Financial system

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A 'financial system' is a system that allows the exchange of funds between lenders, investors, and borrowers. Financial systems operate at national and global levels. [1] They consist of complex, closely related services, markets, and institutions intended to provide an efficient and regular linkage between investors and depositors. [2]

An investor is a person that allocates capital with the expectation of a future financial return. Types of investments include: equity, debt securities, real estate, currency, commodity, token, derivatives such as put and call options, futures, forwards, etc. This definition makes no distinction between the investors in the primary and secondary markets. That is, someone who provides a business with capital and someone who buys a stock are both investors. An investor who owns a stock is a shareholder.

Market (economics) Mechanisms whereby supply and demand confront each other and deals are made, involving places, processes and institutions in which exchanges occur.

A market is one of the many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers. It can be said that a market is the process by which the prices of goods and services are established. Markets facilitate trade and enable the distribution and resource allocation in a society. Markets allow any trade-able item to be evaluated and priced. A market emerges more or less spontaneously or may be constructed deliberately by human interaction in order to enable the exchange of rights of services and goods. Markets generally supplant gift economies and are often held in place through rules and customs, such as a booth fee, competitive pricing, and source of goods for sale.

Contents

Money, credit, and finance are used as medium of exchange in financial systems. They serve as a medium of known value for which goods and services can be exchanged as an alternative to bartering. [3] A modern financial system may include banks (public sector or private sector), financial markets, financial instruments, and financial services. Financial systems allow funds to be allocated, invested, or moved between economic sectors. They enable individuals and companies to share the associated risks. [4]

Money Object or record accepted as payment

Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a medium of exchange, a unit of account, a store of value and sometimes, a standard of deferred payment. Any item or verifiable record that fulfils these functions can be considered as money.

Finance Academic discipline studying businesses and investments

Finance is a field that is concerned with the allocation (investment) of assets and liabilities over space and time, often under conditions of risk or uncertainty. Finance can also be defined as the art of money management. Participants in the market aim to price assets based on their risk level, fundamental value, and their expected rate of return. Finance can be split into three sub-categories: public finance, corporate finance and personal finance.

Service (economics) intangible offering inseparable from its creators labor, which brings utility value to their client

In economics, a service is a transaction in which no physical goods are transferred from the seller to the buyer. The benefits of such a service are held to be demonstrated by the buyer's willingness to make the exchange. Public services are those that society as a whole pays for. Using resources, skill, ingenuity, and experience, service providers benefit service consumers. Service is intangible in nature.

As an alternative to bartering, a modern financial systems may include banks, financial markets, financial instruments and financial services. [5]

Features of financial system

  1. It is a set of interrelated activities or services.
  2. Services are working together to achieve predetermined goals.
  3. The system allows transfer of money between savers and borrowers.
  4. It is applicable at global, regional, and firm level.
  5. It includes Financial Institutions, markets, instruments, services, practices and transactions.
  6. The main objective is to formulate capital, investment and profit generation. de financial services for members and clients. It is also termed as financial intermediaries because they act as middlemen between the savers and borrowers
  7. It bridges the gap between savings and investment through efficient mobilisation and allocation of surplus funds.
  8. It helps a business in capital formation
  9. It helps in minimising risk and allocating risk efficiently .
  10. It helps business to liquidate tied up funds.
  11. It facilitates financial transactions through provision of various financial instruments
  12. It facilitate trading of financial assets/ instruments by developing and regulating financial markets.
  13. It helps in economic development and raising the standard of living of people.
  14. It provides effective financial as well as advisory services.
  15. It protects investors through regulatory bodies like RBI, SEBI etc., [6]

Role

Economic Development

  1. Mobilising savings
  2. Promoting Investments
  3. Encouraging investments in financial assets
  4. Allocating savings on the basis of national priorities.
  5. Creating credit
  6. Providing a spectrum of financial assets.
  7. Financing trade, Industry and agriculture.
  8. Encouraging Entrepreneurial talents.
  9. Providing financial services.
  10. Developing backward areas.
  11. Helping in financial deepening and broadcasting. [7]

Banks

Banks are financial intermediaries that lend money to borrowers to generate revenue and accept deposits . They are typically regulated heavily, as they provide market stability and consumer protection. Banks include:[ citation needed ]

Bank financial institution

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.

A financial intermediary is an institution or individual that serves as a middleman among diverse parties in order to facilitate financial transactions. Common types include commercial banks, investment banks, stockbrokers, pooled investment funds, and stock exchanges. Financial intermediaries reallocate otherwise uninvested capital to productive enterprises through a variety of debt, equity, or hybrid stakeholding structures.

A commercial bank is a type of bank that provides services such as accepting deposits, making business loans, and offering basic investment products that is operated as a business for profit.

Central bank public institution that manages a states currency, money supply, and interest rates

A central bank, reserve bank, or monetary authority is an institution that manages the currency, money supply, and interest rates of a state or formal monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and also generally controls the printing/coining of the national currency, which serves as the state's legal tender. A central bank also acts as a lender of last resort to the banking sector during times of financial crisis. Most central banks also have supervisory and regulatory powers to ensure the solvency of member institutions, to prevent bank runs, and to discourage reckless or fraudulent behavior by member banks.

Non-bank financial institutions

Non-bank financial institutions facilitate financial services like investment, risk pooling, and market brokering. They generally do not have full banking licenses. [8] Non-bank financial institutions include: [9]

A non-banking financial institution (NBFI) or non-bank financial company (NBFC) is a financial institution that does not have a full banking license or is not supervised by a national or international banking regulatory agency. NBFI facilitate bank-related financial services, such as investment, risk pooling, contractual savings, and market brokering. Examples of these include insurance firms, pawn shops, cashier's check issuers, check cashing locations, payday lending, currency exchanges, and microloan organizations. Alan Greenspan has identified the role of NBFIs in strengthening an economy, as they provide "multiple alternatives to transform an economy's savings into capital investment which act as backup facilities should the primary form of intermediation fail."

To invest is to allocate money in the expectation of some benefit in the future.

A risk pool is one of the forms of risk management mostly practiced by insurance companies. Under this system, insurance companies come together to form a pool, which can provide protection to insurance companies against catastrophic risks such as floods or earthquakes. The term is also used to describe the pooling of similar risks that underlies the concept of insurance. While risk pooling is necessary for insurance to work, not all risks can be effectively pooled. In particular, it is difficult to pool dissimilar risks in a voluntary insurance bracket, unless there is a subsidy available to encourage participation.

Financial markets

Financial markets are markets in which securities, commodities, and fungible items are traded at prices representing supply and demand. The term "market" typically means the institution of aggregate exchanges of possible buyers and sellers of such items.

Primary markets

The primary market (or initial market) generally refers to new issues of stocks, bonds, or other financial instruments. The primary market is divided into two segment, the money market and the capital market.

Secondary markets

The secondary market refers to transactions in financial instruments that were previously issued.

Financial instruments

Financial instruments are tradable financial assets of any kind. They include money, evidence of ownership interest in an entity, and contracts. [10]

Cash instruments

A cash instrument's value is determined directly by markets. They may include securities, loans, and deposits.

Derivative instruments

A derivative instrument is a contract that derives its value from one or more underlying entities (including an asset, index, or interest rate). [11]

Financial services

Financial services are offered by a large number of businesses that encompass the finance industry. These include credit unions, banks, credit card companies, insurance companies, stock brokerages, and investment funds.

See also

Related Research Articles

Capital market financial market for medium and long-term capital raising

A capital market is a financial market in which long-term debt or equity-backed securities are bought and sold. Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments. Financial regulators like the Bank of England (BoE) and the U.S. Securities and Exchange Commission (SEC) oversee capital markets to protect investors against fraud, among other duties.

Financial market generic term for all markets in which trading takes place with capital

A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Securities include stocks and bonds, and precious metals.

Financial capital is any economic resource measured in terms of money used by entrepreneurs and businesses to buy what they need to make their products or to provide their services to the sector of the economy upon which their operation is based, i.e. retail, corporate, investment banking, etc.

An Investment bank is a financial services company or corporate division that engages in advisory-based financial transactions on behalf of individuals, corporations, and governments. Traditionally associated with corporate finance, such a bank might assist in raising financial capital by underwriting or acting as the client's agent in the issuance of securities. An investment bank may also assist companies involved in mergers and acquisitions (M&A) and provide ancillary services such as market making, trading of derivatives and equity securities, and FICC services. Most investment banks maintain prime brokerage and asset management departments in conjunction with their investment research businesses. As an industry, it is broken up into the Bulge Bracket, Middle Market, and boutique market.

Money market type of financial market

Money market is an important part of the economy which provides short-term fund.The money market is the part of financial market which deals in the borrowing and lending of short-term loans generally for a period of less than or equal to 365 days.

Financial services economic service provided by the finance industry

Financial services are the economic services provided by the finance industry, which encompasses a broad range of businesses that manage money, including credit unions, banks, credit-card companies, insurance companies, accountancy companies, consumer-finance companies, stock brokerages, investment funds, individual managers and some government-sponsored enterprises. Financial services companies are present in all economically developed geographic locations and tend to cluster in local, national, regional and international financial centers such as London, New York City, and Tokyo.

A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield.

Mortgage-backed security security

A mortgage-backed security (MBS) is a type of asset-backed security which is secured by a mortgage or collection of mortgages. The mortgages are sold to a group of individuals that securitizes, or packages, the loans together into a security that investors can buy. The mortgages of a MBS may be residential or commercial, depending on whether it is an Agency MBS or a Non-Agency MBS; in the United States they may be issued by structures set up by government-sponsored enterprises like Fannie Mae or Freddie Mac, or they can be "private-label", issued by structures set up by investment banks. The structure of the MBS may be known as "pass-through", where the interest and principal payments from the borrower or homebuyer pass through it to the MBS holder, or it may be more complex, made up of a pool of other MBSs. Other types of MBS include collateralized mortgage obligations and collateralized debt obligations (CDOs).

Financial risk Any of various types of risk associated with financing

Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent.

Real estate investing involves the purchase, ownership, management, rental and/or sale of real estate for profit. Improvement of realty property as part of a real estate investment strategy is generally considered to be a sub-specialty of real estate investing called real estate development. Real estate is a asset form with limited liquidity relative to other investments, it is also capital intensive and is highly cash flow dependent. If these factors are not well understood and managed by the investor, real estate becomes a risky investment.

Financial market participants

There are two basic financial market participant categories, Investor vs. Speculator and Institutional vs. Retail. Action in financial markets by central banks is usually regarded as intervention rather than participation.

Asset and liability management is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting.

The Feldstein–Horioka puzzle is a widely discussed problem in macroeconomics and international finance, which was first documented by Martin Feldstein and Charles Horioka in a 1980 paper. Economic theory assumes that if investors can easily invest anywhere in the world, acting rationally they would invest in countries offering the highest return per unit of investment. This would drive up the price of the investment until the return across different countries is similar.

The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal banking regulations. The phrase "shadow banking" contains the pejorative connotation of back alley loan sharks. Many in the financial services industry find this phrase offensive and prefer the euphemism "market-based finance".

This article provides background information regarding the subprime mortgage crisis. It discusses subprime lending, foreclosures, risk types, and mechanisms through which various entities involved were affected by the crisis.

References

  1. O'Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 551. ISBN   0-13-063085-3.
  2. Gurusamy, S. (2008). Financial Services and Systems 2nd edition, p. 3. Tata McGraw-Hill Education. ISBN   0-07-015335-3
  3. "Back to Basics: What Is Money? - Finance & Development, September 2012". www.imf.org. Retrieved 2016-01-10.
  4. Allen, Franklin; Gale, Douglas (2000-01-01). Comparing Financial Systems. MIT Press. ISBN   9780262011778.
  5. Indian Financial System, Gordon, 21st page
  6. Indian Financial System, Gordon, 24th page
  7. Indian Financial System, Gordon, 125th page
  8. Development and Regulation of Non-Bank Financial Institutions. The World Bank. 2002-03-05. doi:10.1596/0-8213-4839-6. ISBN   978-0-8213-4839-0.
  9. "Online Manual - BSA InfoBase - FFIEC". www.ffiec.gov. Retrieved 2016-01-10.
  10. "Accounting for Financial Instruments". www.fasb.org. Retrieved 2016-01-10.
  11. "Understanding Derivatives: Markets and Infrastructure". Federal Reserve Bank of Chicago. Retrieved 2016-01-10.