1 introduction to the financial system what is financial system? a financial system consist of...
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Introduction to the Financial System
What is financial system?• A financial system consist of institutional units and markets that interact, typically in a
complex manner, for the purpose of mobilizing funds for investment, and providing facilities, including payment system, for financing of commercial activity.
• The collection of markets, institutions, laws, regulations, and techniques through which bonds, stocks, and other securities are traded, interest rates are determined, and financial services are produced and delivered around the world.
• The role of financial institutions within the system is primarily to intermediate between those that provide the funds and those that need the funds, and typically involves transforming and managing risk.
• Financial markets provide a forum within which financial claims can be traded under established rules of conduct, and can facilitate the management and transformation risk. They also play important role in identifying market prices (price discovery). (IMF(http//:IMF.ORG., Nov.2004)
• Its primary task is to move scarce loanable funds from those who save to those who borrow to buy goods and services and to make investments in new equipment and facilities so that the global economy can grow and increase the standard of living enjoyed by its citizens.
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Circular Flow of Income, Payments, and Productionin the Global Economic System
Producing units (mainly business firms and
governments)Consuming units (mainly
households)
The basic function of the economic system is to allocate scarce resources – land, labor, management skill, and capital – to produce the goods and services needed by society.
The global economy generates a flow of production in return for a flow of payments.
The circular flow of production and income is interdependent and never ending.
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The Role of Markets in the Global Economic System
• Most economies around the world rely principally upon markets to carry out the complex task of allocating scarce resources.
• The marketplace is dynamic. It determines what goods and services will be produced and in what quantities through their prices.
• Markets also distribute income by rewarding superior producers with increased profits, higher wages, and other economic benefits.
• There are essentially three types of markets within the global economic system. The factor markets allocate factors of production (land, labor, skills, capital) and
distribute income (wages, rent) to the owners of productive resources. Consuming units use most of their income from factor markets to purchase goods and
services in the product markets. The financial markets channel savings to those individuals and institutions needing
more funds for spending that are provided by their current incomes.
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Types of Markets
Producing units (mainly business firms
and governments)Consuming units
(mainly households)
Flow of funds (savings)Flow of financial
services, income, and financial claims
Financial marketsFlow of p
roduction
Product markets
Goods and servicesFlow of paymen
ts
Flow of payments for
consumption and taxes
Flow of incomes
Flow of incomes Factor markets
Productive s
ervice
s
Productive services
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Financial SystemFinancial System
Households Firms Government
Borrowers
Households Firms Government
Savers
Returns
Funds
Returns
Funds
Funds
Returns
Returns
Funds
Transfer of funds in the financial system
Source: Hubbard (2005)
Government Involvement
Financial Intermediaries
Financial Market
Infrastructure and Environtment
Infrastructure and Environtment
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RiskSharing
Information
Financial System
Financial Market
Financial Intermediaries
Liquidity
Funds
Returns
Funds
ReturnsFirms Governmen
ts
Households Firms Governments
BorrowersHouseholds
Savers
The role of financial system
Source: Hubbard (2005)
Issues: •Asymmetric information•Moral Hazard•Adverse Selection
Issues: •The Law of large number•Pooled Information•Free Riding
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The Global Financial System:Channel for Savings and Investment
Flow of financial services, incomes, and financial claims
Demanders of funds (mainly business firms
and governments)
Flow of loanable funds (savings)Suppliers of
funds (mainly households)
• Nature of savings Households: current income – tax payments – consumption expenditures Businesses: retained earnings Governments: current revenues – expenditures
• Nature of investment Households: purchase of a home Businesses: expenditures on capital goods and inventories Governments: building/maintaining public facilities
• The financial markets enable the exchange of current income for future income and the transformation of savings into investment so that production, employment, and income can grow, and living standards can improve.•The suppliers of funds to the financial system expect not only to recover their original funds but also to earn additional income as a reward for waiting and assuming risk.
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Functions Performed by the Global Financial System and the Financial Markets
• Savings function. The global system of financial markets and institutions provides a conduit for the public’s savings.
• Wealth function. The financial instruments sold in the money and capital markets provide an excellent way to store wealth.
• Liquidity function. Financial markets provide liquidity for savers who hold financial instruments but are in need of money.
• Credit function. Global financial markets furnish credit to finance consumption and investment spending.
• Payments function. The global financial system provides a mechanism for making payments for goods and services, in the form of currency, checking accounts, debit cards, credit cards, digital cash, etc.
• Risk protection function. The financial markets offer protection against life, health, property, and income risks, by permitting individuals and institutions to engage in both risk-sharing and risk reduction.
• Policy function. The financial markets are a channel through which governments may attempt to stabilize the economy and avoid inflation.
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Financial Intermediaries
Source: Chatterji (2001)
Commercial BanksCommercial Banks
Securities Companies (Investment Banks)
Securities Companies (Investment Banks)
InsuranceInsurance
Pension FundPension Fund
MultifinanceMultifinance
MicrofinanceMicrofinance
Pawn ShopPawn Shop
- Saving and Loan Products - other fee based products
- Saving and Loan Products - other fee based products
Brokerage, Trading and securities transaction, Underwriting, investment management (including mutual fund), asset management,
financial advisory
Brokerage, Trading and securities transaction, Underwriting, investment management (including mutual fund), asset management,
financial advisory
- Life Insurance- General insurance
- Reinsurance
- Life Insurance- General insurance
- Reinsurance
- Defined Benefit and Defined Contribution - Defined Benefit and Defined Contribution
- Leasing, Consumer Financing, credit cards, and Factoring - Leasing, Consumer Financing, credit cards, and Factoring
- SME Financing, personal financing - SME Financing, personal financing
- Personal Financing- Personal Financing
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Money market vs Capital market
Primary vs secondary markets.(Financial capital is raised when new securities are sold in the primary markets. Security trading in the secondary markets then provides liquidity for the investors)
Open vs Negotiated markets(In open markets, financial instruments are sold to the highest bidder, and they can be traded as often as is desirable before they mature.In negotiated markets, the instruments are sold to one or a few buyers under private contract.)
Spot vs Futures, Forward, and Option markets(In the spot market, assets are traded for immediate delivery (usually within one or two business days). A futures or forward market is designed to trade contracts calling for the future delivery of financial instruments. Options markets enable contracts that grant the right to buy or sell certain securities at specific prices within a certain time to be traded Organized vs Over-the-counter markets
Stock vs debt (fixed income) marketsForeign exchange marketsInternational vs domestic markets
Types of financial markets
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•Capital market instruments - long-term maturity (more than 1 year)- corporate stock- corporate bonds- government bonds- municipal bonds- eurobonds- mortgages
Money market instruments – short-term maturity (less than 1year)- treasury bills (T-Bills)- negotiable certificate of deposits (NCDs)- bankers’ acceptance - commercial paper- federal funds- eurocurrencies- Sertifikat Bank Indonesia
Financial market instruments
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Factors Tying All Financial Markets Together
• Credit, the common commodity. The shifting of borrowers among markets helps to weld the financial system together and to balance the costs of credit in the different markets.
• Speculation and arbitrage. Speculators who gamble on their market forecasts and arbitrageurs who watch for profitable arbitrage opportunities help to level out prices and maintain price consistency among the markets.
• Perfect and efficient markets. There is some research evidence suggesting that financial markets are closely tied to one another due to their near perfection and efficiency.
• Financial markets in the real world. In the real world however, market imperfection and information asymmetry exist.
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Types of Financial Intermediaries
in the US
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Sistem Keuangan di Indonesia
Sistem Keuangan
Sistem Keuangan
Sistem MoneterSistem Moneter
Di luar Sistem Moneter
Di luar Sistem Moneter
Otoritas MoneterOtoritas Moneter Bank IndonesiaBank Indonesia
Bank UmumBank UmumPerbankanPerbankan
BPRBPR
Lembaga Pembiayaan
Lembaga Pembiayaan
Lembaga Lainnya
Lembaga Lainnya
Modal VenturaModal Ventura
LeasingLeasing
FactoringFactoring
Kartu KreditKartu Kredit
Pembiayaan Konsumen
Pembiayaan Konsumen
AsuransiAsuransi
Dana PensiunDana Pensiun
Pasar ModalPasar Modal
Kantor PosKantor Pos
PegadaianPegadaian
Pialang Pasar UangPialang Pasar Uang
PefindoPefindo
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Ratio of Assets of Financial Intermediaries to GDP of several countries
Indonesia Malaysia Thailand Singapore
AssetsUS$
billion % of GDP US$ billion % of GDPUS$
billion% of GDP
US$
billion % of GDP
Commercial banks 138 56% 166 160% 172 115% 213 233%
Insurance firms 10 4% 20 20% 5 3% 46 50%
Mutual funds 8 3% 21 20% 18 12% 18 20%
Pension funds 4 2% 58 56% 7 5% 60 66%
Stock market capitalization 55 22% 168 162% 119 79% 148 162%
Funds raised through capital market 4 2% 7 7% n/a n/a
GDP 247 104 150 91
Exchange rate 8.441 4 39,7 1,7
Source: Srinivas, PS (2004)
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Structure of Assests of Nonbank Financial Institutions in Indonesia
2001 2002 2003
Investasi Amount % Amount % Amount %
Pension Funds
- Bank deposits 23 69 28 69 27 57
- SBI 0 1 0 0 1 1
- Shares 2 5 2 4 2 4
- Corporate bonds 3 10 5 12 9 19
- Government bonds 0 0 0 0 2 4
- Direct investment 2 7 0 0 2 5
- Land & Buildings 2 7 2 6 2 3
- Mutual funds 0 1 1 1 2 4
- Others 0 1 3 7 1 3
Total 34 100 40 100 47 100
Insurance
- Bank deposits 31 59 37 58 35 44
- SBI 1 3 1 1 1 1
- Shares 1 2 3 4 4 5
- Bonds 5 9 10 16 21 27
- Direct investment 4 7 4 6 5 6
- Land & Buildings 1 2 2 3 2 2
- Mutual funds 4 7 1 2 3 4
- Others 6 11 6 9 8 11
Total 53 100 64 100 80 100
Source: Srinivas, P.S. (2004)
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Banks’ dominance of Indonesia’s Financial System
Keterangan
Tahun 2001 Tahun 2002 Tahun 2003
Asset Kontribusi Asset Kontribusi Asset Kontribusi
Bank Umum 1,099.7 88.0% 1,112.2 86.4% 1,213.5 85.1%
Bank Perkreditan Rakyat 4.7 0.4% 6.4 0.5% 9.1 0.6%
Perusahaan Asuransi 64.8 5.2% 77.6 6.0% 94.1 6.6%
Dana Pensiun 34.9 2.8% 41.2 3.2% 49.4 3.5%
Perusahaan Pembiayaan 37.3 3.0% 39.9 3.1% 47.2 3.3%
Perusahaan Sekuritas 6.7 0.5% 7.8 0.6% 10.0 0.7%
Pegadaian 1.8 0.1% 2.4 0.2% 2.7 0.2%
Total 1.249,9 100% 1.287,5 100% 1.426,0 100%
Source : BI, MoF.