Lecture35 Revision 1

8/13/2019 Lecture35 Revision 1

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BF101 Revision

BF101 revision notes 2013


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What is a Financial System

Definition

A financial system is that part of the economywhich includes all the institutions involved in

moving savings from savers to borrowers, andin transferring, sharing and insuring risks(Reserve Bank of Fiji).

A financial system is a network of markets andinstitutions to bring savers and borrowerstogether (Hubbard, RG, 1994).



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Constituents of a Modern Financial System

1. Financial Institutions Formal structures/entities providing financial

products and services and performing financialfunctions. Non formal financial institutions belonging

to informal financial sector are also included. Banks and non-banks/type of services provided :

-Deposit-taking institutions, risk poolinginstitutions, market makers, specialized sectoral

financiers, financial service providers.2. Financial Markets- provide an ordered and often

regulated structure in which the creation, sale andtransfer of financial assets may take place.



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Constituents of a Modern Financial

System..

3. Financial Assets/Instruments are the medium by which the value of financial

transactions within the financial system is createdand recognized.

Issued by DSUs and purchased by SSUs

4. Government and Regulatory Bodies to maintain confidence and stability in the

financial institutions and the financial systemgenerally.

Rules and regulations ensure efficient and orderlyfunction of the financial system.



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Revision-Financial System

FinancialInstitutions

Financialmarkets

Regulatorybodies

FinancialAssetsInstruments



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Financial Flows

Mismatch of income and spendingneeds

surplus funds

financial assets

SSU DSUIntermediary

Intermediary



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Functions of a Financial System

Facilitates efficient flow of funds between SSUs

(lenders) and DSUs (borrowers)

Allows individuals to allocate funds according to

current and future consumption

Encourages savings and accumulation of savings

(wealth creation and accumulation)

Facilitates economic growth and development

by providing finance to business.



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Functions of the Financial System

Facilitate portfolio structuring and restructuring

Provider of financial and economic information tomarket participants to allow informed decisions tomade.

Encouraging savings to build capital investments andthus improve productive capacity in a country.

Facilitates the implementation of government policies-monetary;

Well functioning financial system increases the flow ofsavings and ensures that such savings are directed tomost efficient users.



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Flow of Funds Markets

Financial markets facilitate the flow of funds between aborrower and a lender giving rise to financialclaims/financial assets;

Financial Markets provide an ordered and regulatedstructure in which the creation, sale and transfer offinancial assets take place.

Generic types of Financial Markets

Primary markets - involves the issue of newinstruments

Secondary marketsinvolves the trading of existingfinancial instruments



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PrimaryMarkets

SecondaryMarkets

CapitalMarkets

MoneyMarkets

Types of Financial

Markets



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Money Market

Sub Markets

CentralBank

Interbank Bills CommercialPaper



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Capital Market

Sub Markets

Equity CorporateDebt

GovtDebt

ForeignExchange Derivatives



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Financial Asset

an item of monetary/financial and economicvalue,

value of a financial asset arises not from its

physical embodiment (as would be a buildingor a piece of land or capital equipment or

other real assets) but from the financial claims

and contractual relationship embodied in theasset;



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Types of financial instruments

Debt, Equity, Derivatives Debt instrument represents a contractual claim

against the issuer and requires the borrower to makespecified payments such as periodic interest

payments and principal payments. Equity- a stock or any other security representing an

ownership interest in another company; a long termsecurity which entitles holder to share in profits ofthe issuing company;

Derivative- A security whose price and form isdependent upon or derived from one or moreunderlying assets and /or instruments.



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What are Financial Institutions?

Formal structures/entities providing financialproducts and services and performing financialfunctions. Non formal financial institutions belongingto informal financial sector are also included.

Banks and non banks



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Structure of Financial System in PICs

Financial sector in PICs consists largely of:

1. Commercial banks most of which are

foreign owned;2. Non Bank Financial Institutions (NBFIs)



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Constraints to Financial Development

in PICsReal Sector Constraints

1. Slow Economic Growth2. Lack of private investment

Financial Sector Constraints

lack competitive banking sector

poor governance

lack prudential standardsundeveloped financial markets



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What is a bank?

Banks as private institutions are providing uniqueservices to the public.

Banks are financial institutions providing the widest

range of financial products and services The latter definition highlights change in the banks

as they respond to the forces of changes in the

business environment.



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Role and Functions of Banks

As financial intermediaries banks attract savings andefficiently allocate the funds to borrowers;

Seek and obtain funds to meet consumption andinvestment needs,

providing liquidity and the payment function andtransactions services

Delegated monitoring- information processing,

resource allocation and monitoring Asset transformation- denomination, quality,

maturity, liquidity, location

managing risksBF101 revision notes 2013


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Sources and Uses of funds

Sources Deposits

Non deposits

equity

Uses

Short term investments

Long term investment

Loans and leases Trading assets

Other real assets

Miscellaneous assetsBF101 revision notes 2013


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What are Non Bank Financial Institutions

Any financial institution which by legislation is

not a bank, providing specialized financial

products/services for a target group.



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Importance of NBFIs

These studies show that:

There is strong evidence that financial

development adds to economic growth and

development.

There is strong evidence that financial depth

and diversity adds to economic growth and

development.



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What is Financial Regulation?

A form of regulation/supervision which subjectsfinancial institutions to certain requirements andguidelines aimed at promoting and maintaining

efficiency, integrity, stability, safety andsoundness of the financial system.

It is of special importance because of the criticalrole of finance to the efficient functioning of an

economy. Attempts to establish the legal and ethical

framework within which commerce can flourishfor the benefit of all.



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Regulatory Objectives and Market

Failure?

Anticompetitive behaviour

Market misconduct

Information asymmetry Systemic instability



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Models of Regulatory Structure

1. Institutional model

Establishment of separate agencies to

regulate different institutional groups

2. Regulatory functional model

Involves the establishment of separate

agencies to regulate different sources of

market failure

Many countries have structures that combine

elements of bothBF101 revision notes 2013


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Regulatory Effectiveness

How well and how cost effective the regulator

meets its objective of counteracting market

failure.

True effectiveness comes when cost of

eliminating market failure is not greater than

cost of market failure itself.

Effectiveness can be reduced to:

Back up or support available to the regulators,

Regulatory implementation.


Lecture35 Revision 1

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