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
Credit
Services
finance

Functions of Financial system

Financial Institutions- act as

mobilisers and depositories of saving
and as the custodian of finance.
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

Classifications of Financial
Institutions

Banks
Stock Brokerage Firms
Non Banking Financial Institutions
Building Societies
Asset Management Firms
Credit Unions
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.

Financial Markets

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

Price Determination
Information Aggregation and
Coordination
Risk Sharing
Liquidity
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.

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
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.

Determinants of supply of funds

Aggregate savings by the household

sector
Aggregate savings by the business
sector
Aggregate savings by the
government

Determinants of demand for funds

Investment in fixed and circulating

capital (working capital)
Demand for consumer durables
Investment for housing

Theories on savings and

investment

Prior Savings Theory- Samuelson

Credit Creation Theory- Kalecki and
Schumpeter
Theory of forced Savings- Keynes and
Tobin
Financial Regulation theory- Stiglitz
Financial Liberalisation TheoryMckinnon and Shaw

Prior Savings Theory- Samuelson

Saving as a Prerequisite for Investment

Appropriate monetary and fiscal policy
Generate high rate of inflation
Controlled by interest rate
Role of financial system to promote
financial development-transformation like
Liability- Asset transformation
Size- transformation
Risk- transformation
Maturity- transformation

Credit Creation Theory

Credit creation in anticipation to

saving
Investment through credit creation
results in prompt income generation

Theory of forced Savings

Other wise known as inflationary

financing through forced savings
It is the saving that determines the
investment- monetary expansion
Four channels for monetary expansionif 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
Government interventions makes
them function better
Lowering interest rates and credit
programmes

Financial Liberalisation Theory

In the form of interventions, political

pressures
Financial liberalisation, privatisation.