Department of Accounting Education

Mabini Street, Tagum City

Dav ao del Norte
Telefax: (084) 655-9591, Local 116

Big Picture A
Week 1–3: Unit Learning Outcomes (ULO): At the end of the unit, you are expected to:

a. Discuss the importance of an efficient financial system.

b. Differentiate the types of financial markets.

Big Picture in Focus: ULOa. Discuss the importance of an efficient financial

system.

M etalanguage
For you to demonstrate ULOa, you will need operational understanding of the terms
enumerated below.
1. Financial System. This refers to a network that facilitates a more efficient transfer of
funds between savers and borrowers.

2. Financial Markets. This refers to the system that allows buy and sell of financial
instruments by the market participants

3. Financial Institutions / Financial Intermediaries. This refers to the banks or non-bank

institutions that act as mediators to facilitate financial transactions.

4. Financial Regulators. This refers to the government agencies that supervises the
financial activities and ensures to maintain safety and protection of the investing public.

5. Asymmetric Information. This refers to information that market participants may have
about their opportunities or activities that they do not disclose and can take advantage of
it.

6. Direct Transfer. This refers to the condition wherein a corporation sells its stock or debt
directly to investors without going through a financial institution.

7. Indirect Transfer. This refers to the transfer of funds between suppliers and users of
funds through a financial institution.

8. Price Risk. This refers to the risk that an asset’s sale price will be lower than its purchase
price.

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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

Essential Knowledge
To perform the aforesaid big picture (unit learning outcomes) for the first 3 weeks of the course,
you need to fully understand the following essential knowledge lay down in the succeeding
pages. Please note that you are not limited to exclusively refer to these resources. Thus, you
are expected to utilize other books, research articles and other resources that are available in
the university’s library e.g. ebrary, search.proquest.com etc., and even online tutorial websites.
1. Financial System. In finance, the term financial system is used to describe a system that
allows money to flow between savers and borrowers. It plays the key role in the economy as
this system provides channels to transfer funds from individual and groups who have saved
money to individuals and group who want to borrow money in a safe and efficient manner.
2. Functions of Financial System. The functions of financial system include the following:
 Works as an effective channel for optimum allocation of financial resources in an
economy.
 Helps in establishing a link between the savers and the investors.
 Allows ‘asset-liability transformation’. Banks create claims (liabilities) against themselves
when they accept deposits from customers but also create assets when they provide
loans to clients.
 Facilitate transfers of economic resources (i.e., funds) from one party to another.
 Ensures the efficient functioning of the payment mechanism in an economy.
 Helps in risk transformation by diversification, as in case of mutual funds.
 Enhances liquidity of financial claims.
 Helps price discovery of financial assets resulting from the interaction of buyers and
sellers. For example, the prices of securities are determined by demand and supply
forces in the capital market.
 Helps reducing the cost of transactions.

3. Services Provided by the Financial System.

3.1 Risk Sharing: Financial system provides risk sharing by allowing savers to hold many
assets which means it enables individuals to transfer risk. The ability of the financial
system to provide risk sharing makes savers more willing to buy borrowers’ IOUs. This
willingness, in turn, increases borrowers’ ability to raise funds in the financial system.

3.2 Liquidity: The financial system provides savers and borrowers liquidity. This means
that an asset can be easily converted to money to purchase other assets or exchanges
for goods and services. Generally, savers would want to hold highly liquid assets to be
more flexible that allows them to respond quickly to new opportunities or unexpected
events.

3.3 Information: The financial system has two informational roles, namely: collection and
communication of information. The first informational role the financial system play is
to gather information about the prospective borrowers and what they will do with the

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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

funds. This is important because of the presence of asymmetric information which

refers to information that borrowers may have about their opportunities or activities that
they do not disclose to lenders or creditors and can take advantage of it. The second
informational role that financial system plays is communication of information. Financial
system thru the financial market can incorporate information into the prices of stocks,
bonds, and other financial assets. For as long as market participants are informed, the
information would be reflected into asset returns and prices.

4. The three main components of financial system and their roles are:

4.1 Financial markets. This component is a system that enables participants to buy and
sell financial instruments and facilitates the flow of funds to finance investments of
corporations, government, and individuals.

4.2 Financial institutions. This component represents the key players in the financial
markets as they perform intermediary functions; therefore, determine the flow of funds.
This includes banks and non-bank institutions like insurance companies, investment
houses, financing companies, securities dealers and brokers, pawnshops, non-stock
savings and loan associations, cooperatives, and the like.

Importance of Financial Institutions

Without financial institutions, there would be a direct transfer of funds from suppliers of
funds to users of funds. In the same manner, financial claims would flow directly from
users of funds to suppliers of funds. In this situation, suppliers of fund will not be attracted
to invest which will result to a low level of flow of funds and lesser financial market
activities. This is likely to happen because without financial institutions, there will be:
1. high monitoring costs
2. liquidity concerns
3. price risk

With the presence of financial institutions in the financial system, there is indirect
transfer of funds from the suppliers to the ultimate users of funds. The following are the
services performed by the financial institutions:

Services benefiting suppliers of funds:

1. Lower monitoring costs

2. Higher liquidity and lower price risk
3. Reduced transaction costs
4. Maturity intermediation – financial institutions can better handle
mismatching of maturities of their assets and liabilities
5. Denomination intermediation – financial institutions allow small investors
to overcome constraints to buying assets imposed by large minimum
denomination size

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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

Services benefiting the overall economy:

1. Money supply transmission

2. Credit allocation
3. Intergenerational wealth transfers – financial institutions provide savers
with the ability to transfer wealth from one generation to the next.
Example: life insurance companies and pension funds.
4. Payment services

4.3 Financial regulators. This component is responsible for monitoring and regulating the
participants in the financial system for the purpose of ensuring safety and security.
Among the regulatory bodies in the Philippines are as follows:
 Securities and Exchange Commission (SEC) is a national regulatory agency that
oversees corporations, capital market participants, and the securities and investment
instrument market, to protect the investing public.
 Bangko Sentral ng Pilipinas (BSP) supervises operations of banks and exercises
regulatory powers over non-bank financial institutions with quasi-banking functions.
 Insurance Commission (IC) regulates and supervises the insurance, pre-need, and
Health Maintenance Organization (HMO) industries in the Philippines.
 Philippine Stock Exchange (PSE) is the only stock exchange in the Philippines.

5. How Financial System Works. The activities in a financial system are depicted in the
diagram below:

Financial Regulators

[ Financial Institutions
Savings (Indirect) Lending

Savers
(those who have excess Borrowers
cash to invest: (those who need cash:
SURPLUS units) Lending DEFICIT units)

Savings
Lending
[ Financial Markets
(Direct)

Figure 1. How Financial System Works

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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

Figure 1 shows that in a society there will always be individuals, firms, government or any other
institutions that either looking for good investments to place their excess money (the savers or
surplus units) or looking for funds to finance their cash needs (the borrowers or deficit
units). Primarily, the financial system facilitates the matching of the supply and demand for
funds through the financial institutions and the financial markets. The savers have two options:
save their money through financial institutions or invest it directly to financial markets. Either
way, the objective of the saver is to increase the value of his money with the earnings that he
can get from his investment. Earnings from such investment vary relative to the risk associated
with the investment. Meanwhile, the collected deposits by the financial institutions will then be
made available by extending loans to those qualified borrowers who will opt to get their
financing needs from a financial institution or financial institutions may also make the funds
available to the borrowers through thenote
A municipal financial markets.
is debt issued Some
by state borrowers
and local governmentsmay opt to
to finance get expenditures,
capital their such
as construction projects. Municipal notes are appealing
financing needs from the financial markets through issuance of financial instruments like to investors because they mature in one year
or less, offer fixed income, and are often exempt from income tax at the federal and/or state levels.
shares, bonds, money market, etc.

Self-Help: You can also refer to the sources below to help you further
understand the lesson.

Alimar-Mutya, R. F. (2017). Introduction to money, credit and banking. Mandaluyong City: Anvil
Publishing, Inc.

Darškuvienė, V. (2010). Financial markets. Retrieved from

https://www.bcci.bg/projects/latvia/pdf/7_Financial_markets.pdf.

Francis, A. (2010). Financial system – meaning, functions and services. Retrieved from MBA
Knowledge Base website: https://www.mbaknol.com/business-finance/financial-system-
and-its-functions

Laman, R. B., Laman, V. B., & Evia, Emiliana P. (2015). Financial system, market &
management: the basics. Manila: GIC Enterprises & Co., Inc.

Let’s Check

Activity 1:

TRUE or FALSE. Write TRUE if the statement is correct and FALSE if it incorrect.

__________ 1. Financial markets, financial institutions and financial regulators must be present
for a financial system to work efficiently and effectively.
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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

__________ 2. Financial system increases the liquidity of financial assets.

__________ 3. In a financial system, all information is always available to the investing public.
__________ 4. Financial system allows risk sharing by making it possible for an investor to
hold various types of assets.
__________ 5. Financial institutions include only all types of banks.
__________ 6. It would be more beneficial if there are no financial institutions because without
them, financial costs will be lower.
__________ 7. Financial regulators ensure the safety and security of all the participants in the
financial system.
__________ 8. Direct transfer of funds from suppliers to borrowers is better compared to
indirect fund transfers.
__________ 9. Financial system provides risk sharing, liquidity and information.
__________ 10. Financial system collects information and communicates them to the
participants.

Activity 2:

ENUMERATION. Enumerate the following:

1. What are the three components of the financial system?

1.1 ___________________________________________________________
1.2 ___________________________________________________________
1.3 ___________________________________________________________

2. Give at least five (5) functions of the financial system?

2.1 ___________________________________________________________
2.2 ___________________________________________________________
2.3 ___________________________________________________________
2.4 ___________________________________________________________
2.5 ___________________________________________________________

3. What are the three components of the financial system?

3.1 ___________________________________________________________
3.2 ___________________________________________________________
3.3 ___________________________________________________________

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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

Let’s Analyze

Activity 1. In this activity, you are required to elaborate your answer to the given questions
below.

1. Explain how financial system works.

_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____

2. Discuss the importance of an efficient financial system in relation to a country’s

economy.

_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____________________________________________________________________
_____

In a Nutshell

Grasping the basic concepts of how financial system works is important towards better
investment decision making in the future. Based on the concepts presented, write the three
remarkable lessons you learned.

1. _____________________________________________________________________
_____________________________________________________________________
_____________________________

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 Department of Accounting Education
Mabini Street, Tagum City
Dav ao del Norte
Telefax: (084) 655-9591, Local 116

2. _____________________________________________________________________
_____________________________________________________________________
_____________________________

3. _____________________________________________________________________
_____________________________________________________________________
_____________________________

Q&A List

Do you have any question for clarification? Write them here.

Questions/Issues Answers

1.

2.

3.

4.

5.

Keyword Index

Asymmetric information
Financial system
Financial markets
Financial institutions
Financial regulators

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