Lecture2_A Modern Financial System.pptx

7/27/2019 Lecture2_A Modern Financial System.pptx

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A Modern Financial System


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Lecture Outline

What is a Financial System

Components of a Financial system

Role of Money in an economy

Flow of Funds/Financial Flows

Functions of a Financial system

Importance of a Financial system


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Definitions

1. In finance, the financial system is a system

that allows the transfer of money between

savers and borrowers.

2. The complex of institutions.that facilitate

payments and link lenders with borrowers and

investors with the assets they invest in.


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3. A financial system is that part of the economy

which includes all the institutions involved in

moving savings from savers to borrowers, and

in transferring, sharing and insuring risks

(Reserve Bank of Fiji).

4. A financial system is a network of markets and

institutions 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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Role of money in an economy

Early forms of exchange- barter

Functions of money

Acts as medium of exchange/legal tender

Allows specialisation in production

Solves the divisibility problem; i.e. where

medium of exchange does not represent equal

value for the parties to the transaction Facilitates saving

Represents a store of wealth


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Need for Exchange or Flow of Funds

Funds are needed for productive investments orbusiness projects; acquisition of assets; consumption

Savings/surplus funds- Surplus Spending Units (SSUs)or savers

Deficit Spending Units (DSUs) Mismatch between income and spending needs

create an opportunity for trade

Double coincidence of wants satisfied

A transaction between two parties that meetstheir mutual needs


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Types of Financial Flows Direct Finance

Direct Finance

Funds flow directly from savers to users involvingone set of contract

AdvantagesAvoids costs of intermediation

Simple

Disadvantages

Matching of preferences (risk, return, liquidity,maturity,

Search and transaction costs

Assessment of risk


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Indirect Finance/Intermediated Flows

Funds flow from saver to user through an

intermediary

Lenders and borrowers contract with an

intermediary (2 sets of contract)

Advantages

asset and maturity transformation,

risk diversification,

increased/improved liquidity,

reduced distribution and search costs.


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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 markets involves the trading of existingfinancial instruments


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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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1.1 Functions of a financial system

(cont.)

(cont.)


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Importance of a financial system

The financial system including banks and other financialintermediaries, equity markets, and debt markets solvesthe problems faced savers and investors by agglomeratingcapital from many smaller savers, allocating capital to themost important uses, and monitoring to ensure that it isbeing used well. At the same time, the financial systemtransfers, pools, and reduces risk, increases liquidity, andconveys information.

Financing/intermediary role; payments role; Informationaland risk sharing role.


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Importance of a financial system..

Since 2007, the financial markets have beencharacterised by a great deal of volatility

What started as a liquidation of credit derivatives

sparked by a fall in house prices in the UnitedStates has become a watershed moment inmodern financial history

As nations continue to battle the economic

effects of the GFC, debate continues to rageabout the regulatory response necessary to bringstability to the system

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Lecture2_A Modern Financial System.pptx