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Function & Structure of FIM

The document discusses several key topics related to financial markets: 1. The basic function of financial markets is to channel funds from savers to borrowers. This can occur directly through markets or indirectly through financial institutions. 2. Distinctions between commercial banks, investment banks, and insurance companies have blurred in recent decades. 3. Indian banks perceived threats from disintermediation in the 1990s but ultimately grew substantially over the following decade. 4. Financial markets are structured around debt/equity and primary/secondary markets. Regulations aim to increase information, ensure stability, and aid monetary policy.

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Aniket Gupta
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181 views

Function & Structure of FIM

The document discusses several key topics related to financial markets: 1. The basic function of financial markets is to channel funds from savers to borrowers. This can occur directly through markets or indirectly through financial institutions. 2. Distinctions between commercial banks, investment banks, and insurance companies have blurred in recent decades. 3. Indian banks perceived threats from disintermediation in the 1990s but ultimately grew substantially over the following decade. 4. Financial markets are structured around debt/equity and primary/secondary markets. Regulations aim to increase information, ensure stability, and aid monetary policy.

Uploaded by

Aniket Gupta
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Function of Financial Markets

Basic Function: Channeling of funds from savers (households, firms and government) to borrowers, including investors Borrowers can borrow directly from savers, say households, by selling them securities (financial instruments) e.g. selling bonds via the bond markets. Historically, the indirect route was being adopted of going through a financial institution say a bank. The world is now changing with the bigger borrowers taking the direct route more often. This disintermediation has huge implications for the players involved

Blurring of the Distinction


In the context of what we have just discussed, think of the dramatic way in which the business mix of the financial institutions say in the US has changed over the past few decades the blurring of the distinction between the products offered by the commercial banks, investment banks and insurance companies

Threat perceived by Indian banks during the 90s


With the stock markets picking up huge momentum in the 90s, the commercial banks had felt gravely threatened. They felt that they would get bypassed on account of disintermediation, with Mutual Funds & insurance Companies, taking away the resources and the big borrowers going direct to the market

Look at what actually happened in India during the last decade, 1999-2009
The aggregate loan book of commercial banks went up from Rs 4 trillion to Rs 29.41 trillion CD ratio of the banks went up from 53.3% to 70.3% The assets and net profits of Axix Bank, ICICI & HDFC Bank went up by much more than 10 times and the assets and net profits of SBI, PNB and BOB went up by more than 3 to 4 times.

Structure of Financial Markets


Debt and Equity Markets
Most common way of raising money in the market is by issuing a debt instrument a bond or a mortgage Short term maturity of less than one year Intermediate term of maturity between one and ten years Long term maturity of ten years or longer The other - less used - option is of issuing equity Total value of equities in the US has fluctuated between $1 and $20 trillion since the 70s The value of the debt instruments ($35.1 trillion at the end of 2004) was more than 50% larger than the value of equities in the US ($15.9 trillion at the end of 2004)

Structure of Financial Markets


Primary and Secondary Markets Primary Market Investment Bank assists in the sale of securities in the primary market. It does it by underwriting securities it guarantees a price for a corporations securities and then arranges to sell them to the public

Secondary Market NYSE is the best known example of an exchange As per Wikipedia, as at the end of 2008, the size of the international bond market was an estimated $67.0 trillion, of which the size of the outstanding U.S. bond market was $33.5 trillion. Nearly all of the $923 billion average daily trading volume (as of early 2007) in the U.S. bond market takes place between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges. Other examples are foreign exchange markets, futures markets and options markets Brokers, as agents of investors, and dealers, who buy and sell securities, are important players in the secondary markets

Primary and Secondary Markets

Structure of Financial Markets


Exchanges and Over-the-counter Markets

Organized exchanges NYSE for stocks, and CBOT (Chicago Board of Trade) for commodities, like wheat, corn, silver, gold, are best known examples of organized exchanges

Exchanges and Over-the-counter Markets


OTC market The other way of organizing a secondary market is to have an OTC market, in which dealers at different locations have an inventory of different securities and stand ready to buy and sell securities over the counter to anyone who comes to them and is willing to accept their prices. Because the OTC dealers are in computer contact and know the prices set by one another, the OTC market is very competitive, and not very different in this regard from a market with an organized exchange

Structure of Financial Markets


Money and Capital Markets

Money market: Only short term debt instruments (original maturity of less than 1 year) are traded Capital market: Market in which longer term debt (original maturity of one year or greater) and equity instruments are traded

Internationalization of Financial Markets


Before the 80s, the US financial markets were much larger than markets outside the US In recent years the dominance of US markets has been disappearing American corporations and banks are now more likely to tap international capital markets to raise funds and American investors seek investment opportunities abroad Similarly, corporations from other countries raise funds from Americans, and foreigners have become important investors in the US

Foreign Bonds
Foreign bonds are sold in a foreign country and are denominated in that countrys currency. For example, if a German carmaker sells a bond in the US, denominated in USD, it will be a foreign bond As another example, a large percentage of US railroads built in the 19th century were financed by sale of foreign bonds in Britain

Euro Bond
Euro Bond: A bond denominated in the currency other than that of the country, in which it is sold. An example: A bond denominated in USD sold in London

Eurocurrencies/Eurodollars
Eurocurrencies are foreign currencies that are deposited in banks, outside of the home country The most important of the eurocurrencies, the eurodollars, are US dollars deposited in foreign banks outside the US, or in foreign branches of US banks

The Euro confusion


A bond denominated in euros is called a eurobond only if it is sold outside the countries that have adopted the euro In fact, most bonds issued by euro zone entities are not denominated in euros but instead denominated in USD Eurodollars have nothing to do with euros, or for that matter with Europe, but are instead US dollars deposited in banks outside the US

World Stock markets


While NYSE had been the leading SE for a long time, currently the list is headed by NYSEEuronext. The relative importance of the other major markets has been growing Nasdaq OMX, Tokyo SE, Shanghai, Shenzhen, London are among the other major stock exchanges

Financial Intermediation
The process of moving funds from savers to borrowers While the media focus is on the securities markets, in particular the stock markets, the financial intermediaries are a far more important source of finance for corporations

Transaction costs & economies of scale


Financial intermediaries can substantially reduce transaction costs because they have developed the expertise and their large size enables them to take advantage of economies of scale

Risk Sharing
Financial Intermediaries promote risk sharing by helping individuals to diversify

Asymmetric information
An additional reason for the importance of financial intermediaries

What is asymmetric information? An additional reason for the importance of financial intermediaries is that in financial markets, one party often does not know enough about the other party to make accurate decisions .This inequality is called asymmetric information.

Problems arising due to asymmetric information


Adverse selection is the problem created by asymmetric information before the transaction occurs. An example of the above: all other things being equal, you as a lender are more likely to entertain a worse risk as it would be more persistent in chasing you for loan than a better risk Moral hazard is the problem created by asymmetric information after the transaction occurs An example of that would be a borrower engaging in undesirable activity from a lenders point of view Financial Intermediaries can alleviate these problems by developing processes for better assessment of credit risks and monitoring loans

Financial Intermediaries
1. Depository Institutions (In US these are Commercial Banks and thrifts) Commercial Banks Savings & Loans Associations Mutual Savings Banks Credit Unions 2. Contractual Savings Institutions Life Insurance Companies Fire & casualty Insurance companies Pension funds & Government Retirement Funds 3. Investment Intermediaries Finance Companies Mutual Funds Money Market Mutual Funds

Regulation of the US Financial System


The financial system is among the most regulated sectors of the US economy The main regulatory agencies/subjects of regulation are:
Securities & Exchange Commission-organized exchanges & fin mkts Commodities Futures & Trading Commission-futures exchanges Office of the Controller of the Currency-federally chartered com banks National Credit Union Administration-federally chartered credit unions State Bkg & Insurance Commissions-state chartered dep institutions Federal Deposit insurance Corporation-Com banks, mutual saving banks, savings and loans associations Office of Thrift supervision-savings and loans associations Federal Reserve System-All depository institutions

Why regulations?
Increasing the information available to investors
The stock market crash of 1929 led to the Securities Act of 1933 and establishment of the SEC The SEC requires corporations issuing securities to disclose certain information, restricts trading by the largest stockholders (known as insiders) in the corporation

Ensuring the soundness of financial intermediaries


Regulations have been imposed on the intermediaries in regard to restrictions on their entry into business, disclosures by them, restrictions on assets & activities, insurance of deposits by FDIC (created in 1934) & other agencies, limits on opening of branches and locations, restrictions on interest rates

Improving control of monetary policy


Reserve requirements etc.

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