Introduction to Financial Institutions and Markets Financial System- implies a set of Complex and closely connected institutions, markets, transactions, agents, practices, claims and liabilities in a economy

What is the financial system concerned with? Money Money Credit Credit Services Services finance finance

Functions of Financial system Financial Institutions- act as mobilisers and depositories of saving and as the custodian of finance. Financial Institutions- act as mobilisers and depositories of saving and as the custodian of finance. Provides various financial services to the society. Provides various financial services to the society.

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

Classifications of Financial Institutions 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 Companies Insurance Companies

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

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

Six basic functions of financial markets Borrowing and Lending Borrowing and Lending Price Determination Price Determination Information Aggregation and Coordination Information Aggregation and Coordination Risk Sharing Risk Sharing Liquidity Liquidity Efficiency Efficiency

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

Categorization of Financial Instruments Cash instruments :are financial instruments whose value is determined directly by markets. They can be divided into securities, which are readily transferable, and other cash instruments such as loans and deposits, where both borrower and lender have to agree on a transfer Cash instruments :are financial instruments whose value is determined directly by markets. They can be divided into securities, which are readily transferable, and other cash instruments such as loans and deposits, where both borrower and lender have to agree on a transfersecuritiesloansdepositssecuritiesloansdeposits Derivatives instruments: are financial contracts, or financial instruments, whose prices are derived from the price of something else Derivatives instruments: are financial contracts, or financial instruments, whose prices are derived from the price of something else

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

Determinants of supply of funds Aggregate savings by the household sector Aggregate savings by the household sector Aggregate savings by the business sector Aggregate savings by the business sector Aggregate savings by the government Aggregate savings by the government

Determinants of demand for funds Investment in fixed and circulating capital (working capital) Investment in fixed and circulating capital (working capital) Demand for consumer durables Demand for consumer durables Investment for housing Investment for housing

Theories on savings and investment Prior Savings Theory- Samuelson Prior Savings Theory- Samuelson Credit Creation Theory- Kalecki and Schumpeter Credit Creation Theory- Kalecki and Schumpeter Theory of forced Savings- Keynes and Tobin Theory of forced Savings- Keynes and Tobin Financial Regulation theory- Stiglitz Financial Regulation theory- Stiglitz Financial Liberalisation Theory- Mckinnon and Shaw Financial Liberalisation Theory- Mckinnon and Shaw

Prior Savings Theory- Samuelson Saving as a Prerequisite for Investment Saving as a Prerequisite for Investment Appropriate monetary and fiscal policy Appropriate monetary and fiscal policy Generate high rate of inflation Generate high rate of inflation Controlled by interest rate Controlled by interest rate Role of financial system – to promote financial development-transformation like Role of financial system – to promote financial development-transformation like Liability- Asset transformation Liability- Asset transformation Size- transformation Size- transformation Risk- transformation Risk- transformation Maturity- transformation Maturity- transformation

Credit Creation Theory- Credit creation in anticipation to saving Credit creation in anticipation to saving Investment through credit creation results in prompt income generation Investment through credit creation results in prompt income generation

Theory of forced Savings Other wise known as inflationary financing – through forced savings Other wise known as inflationary financing – through forced savings It is the saving that determines the investment- monetary expansion It is the saving that determines the investment- monetary expansion Four channels for monetary expansion- if the resources are unemployed, if resources are fully employed, inflation changes income distribution among the profit earners, inflation imposes taxes Four channels for monetary expansion- if the resources are unemployed, if resources are fully employed, inflation changes income distribution among the profit earners, inflation imposes taxes

Financial Regulation theory- Financial markets are prone to market failures Financial markets are prone to market failures Government interventions makes them function better Government interventions makes them function better Lowering interest rates and credit programmes Lowering interest rates and credit programmes

Financial Liberalisation Theory- In the form of interventions, political pressures In the form of interventions, political pressures Financial liberalisation, privatisation. Financial liberalisation, privatisation.