BF101 Revision

BF101 revision notes 2013

What is a Financial System

Definition 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). A financial system is a network of markets and institutions to bring savers and borrowers together (Hubbard, RG, 1994).
BF101 revision notes 2013

Constituents of a Modern Financial System

1. Financial Institutions Formal structures/entities providing financial products and services and performing financial functions. Non formal financial institutions belonging to informal financial sector are also included. Banks and non-banks/type of services provided : -Deposit-taking institutions, risk pooling institutions, market makers, specialized sectoral financiers, financial service providers. 2. Financial Markets- provide an ordered and often regulated structure in which the creation, sale and transfer of financial assets may take place.
BF101 revision notes 2013

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 created and 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 system generally. Rules and regulations ensure efficient and orderly function of the financial system.
BF101 revision notes 2013

Revision-Financial System
Financial Institutions

Financi al Assets/ Instrum ents

Regulatory bodies
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Financi al markets

Financial Flows
surplus funds

SSU

Intermediary Intermediary

DSU

Mismatch of income and spending needs financial assets

BF101 revision notes 2013

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.
BF101 revision notes 2013

Functions of the Financial System

Facilitate portfolio structuring and restructuring Provider of financial and economic information to market participants to allow informed decisions to made. Encouraging savings to build capital investments and thus improve productive capacity in a country. Facilitates the implementation of government policiesmonetary; Well functioning financial system increases the flow of savings and ensures that such savings are directed to most efficient users.
BF101 revision notes 2013

Flow of Funds Markets

Financial markets facilitate the flow of funds between a borrower and a lender giving rise to financial claims/financial assets; Financial Markets provide an ordered and regulated structure in which the creation, sale and transfer of financial assets take place. Generic types of Financial Markets Primary markets - involves the issue of new instruments Secondary markets involves the trading of existing financial instruments
BF101 revision notes 2013

Primary Markets
Types of Financial Markets

Secondary Markets

Capital Markets
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Money Markets

Money Market Sub Markets

Central Bank

Interbank

Bills

Commercial Paper

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Capital Market Sub Markets

Equity

Corporate Debt

Govt

Debt

Foreign Exchange

Derivatives

BF101 revision notes 2013

Financial Asset
an item of monetary/financial and economic value, value of a financial asset arises not from its physical embodiment (as would be a building or a piece of land or capital equipment or other real assets) but from the financial claims and contractual relationship embodied in the asset;
BF101 revision notes 2013

Types of financial instruments

Debt, Equity, Derivatives Debt instrument represents a contractual claim against the issuer and requires the borrower to make specified 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 term security which entitles holder to share in profits of the issuing company; Derivative- A security whose price and form is dependent upon or derived from one or more underlying assets and /or instruments.
BF101 revision notes 2013

What are Financial Institutions?

Formal structures/entities providing financial products and services and performing financial functions. Non formal financial institutions belonging to informal financial sector are also included. Banks and non banks

BF101 revision notes 2013

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)

BF101 revision notes 2013

Constraints to Financial Development in PICs

Real Sector Constraints 1. Slow Economic Growth 2. Lack of private investment Financial Sector Constraints lack competitive banking sector poor governance lack prudential standards undeveloped financial markets

BF101 revision notes 2013

What is a bank?
Banks as private institutions are providing unique services 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.

BF101 revision notes 2013

Role and Functions of Banks

As financial intermediaries banks attract savings and efficiently allocate the funds to borrowers; Seek and obtain funds to meet consumption and investment needs, providing liquidity and the payment function and transactions services Delegated monitoring- information processing, resource allocation and monitoring Asset transformation- denomination, quality, maturity, liquidity, location managing risks
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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 assets
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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.

BF101 revision notes 2013

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.

BF101 revision notes 2013

What is Financial Regulation?

A form of regulation/supervision which subjects financial institutions to certain requirements and guidelines aimed at promoting and maintaining efficiency, integrity, stability, safety and soundness of the financial system. It is of special importance because of the critical role of finance to the efficient functioning of an economy. Attempts to establish the legal and ethical framework within which commerce can flourish for 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 both
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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.
BF101 revision notes 2013