Introduction to Financial Introduction to Financial Institutions and MarketsInstitutions and Markets

Financial System- implies a set of Financial System- implies a set of Complex and closely connected Complex and closely connected

institutions, markets, transactions, institutions, markets, transactions, agents, practices, claims and liabilities agents, practices, claims and liabilities

in a economy in a economy

What is the financial system What is the financial system concerned with?concerned with?

MoneyMoney CreditCredit ServicesServices financefinance

Functions of Financial systemFunctions of Financial system

Financial Institutions- act as Financial Institutions- act as mobilisers and depositories of saving mobilisers and depositories of saving and as the custodian of finance.and as the custodian of finance.

Provides various financial services to Provides various financial services to the society. the society.

Financial institutionFinancial institution

A A financial institutionfinancial institution is an institution is an institution whose primary source of profits is whose primary source of profits is through financial asset transactions through financial asset transactions

Classifications of Financial Classifications of Financial InstitutionsInstitutions

Banks Banks Stock Brokerage Firms Stock Brokerage Firms Non Banking Financial Institutions Non Banking Financial Institutions Building Societies Building Societies Asset Management Firms Asset Management Firms Credit Unions Credit Unions Insurance CompaniesInsurance Companies

Functions of Financial InstitutionsFunctions of Financial Institutions

The principal The principal function of financial function of financial institutionsinstitutions is to collect funds from is to collect funds from the investors and direct the funds to the investors and direct the funds to various financial services providers in various financial services providers in search for those funds.search for those funds.

Financial MarketsFinancial Markets

A A financial marketfinancial market is a market in is a market in which financial assets are traded. In which financial assets are traded. In addition to enabling exchange of addition to enabling exchange of previously issued financial assetspreviously issued financial assets

Six basic functions of financial Six basic functions of financial markets markets

Borrowing and LendingBorrowing and Lending Price DeterminationPrice Determination Information Aggregation and Information Aggregation and

CoordinationCoordination Risk SharingRisk Sharing LiquidityLiquidity EfficiencyEfficiency

Financial Instruments Financial Instruments

Financial instrumentsFinancial instruments are cash, are cash, evidence of an ownership interest in evidence of an ownership interest in an entity, or a contractual right to an entity, or a contractual right to receive, or deliver, cash or another receive, or deliver, cash or another financial instrument. financial instrument.

Categorization of Financial Categorization of Financial InstrumentsInstruments

Cash instrumentsCash instruments :are financial instruments :are financial instruments whose value is determined directly by whose value is determined directly by markets. They can be divided into markets. They can be divided into securitiessecurities, , which are readily transferable, and other which are readily transferable, and other cashcash instruments such as instruments such as loansloans and and depositsdeposits, , where both borrower and lender have to where both borrower and lender have to agree on a transfer agree on a transfer

Derivatives instruments:Derivatives instruments: are financial are financial contracts, or financial instruments, whose contracts, or financial instruments, whose prices are derived from the price of something prices are derived from the price of something else else

Equilibrium in financial MarketsEquilibrium in financial Markets

When the expected demand for When the expected demand for funds matches with the planned funds matches with the planned supply of funds generated out of supply of funds generated out of saving and credit creation or when saving and credit creation or when the total desired borrowing is equal the total desired borrowing is equal to the total desired lending. to the total desired lending.

Determinants of supply of fundsDeterminants of supply of funds

Aggregate savings by the household Aggregate savings by the household sector sector

Aggregate savings by the business Aggregate savings by the business sector sector

Aggregate savings by the Aggregate savings by the governmentgovernment

Determinants of demand for fundsDeterminants of demand for funds

Investment in fixed and circulating Investment in fixed and circulating capital (working capital)capital (working capital)

Demand for consumer durablesDemand for consumer durables Investment for housingInvestment for housing

Theories on savings and Theories on savings and investment investment

Prior Savings Theory- SamuelsonPrior Savings Theory- Samuelson Credit Creation Theory- Kalecki and Credit Creation Theory- Kalecki and

SchumpeterSchumpeter Theory of forced Savings- Keynes Theory of forced Savings- Keynes

and Tobinand Tobin Financial Regulation theory- StiglitzFinancial Regulation theory- Stiglitz Financial Liberalisation Theory- Financial Liberalisation Theory-

Mckinnon and ShawMckinnon and Shaw

Prior Savings Theory- SamuelsonPrior Savings Theory- Samuelson

Saving as a Prerequisite for InvestmentSaving as a Prerequisite for Investment Appropriate monetary and fiscal policyAppropriate monetary and fiscal policy Generate high rate of inflationGenerate high rate of inflation Controlled by interest rateControlled by interest rate Role of financial system – to promote Role of financial system – to promote

financial development-transformation likefinancial development-transformation like Liability- Asset transformationLiability- Asset transformation Size- transformationSize- transformation Risk- transformationRisk- transformation Maturity- transformation Maturity- transformation

Credit Creation Theory-Credit Creation Theory-

Credit creation in anticipation to Credit creation in anticipation to savingsaving

Investment through credit creation Investment through credit creation results in prompt income generationresults in prompt income generation

Theory of forced SavingsTheory of forced Savings

Other wise known as inflationary Other wise known as inflationary financing – through forced savingsfinancing – through forced savings

It is the saving that determines the It is the saving that determines the investment- monetary expansioninvestment- monetary expansion

Four channels for monetary Four channels for monetary expansion- if the resources are expansion- if the resources are unemployed, if resources are fully unemployed, if resources are fully employed, inflation changes income employed, inflation changes income distribution among the profit earners, distribution among the profit earners, inflation imposes taxes inflation imposes taxes

Financial Regulation theory-Financial Regulation theory-

Financial markets are prone to Financial markets are prone to market failuresmarket failures

Government interventions makes Government interventions makes them function betterthem function better

Lowering interest rates and credit Lowering interest rates and credit programmes programmes

Financial Liberalisation Theory-Financial Liberalisation Theory-

In the form of interventions, political In the form of interventions, political pressures pressures

Financial liberalisation, privatisation.Financial liberalisation, privatisation.