The Philippine Financial

System
SUBTITLE
Financial System Definition:

• Describes collectively as the financial markets, the financial system participants, and the
financial instruments and securities that are traded in the financial markets.

• Functions :

to channel funds from savings units(lenders)to the deficit units (borrowers)

to provide medium of exchange

to mechanism for risk sharing : matching individual savers and borrowers

to provide a channel by which the BSP can influence the economy in general and

the financial system in particular

Figure 3.1: Funds Flowing through the
Financial System

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Financial Institutions

Financial institutions are entities that help individuals and

businesses fulfill their monetary or financial requirements,
either by depositing money, investing it, or managing it.
Some of the institutions labeled under this category
include – banks, investment firms, trusts, brokerage
ventures, insurance companies, etc.

Functions

Though the financial institutions aim to ensure a healthy economy, there

are other minor and major roles they play to ensure they achieve their
final goal.
The primary function of these institutions is to regulate the money supply.
With the regular flow of money, the financial entities keep the financial
ecosystem active. The money supply process must be efficient, given the
wide use of money in carrying out transactions.
 THE EVOLUTION OF FINANCIAL
TRANSACTIONS
“All financial systems perform at least one basic function:
they move scarce funds from those who save and lend
(surplus-budget units) to those who wish to borrow and
invest (deficit-budget units).”

The transfer of funds from lenders to borrowers can be

accomplished in at least three different ways. These
methods of funds transfer labeled as: (1) direct finance, (2)
semidirect finance, and (3) indirect finance.
Introduction
• Indirect Finance: An institution stands between lender and
borrower.
• We get a loan from a bank or finance company to buy a car.

• Direct Finance: Borrowers sell securities directly to lenders in the

financial markets.
• Direct finance provides financing for governments and corporations.

• Asset: Something of value that you own.

• Liability: Something you owe.

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 DIRECT FINANCE

Flow of funds
(loans of spending power for an
Borrowers agreed-upon period of time) Lenders
(deficit-budget (surplus-budget
units (DBUs)) Primary securities units (SBUs))
(stocks, bonds, notes, etc., evidencing
direct claims against borrowers)
 SEMIDIRECT FINANCE

Borrowers Primary securitiesSecurity brokers, Primary securities

Lenders
(deficit- (direct claims dealers, and (direct claims (surplus-
against against
budget units investment budget units
borrowers) borrowers)
(DBUs)) bankers (SBUs))
Proceeds of Flow of funds
security sales (loans of
(less fees and spending
commissions) power)
 INDIRECT FINANCE

Primary securities Secondary securities

Ultimate Financial intermediaries Ultimate
borrowers (direct claims against (indirect claims against lenders
(banks, savings and loan
(deficit- ultimate borrowers in ultimate borrowers (surplus-
associations, insurance
budget the form of loan issued by financial budget
companies, credit unions,
units contracts, stocks, intermediaries in the units
mutual funds, finance
(DBUs)) bonds, notes, etc.) form of deposits, (DBUs))
companies, pension
funds) insurance policies,
retirement savings
accounts, etc.)
Flow of funds Flow of funds
(loans of (loans of
spending spending
power) power)
Basic Functions:
• Fund acquisition – a way of getting deposits and necessary funds to finance
projects and investments

• Fund allocation – determining to which uses,projects, or investments the

acquired funds will be used

• Fund utilization – alloted funds for intended purpose

Six Parts of the Financial System
1. Money
To pay for purchases and store wealth.
2. Financial Instruments
To transfer resources from savers to investors and to transfer risk to
those best equipped to bear it.
3. Financial Markets
To buy and sell financial instruments.
4. Financial Institutions
To provide access to financial markets, collect information & provide
services.
5. Regulatory Agencies
To provide oversight for financial system.
6. Central Banks
To monitor financial Institutions and stabilize the economy.

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Six Parts of the Financial System
1. Money
• Money has changed from gold/silver coins to paper currency to electronic funds.
• Cash can be obtained from an ATM any where in the world.
• Bills are paid and transactions are checked online.

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Six Parts of the Financial System
2. Financial instruments
• Buying and selling individual stocks used to be only for the wealthy.
• Today we have mutual funds and other stocks available through banks or online.
• Putting together a portfolio is open to everyone.

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Six Parts of the Financial System
3. Financial Markets
• Once financial markets were located in coffeehouses and taverns.
• Then organized markets were created, like the New York Stock Exchange.
• Now transactions are mostly handled by electronic markets.
• This has reduced the cost of processing financial transactions.
• There is a much broader array of financial instruments available.

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Six Parts of the Financial System
4. Financial Institutions
• Banks began as vaults, developed into institutions, to today’s financial
supermarket.
• Offer a huge assortment of financial products and services.

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Six Parts of the Financial System
5. Government regulatory agencies
• Government regulatory agencies were introduced by federal
government after the Great Depression.
• Government regulatory agencies provide wide-ranging
financial regulation - rules and supervision.
• Government regulatory agencies examine the systems a bank
uses to manage its risk.
• The 2007-2009 financial crises has led governments to
consider greater regulation.

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Six Parts of the Financial System
6. Central banks
• Central banks began as large private banks to finance wars.
• Central banks control the availability of money and credit to ensure low inflation,
high growth and stability of financial system.
• Today’s policymakers strive for transparency in their operations.

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Participants / Sectors
• Individual / household
• Financial institutions / intermediaries
• non financial institutions
• Governments
• BSP as regulator
• foreign participants
Monetary Policy and the Financial System
• Monetary Policy refers to the manipulation of money supply to affect the
economy by attaining set economic program of the government. Interest rate
plays a key factor. The BSP affects money supply in the economy by way of
implementing expansionary or contractionary policies set by the monetary
authority. Expansionary if the economy is slowing down or going to recession
and contractionary if there is a threat of inflation.
Increase Money Supply Expansionary

• When Government needs to attain certain economic concern by increasing

money supply BSP can implement the three monetary tools combination;
• Purchase securities in the open market(open market operation)
• Lower government discount rate
• Lower reserve requirement on banks
Impact:
• These combination directly impact the interest rate;
• When government buys back securities in the open market through the banks,
price of securities rise bringing more funds into the circulation.
• Goverment discount rate an interest rate. So lowering discount rate is
essentially lowering interest rate.
• If the government thinks that lowering reserve requirements, this in effect will
allow the banks to increase the amount of money they can invest or lend. And
this will cause price of investments like bonds to rise bec interest rate must fall.
• Increase in bond prices will affect the exchange market.
Scenario:
• An increase in Philippine bond prices would attract investors to unload and sell off
their bonds for lower priced bonds. Some will sell their Php bonds and buy USD
denominated bonds. This will cause an increase supply of Php , and a decrease of
USD in the foreign exchange market causing Php less valuable relative to the dollar.
The lower exchange rate will make Philippine produced goods cheaper in the US
and US produced goods in be more expensive in the Philippines. In effect, export will
increase and import will decrease causing balance of trade to increase (+). When
interest rates are lower, the cost of financing capital project is less. Lower interest
rates will eventually bring higher rates of capital investment.
Contractionary Monetary policy
• Causes an increase in bond price and reduction in the interest rate
• Lower interest rate led to higher levels of capital investment
• Lower interest rates make domestic bonds less attractive, and the demand for
domestic bond falls while rising the demand for foreign bonds.
• Demand for domestic currency falls and the demand for foreign currency rises,
causeing a decrease in the exchage rate. The value of our Php is now lower
relative to foreign currency
• Lower exchange rate causes export to increase, while imports decreased, and
balance of trade to increase.
BSP Decreases Money Supply
• The effects of contractionary monetary policy are precisely the opposite of an
expansionary monetary policy, when BSP decreases money supply, it can do the
combination of the following;
• Sell securities in the open market
• Raise discount rate
• Raise reserve requirement
• These combination will cause interest rates to rise, directly or through the
increase in the supply of bonds issuances which in effect reduces the price of
bonds. Foreign investors will be attracted to buy causing an increase demand for
domestic currency and fall in foreign currency. The higher exchange rate makes
our domestic products in foreign markets and foreign goods relatively cheaper in
domestic market.
• More foreign goods sold domestically and less domestic goods sold abroad,
balance of trade decreases. The interest rates trigger a higher cost of financing
projects, so capital investment will be reduced.
Contractionary Monetary policy
• Causes a decrease in bond price and an increase in the interest rates
• Higher interest rate lead to lower levels of capital investment
• Higher interest rates make domestic bonds more attractive, and the demand for
domestic bond rises and the demand for foreign bonds fallls.
• Demand for domestic currency rises and the demand for foreign currency falls,
causing an increase in the exchage rate. The value of our Php is now higher
relative to foreign currency
• Higher exchange rate causes export to decrease, while imports to increase, and
balance of trade to decrease.
 CLASSIFICATION OF FINANCIAL INSTITUTIONS

qDepository Institutions- derived the bulk of their loanable

funds from deposit accounts sold to the public.
ü commercial banks, savings and loan associations, savings banks, and credit
unions
qContractual Institutions- attract funds by offering legal
contracts to protect the saver against risk
ü insurance companies and pension funds
qInvestment Institutions- sells shares to the public and
investment the proceeds in stocks, bonds, and other assets.
ü investment companies, money market funds, and real estate investment
trusts
 PORTFOLIO (FINANCIAL-ASSET) DECISIONS BY FINANCIAL
INTERMEDIARIES AND OTHER FINANCIAL INSTITUTIONS

The management of a financial institution is called

on daily to make portfolio decisions:
qDeciding what financial assets to buy or sell
qRelative rate of return and risk
qCost, volatility, and maturity of incoming funds
qEconomies of scale
qRegulations and competition
 DISINTERMEDIATION OF FUNDS
Withdrawal of funds from a financial intermediary by ultimate lender
and the lending of those funds directly to ultimate borrowers.

Ultimate lenders
Ultimate borrowers (surplus-budget units
Financial Intermediaries
(deficit-budget units (DBUs)) (SBUs))
Loanable funds

Primary securities
TWO BROAD CATEGORIES OF FINANCIAL SYSTEMS

üBank-dominated financial systems- majority of financial assets arise

from the banking system.
üSecurity-dominated financial systems- security brokers and dealers
tend to be leaders in the financial system.

*Thus, security-dominated financial systems are highly dependent upon direct

and semidirect finance, while bank-dominated financial systems tend to rely
highly upon financial intermediaries- indirect finance.
• Thank you.