FINANCIAL

INSTITUTIONS AND
SERVICES

Finance Terms
Finance:
The
management of money.

proper

Money: The current medium of

exchange or means of payment.
Credit or Loan: A sum of money
to be returned normally with
interest.

Classification of finance
1. Public finance
It studies the sources of funds of public
authorities such as states, local selfgovernments and the Central
Government.
It is concerned with the income and
expenditure of public authorities and
with the adjustment of one to another.

Contd

Classification of finance
Private finance
An individual
Profit-seeking business organizations
External finance (outside sources)
Direct financing (through issuing securities)
Indirect financing (through middlemen)

Internal finance (ploughing back of profits)

A non-profit organization

Financial system
A
set
of
institutions,
instruments
and
markets
which promote savings and
channel them to their most
efficient use.

Contd

Financial system
Financial
Institutio
ns
Regulator
y

Financial
Markets

Intermediari
es

Banking

NonIntermediari
es

Debt
Market

Financial
Services

(Claims,
assets,
securities)

Other
s

Nonbanking

Equity
Market

Financial
instrument
s

Organis
ed

Unorganised

Primary

Secondary

Capital
Markets

Money
Markets
Derivatives
Market

Primary

Secondary

Short
term

Medium
Term

Long
Term

Financial Institutions
Banking
These are participate in the economys
payments mechanism
Their deposit liabilities constitute a
major part of the national money supply
They can, as a whole, create deposits or
credit, which is money

Financial Institutions
Non-Banking
Lend only out of resources put at their
disposal by the savers.
LIC, UTI, IDBI

Financial Markets
These are the centers or
arrangements that provide facilities
for buying and selling of financial
claims and services.
These are classified into
Primary and secondary markets
Money and capital markets

Primary and Secondary

Markets

Primary Markets

deal in the new financial claims or new

securities (new issue markets)
these are mobilize savings and they supply
fresh or additional capital

Secondary Markets
deal in securities already issued or existing
or outstanding.
these do not contribute directly to the
supply of additional capital

Money and Capital Markets

Both are perform the same
function of transferring
resources to the producers.
Money markets deals short-term
claims
Capital markets deals long-term
claims

Financial Instruments
and Services

Financial asset

A sum of money sometime in future

(repayment of principal) and/or a
period (regular/intervals) payment
in the form of interest or dividend.

Financial instruments

Technology in Financial System

Financial Services will be provided by a wide
variety of institutions.
Small financial service firms will be able to
obtain access to the technologies they will
require to remain viable.
Large number of small, specialized financial
service organizations will prevent the few from
dominating the market.
Networks are permitting electronic fund transfers
from the merchants counter.
Systems providing access to funds from virtually
any place in the Nation and are likely to be in
use in the next few years.
Contd

Technology in Financial System

Advanced communication technologies including
satellite relays, video cable, fiber optics and cellular
radio will find wide application in the financial
service industry.
Decreasing computer costs will create the
opportunity for large numbers of individual
consumers and managers of small businesses to
take advantage of technology in using financial
services.
Large computers will be used to support the data
bases.
Computers that accept voice inputs and recognize
fingerprints may become cost effective for financial
service delivery.

Financial System
instability

Increased cross-border integration and the

presence of large international financial
institutions facilitate the dissemination of
financial shocks across countries.
Financial innovation in products and
markets, together with the existence of
large financial companies facilitate the
transmission
of
financial
shocks
in
domestic financial markets.
Strong growth in asset prices and the
growing importance of household credit are
potential sources of financial instability.

Financial System
Stability

Monitoring and analysis of financial system

developments
Designing and building up financial system
safety nets
Regulation of the banking system
Market Infrastructure
Safety Buffers
Adoption of Common International Standards
Corporate Bonds and Securities Market
Risk management
Market discipline (through prudential regulation
and supervision)

Development Finance Institution (DFI)

It refers to a range of alternative financial
institutions
including
microfinance
institutions,
community
development
financial institution and revolving loan funds.
These institutions provide a crucial role in
providing credit in the form of higher risk
loans, equity positions and risk guarantee
instruments to private sector investments in
developing countries.
The purpose of DFIs is to ensure investment
in areas where otherwise, the market fails to
invest sufficiently.

Subsidies
There are three main forms of
subsidies in the operations of DFIs in
practice
High level of liquidity;
An ability to access technical assistance
funds; and
Subsidies passed on directly to
beneficiaries.

Universal Banking
Universal banking is a combination of
Commercial banking, Investment banking,
Development banking, Insurance and many
other financial activities.
It is a place where all financial products are
available under one roof.
A universal bank is a bank which offers
commercial bank functions plus other
functions such as Merchant Banking, Mutual
Funds, Credit cards, Housing Finance, Auto
loans, Retail loans, Insurance, etc.

Advantages of Universal
Banking

Investors' Trust
Economics of Scale
Resource Utilisation
Profitable
Diversification
Easy Marketing
One-stop Shopping

Disadvantages of Universal
Banking
Different Rules and
Regulations
Effect of failure on Banking
System
Monopoly
Conflict of Interest

Financial
Intermediaries &
Financial Innovation

Financial Institutions
Provider of financial services such as
transforming financial assets in terms of maturity of
liquidity (these arefinancial intermediaries)
trading financial assets for themselves and others
creating financial assets and then selling those
assets on the behalf of customers
giving professional investment advice to others
managing investment portfolios for others

Depository institutions acquire most of their

funds through accepting deposits
Non depository institutions receive funds from
other sources

Role of Financial
Intermediaries
Makedirect
investmentsby
purchasing bonds, stocks or making
loans. These are their assets
Raise money for these investments by
issuing their own financial assets such
as deposits, insurance policies, mutual
fund shares. These are liabilities for
the intermediary and areindirect
investmentsfor the investors.

Asset/Liability
Management
Not all liabilities of financial intermediaries
are created equal! They differ in terms of
the certainty of their amount and timing
Type I liabilities: timing and amount are certain
example: bank fixed rate CD. Bank knows how much
it owes the depositor and when.

Type II liabilities: amount is certain but timing is

not
example: term life insurance policy. Insurance
company knows amount of policy but uncertain when
the policy holder will die.

Asset/Liability
Management
Type III liabilities: amount is not certain but timing is
example: variable rate Certificate of Deposits (CD). Bank
knows the maturity date, but the interest owed is not
known when the CD is issued.

Type IV liabilities: time and amount are uncertain

example: auto insurance policy. The timing and payout
for an auto accident is not known when the policy is
issued.

The type of liabilities created by a financial

intermediary will determine how they invest
their funds (i.e. the type of assets that they
hold)

Financial Innovation
What is it?
creation of new financial assets or new ways to use
financial assets

Why does it happen?

changing circumstances: increased instability in
interest rates, stock prices and exchange rates led to
the development of derivative securities
advances in technology make new trading strategies
feasible
competition among institutions for unique products
and strategies
desire to avoid regulations or tax laws