
political stability. Strategic risks include the continued viability of an entity as a result of change in the
operating environment, including internally driven change such as merger, or the coverage of a new
group of participants in the pension plan (such as part-time employees – who might have significantly
different characteristics and challenges from existing members). Some of these risks would not be
applicable to the pension fund itself, but might be applicable to the plan sponsor and its ability to
provide capital support (pension accumulation funds are more similar to commercial enterprises, so
might be subject to these kinds of risk directly).

Legal and Regulatory Risk: the likelihood of adverse consequences arising from the failure to comply
with all relevant laws and regulations. Risks concerning changes in legislation in future may also be
considered. Risks of complying with inappropriate or unclear regulation should also be put in this
category.

Contagion and related party/ integrity risk: risks to an entity’s business as a result of close association
with another entity – the risks may be direct through financial exposure or indirect through reputation
damage. Integrity risk is the risk arising from ethical standards. For example injury of third parties
liability, an ambiguous relationship of the fund with other financial institutions in the same group;
insider trading, tax evasion, money laundering, fraud.

http://www.iopsweb.org/rbstoolkit/Module3identifyingrisks.pdf

https://enrsp.org/papersannualmeetings/documentsannualmeetings/samborski2014

MARKET TRANSACTIONS WITHOUT FINANCIAL INSTITUTIONS

A financial institution is a delegate among purchasers and the capital or the obligation markets giving
banking and venture administrations.

They encourage individuals by keeping their cash protected and secure, so individuals can utilize
this cash in any crisis time. On the off chance that somebody needs cash this money related
foundation use to give different sorts of Loan administrations for them.

They likewise use to keep individuals' cash and furthermore give them premium or additional cash
which is relied upon the sum and the premium rate.

Individuals use to get different administrations from this budgetary organization like business
advances, sparing records, money credits, shared subsidizes life coverage, fixed stores, ventures
and so on.

Clearly, if there would be direct transfer of funds between it would be next to difficult to manage all
the cash deposit, there would always be a fear of losing it all, no money can be invested in share
market, economy can’t grow and world would return back to medieval times when barter system was
the only mode of transaction.

https://www2.lawrence.edu/fast/finklerm/mishkin_ch02.pdf ---- OPEN

WHY WOULD DIRECT TRANSFER RESULT IN QUITE LOW LEVELS OF FUND FLOWS
Why do Businesses Choose Indirect
Financing?
As the financial intermediaries take on the responsibility of approaching investors and performing the
due-diligence process, indirect financing is often the quicker way for businesses to raise money. In
many countries, indirect financing takes a front seat, as compared to direct financing methods, since
financial intermediaries are very efficient in reducing the information costs associated with lending.
This is done through economies of scale and expertise. They can quickly curb the problems
associated with asymmetric information; that too at a lower cost.

They also provide critical financial services, such as:

·         Denomination and Maturity Transformation

Suppose a company wants to raise $500 million, which is not possible from retail investors. A bank,
on the other hand, will raise this amount by accumulating savings of thousands of depositors and will
issue a loan to the company. In this way, banks help in denomination transformation. That is, they
take the help of small and medium-sized deposits to raise large sums of money for companies.

Next, a bank can confidently issue long-term loans. On reaching their maturity date, deposits will
either get renewed or be replaced by a different deposit scheme. They offer maturity transformation.
By providing both these benefits, they offer a company sustainable liquidity.

Risk Diversification
Financial intermediaries have greater expertise and invest in multiple loans. Whatever money we put
into the banks, they deploy across a huge section of borrowers. Pooled funds are diversified into
many different instruments. This diversifies the associated risk. Intermediaries like mutual funds and
commercial banks have the resources to employ risk management experts who look into the risk and
return ratio of alternative investments and take appropriate action. Banks take losses from defaulted
loans and still guarantee deposits back.

These factors are both pros and cons of indirect financing. The magnitude of transaction costs, such
as brokerage commissions, are reduced on a per unit scale, but obviously this will happen till a
certain point only, after which fixed costs will be incurred again. The single most prominent
disadvantage is that financial intermediaries offer a spread, which is usually avoided in direct
financing.

Benefits of Financial Intermediaries

1. Lower search costs. You don’t have to find the right lenders, you leave
that to a specialist.
2. Spreading risk. Rather than lending to just one individual, you can deposit
money with a financial intermediary who lends to a variety of borrowers – if
one fails, you won’t lose all your funds.
3. Economies of scale. A bank can become efficient in collecting deposits,
and lending. This enables economies of scale – lower average costs. If
you had to sought out your own saving, you might have to spend a lot of
time and effort to investigate best ways to save and borrow.
4. The convenience of Amounts. If you want to borrow £10,000 – it would
be difficult to find someone who wanted to lend exactly £10,000. But, a
bank may have 1,000 people depositing £10 each. Therefore, the bank
can lend you the aggregate deposits from the bank and save you finding
someone with the exact right sum.