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CHAPTER

THE FINANCIAL SYSTEM

LEARNING OBJECTIVES

After studying this chapter, you should be able to…

1. Define what is financial system is and illustrate the role it plays in the
economy of a nation;
2. Discuss on the roles the different participants in a financial system plays;
3. Elaborate on the role of BSP in the economic development of the
Philippines;
4. Discuss the relationship between monetary policy and the financial system

Introduction

All members of society-households, business (more importantly the financial

institutions), non-profit organizations, the church, and the government are affected by the
financial system of the country to which the society belongs. The government, is
primarily responsible for defining and regulating the financial system. It is because the
central bank and its Monetary Board determines the rules, regulations, and monetary
policies that need to be implemented to ensure a stable and healthy financial system for
the country. Business firms, households, and governments pay a wide variety of roles in
our modern financial system. All of us, one way or another, will be involved in the
financial system either as a borrower or a lender or both.

A country’s financial system is not, however, solely determined by the country

itself because other worldwide organizations like the World Bank, International
Monetary Fund, Asian Development Bank, New York Stock Exchange, Osaka Securities
Exchange, Australian Stock Exchange, BATS Global Markets, Chinese Shenzen Stock
Exchange, among others, and transnational banks all affect the financial system of the
country. Our modern world has what may be called a complex and sophisticated financial
system.

This chapter will discuss what a financial system is all about and the role it plays
in the economy of a nation, as a follow up of the preceding chapter on the financial
environment. In addition, it will discuss the roles the different participants in a financial
system plays. The monetary system, monetary policy, and its effect in the economic
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system of a county, and the tools of monetary policy will be discussed and how they
affect money supply and interest rates.

Lastly, the role of the central bank (BSP for the Philippines) will be discussed.
This is prelude to financial intermediation that will be discussed in the next chapter.

Financial System Participants

There are six participants or sectors in the financial system. They are:

1. Households or customers;
2. Financial institutions/intermediaries;
3. Non-financial firms;
4. The government;
5. The central bank; and
6. Foreign participants.

Households

Households or consumers are generally described as that group receiving income,

majority of which typically come from wages and salaries. Such income is spent on
goods and services and a part is saved (if there is enough to save). Gross savings are
equal to current income less current expenditures. What is spent is termed consumption
(from where the word consumer came from). Goods that are consumed within a current
period are termed non-durable consumer goods or non-durables. Goods that will last for
more than a year are termed durable consumer goods or durables.

Financial Institutions/Intermediaries

The financial institutions/intermediaries are the firms that bridge the gap between the
surplus units (SUs) or investors/lenders and the deficit units (DUs) or borrowers. They
channel the funds from the lenders to the borrowers. They include the depository
institutions and the non-depository institutions. Other than being channels, they are, at
times, also lenders and borrowers themselves. When they underwrite securities or acts as
brokers or dealers, they are intermediaries. If they buy securities, they are investors or
lenders and when they are the ones issuing the securities, they are borrowers.

Non-Financial Institutions

The non-financial institutions are the business other than financial institutions or
intermediaries. They include the trading, manufacturing, extractive industries,
construction, genetic industries, and all firms other than the financial ones. Just like
households and the financial institutions, these non-financial institutions are also
borrowers or lenders or both at one time or the other. When these non-financial
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institutions buy securities, they are lenders. When they issue the securities, they are the
borrowers.

The Government

By government is meant the national, provincial, city, and barangays or towns

comprising the Philippines as a whole. Each division has its heads and agencies that help
in running the division it is made responsible for. The President is responsible for the
entire country; the governor is responsible for his own province, the mayor is responsible
for his own city; and the barangay captain is responsible for his barangay. Each of them
has his own agency. The Philippine Treasury is part of the government that we consider
as participant in the financial system. When the Philippine Treasury or any other
subdivision of government issues their own securities, they act as borrowers/deficit units,
and when the Philippine Treasury or any other subdivision of government buys securities,
they act as investors or savers/surplus units.

The Central Bank

Bangko Secntral ng Pilipinas (Central Bank of the Philippine) and all the other
central banks of the different countries are mandated to assure that their respective
countries have a stable and healthy financial system. They oversee the operations of the
entire financial system of their respective countries and mandate the rules, regulations,
and monetary policies that will help their respective countries maintain a healthy and
stable economy. Any central bank is the “banker” to banks providing various services to
banks, helping them collect and clear checks and loaning them funds as needed. As a
lender and a regulator, the central bank oversees the health of the banking system. The
central banks are the monetary policymakers of their respective countries.

Foreign Participants

Foreign participants refer to the participants from the rest of the world-
households, governments, financial and non-financial firms, and central banks. Goods
and services and financial instruments/securities are exchanged across national
boundaries, as well as within these boundaries. International trade and international
finance are parts of globalization. As globalization affects the entire world, the role of
foreign participants in the financial system has become more important.

Bangko Sentral ng Pilipinas and the Philippine Financial System

Figure 3 shows BSP’s basic organizational structure as of June 2009. Following

on the succeeding pages shoe Bangko Sentral ng Pilipinas and its relation to the
Philippine financial system (the different banking and non-banking institutions).
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Bangko Sentral ng Pilipinas is at the top of the structure, the one mandated to
oversee the financial system of the country. It is the agency that is tasked to ensure that
the country has a healthy financial system and a healthy economy. It is the central
monetary authority.

Monetary Board

Governor

Supervision and Resource Security Plant

Monetary
Examination Management
Stability Sector Sector Complex
Sector
 Executive Management Services
 Functional Sectors
o Monetary Stability Sector
o Supervision and Examination Sector
o Resource Management Sector
 Security Plant Complex

Fig. 3 The BSP’s Organizational Structure as of June 2009

Under the Bangko Sentral are the different banking institutions, both private and
government-owned, and the non-bank financial institutions, also both private and
government-owned. The private banking institutions are composed of the commercial
banking institutions, the thrift banks, and the rural banks. This is depicted in the chart
representation as derived from the descriptive narration in Fajardo and Mansala’s
Money, Credit and Banking (1993).