Financial System

An Overview of the Financial

System
Primary Function of the
Financial System is Financial
Intermediation
 5 Basic Functions of Financial System
1. Savings function
As already stated, public savings find their way
into the hands of those in production through
the financial system. Financial claims are issued
in the money and capital markets, which
promise future income flows. The funds, in the
hands of the producers, resulting in the
production of better goods and services and an
increase in society's living standards. When
savings flow decline, however, the growth of
investment and living standards begins to fall
 5 Basic Functions of Financial System
2. Liquidity Function
Money in the form of deposits offers the least
risk of all financial instruments. But its value
mostly eroded by inflation. That is why one
always prefers to store funds in financial
instruments like stocks, bonds, debentures, etc.
However, in such investments (i) a greater level
of risk is involved, (ii) and the degree of liquidity
(i.e., conversion of the claims into money) is
less. The financial markets provide the investor
with the opportunity to liquidate the
investments.
 5 Basic Functions of Financial System
3. Payment Function
The financial systems offer a very
convenient mode of payment for
goods and services. The check
system, credit card systems et al are
the easiest methods of payment in
the economy; they also drastically
reduce the cost and rime of
transactions.
 5 Basic Functions of Financial System
4. Risk Function
The financial markets provide protection
against life, health, and income risks.
These are accomplished through the sale
of life, health, and property insurance
policies. Overall, they provide immense
opportunities for the investor to hedge
himself/herself against or reduce the
possible risk involved in various
instruments.
 5 Basic Functions of Financial System
5. Policy Function
Most governments intervene in the
financial system to influence
macroeconomic variables like interest
rates or inflation. For example, the federal
bank or a central bank does indulge in
several cuts in CRR and try to force the
interest rates down and increase the
availability of credit-at cheaper rates to
the corporates.
The financial system is the
process by which money
flows from savers to
users.
• Financial System
• Savers
• Users
• Financial Institutions
• Financial Markets

• Savings is a function of many variables.

• Funds can be transferred between

users and savers directly or indirectly.
• The financial system is more
connected.
• Financial institutions are more
global.
• Only 3 of the 30 largest banks in
the world are US institutions.
• Most nations have a central
bank.
 The Financial System
• The financial system is the collection of institutions
that facilitate the flow of funds between lenders and
borrowers.
 The Financial System: Saving

• When people earn income, they

typically don’t want to consume
their entire income all at once.
• But they may have no idea what
to do with the unconsumed
income.
• This unconsumed income is
called saving
 The Financial System: Investment
• On the other hand, there are people
who may wish to spend money on
various potentially valuable projects
but either have no money of their own
or may wish to spend their personal
funds on projects other than their own
• The money that these people need for
their spending plans is called
investment
 The Financial System Makes Saving
Equal Investment
•The financial system makes it easier for
lenders (those who have the saving funds)
and borrowers (those who need funds for
investment) to find each other
•Both groups benefit when the financial
system does its job well
•When the financial system fails, both groups
suffer
 Financial System Participants
• Households or consumers are generally described as that
group receiving income, majority of which typically come from
wages and salaries.
 Financial System Participants
• Financial institutions channel the funds from lenders to borrowers.
They can also be the lenders and borrowers themselves. If they buy
securities they are lenders but if they are the ones issuing the
securities, they are borrowers.
 6 Parts of the Financial System
1. Money - is the start of the
financial system and the means
for making purchases.
Accumulating money is a
determining factor in defining
wealth. Those who store more
money are wealthier than those
who do not.
• Money in the Philippines:
Banks, ATMs, cards & currency
exchange like coins, bank notes
 6 Parts of the Financial System
2. Financial Instruments - are
also known as securities, though
the layman's terms are stocks,
bonds, mortgages and insurance.
 6 Parts of the Financial System
3. Financial Markets - are trading
houses that are dedicated to the
purchase and sale of stocks and
bonds, such as the New York Stock
Exchange or Philippine Stock
Exchange (PSE). Buyers and sellers
gather at the market to determine
buying and selling prices for securities,
typically with assistance from a
stockbroker. Markets continually
fluctuate, resulting in inherent risks in
the process.
 6 Parts of the Financial System
4. Financial Institutions - The
common term for financial institutions
is banks. Though once a brick and
mortar building that held money in
vaults, modern financial institutions
offer a variety of products and services
including mortgages, insurance and
brokerage accessibility.
- Financial institutions now
compete in the financial market by
offering one-stop shopping for
financial transactions and advice.
 6 Parts of the Financial System
5. Regulatory Agencies - were
introduced by the government to monitor
the activities of financial institutions and
markets. Through examination and
enforcement of strict guidelines,
regulatory agencies supervise members of
the financial system to ensure the safety
of the public's money and investments.
Government examiners review the
systems in place at financial institutions
and markets, and they teach and
encourage best practices.
 6 Parts of the Financial System
6. Central Banks - almost every
country in the world has a central
bank that is integral to each country's
government. The founding of central
banks was originally a means to
finance wars, but today's central
banks control the availability of
money and credit. They are integral
to the stability of the country's
financial system as they oversee
national currency and its value.
 Financial System Participants
• Non-Financial Institutions are businesses such as trading,
manufacturing, extractive industries, construction and
genetic industries. Non-financial institution can also be
the lender and borrowers just like financial institution.
• They are also a financial institutions that offer various
banking services but do not have a banking license.
Generally, these institutions are not allowed to take
traditional demand deposits—readily available funds, such
as those in checking or savings accounts—from the public.
 Types of Non-Financial Institutions
1. Insurance Companies
• Risk-pooling institutions like insurance
companies work with economic risks
such as death, damage and risks of loss
to make a return. The two main types of
insurance companies are general
insurance and life insurance. General
insurance is more of a short term
contract while life insurance is long term
and is active until the insurer’s death.
 Types of Non-Financial Institutions
2. Payday Lenders
• Specialized sectorial financiers like
payday lending companies and real
estate financiers provide short term
loans and limited financial services
to a targeted demographic.
• They can help with unsecured
business loans and are a quick fix for
borrowers. Those struggling to get
credit or with limited recourse to
funds are more likely to use a
payday lender when securing a loan.
 Types of Non-Financial Institutions
3. Financial Service Providers
• are made up of management
consultants, security and
mortgage brokers and financial
advisors. They operate on a fee-
for-service basis and offer advice
to investors and brokers. They
improve informational efficiency
for investors and offer a
transactions service for investors
to liquidate their assets.
 Types of Non-Financial Institutions
• 4. Institutional Investors
• are organizations that trade
securities in volumes that qualify
for lower commissions. This kind
of non-bank financial institution
can be found working with
pension funds and mutual funds.
 Financial System Participants
• The Government - is the national,
provincial, city and towns comprising
the Philippines as a whole.

• The Central Bank - is an institution

that manages a state’s currency,
money supply and interest rate.
Central banks also usually oversee
the commercial banking system of
their respective countries.
 Financial System Participants
• Foreign participants refers to the
participants from the rest of the
world such as households,
government, financial and non-
financial firms, and central bank.
• They exchange goods and services
across national boundaries.
International trade and international
finance are parts of globalization.
 What does the financial system do?
The financial system serves multiple purposes:
1. It helps entrepreneurs find the money needed to turn
business ideas into reality
2. It helps entrepreneurs pursue business projects without
having to personally carry too much of the risks
associated with their projects
3. It helps to protect lenders from irresponsible borrowers
4. It helps to foster economic growth by channeling
savings to the most valuable projects and cutting off
funds for the less valuable projects