Financial System

is like the heart of the human beings, if it stops working then the
person is dead in the same way that if the financial system stops
working, then the economy would collapse

It is inherent in every society the law of supply and demand. There will
always be those who have surplus resources and others will have deficit.
Financial System is crucial to the allocation of these resources.

a network of various institutions, together with government agencies, laws

and policies, which generates, circulates and controls money and credit.

-provides link between the lenders and borrowers of money

finances the socioeconomic programs of the country

Philippine Setting

Financial System is composed of banking institutions and nonbank

financial intermediaries, including commercial banks, specialized
government banks, thrift banks and rural banks. It is also
composed of offshore banking units, building and loan associations,
investment and brokerage houses and finance companies. The
Bangko Sentral ng Pilipinas and the Securities and Exchange
Commission maintained the regulatory and supervisory control.
Assessment
The Philippine financial system manifested its strength over the past decade, including
the period of recent global financial crisis

After significant dislocations in prior crises in the 1980s and 1990s as well as the 1997
Asian Financial Crisis, the system saw a steady improvement in the balance sheet of the
banking industry, the issuance and listing of corporate bonds, and the underwriting of
insurance contracts.

Moving forward, however, the system will need to address concerns about the
sustainability of its performance if it is to contribute significantly to development.

Parallel to these, policymakers pursued broad-based financial sector reforms centered on

restructuring the banking sector, institutionalizing corporate governance reforms, improving
risk management and strengthening the supervisory oversight of financial regulators1 in the
early 2000s
Assessment
The Philippine financial system manifested its strength over the past decade, including
the period of recent global financial crisis

Together with improved macroeconomic conditions, the steady inflow of remittances

from OFWs, a minimal investment exposure to foreign structured products and a low
dependence on exports, these reforms allowed the financial system to avoid the worst
difficulties encountered by other economies during the 2007- 2008 financial crisis.

The financial system’s performance has been positively reviewed by third parties.
Stress tests conducted on banks also confirm the strength of the banking system’s
capitalization even with extreme test parameters.

For inclusive finance advocacy, local supervisory initiatives have also been repeatedly
acknowledged by international institutions. These external validations of the
improvements in the financial sector culminated in the sovereign ratings or outlook
upgrades from some the major ratings firms.
Current Structure of the Financial System
The Philippine financial system is primarily bank-based rather than capital market-
based. The banking sector, whose total assets accounted for more than 80 percent
of the total resources of the financial systems and of GDP in 2010, plays the
primary role in financial intermediation and is the main source of credit in the
economy

Across banking groups,

universal and commercial
banks continued to hold the
lion’s share of key balance
sheet accounts of the banking
system on account of their
market maturity, branch
network and capitalization.
The comparative market
shares of key banking groups
Current Structure of the Financial System
The market share of nonbank financial institutions remains relatively small, accounting for
about 18 percent of total assets of the financial system and 17 percent of economic output in
2010

The Insurance Commission (IC), for instance, reports that only 13.9 percent of the
Philippine population has private life insurance coverage.

In 2008, the private insurer’s penetration rate or the proportion of the premiums to the
country’s GDP was only 1.1 percent

Among the reasons cited for the low insurance coverage is the lack of priority being
placed on insurance products by the citizenry and the low financial literacy level among low
income households including the informal sector.
Current Structure of the Financial System
The insurance industry’s total assets reached P528.2 billion as of end- December 2009
with 122 market players. Life insurers captured the bulk of the insurance market at
79% while nonlife insurers at 19% and professional reinsurers at 2 percent.
Current Structure of the Financial System

Meanwhile, the number of companies listed in the Philippine Stock Exchange (PSE) grew to
259 companies in 2011 from just 12 companies in 2003. Despite the rise in the number of
listed companies, market capitalization as a percentage of economic output remained small
(except Indonesia) compared to other ASEAN-5 economies. In 2009, market capitalization
dropped to 45.8 percent of GDP from 54 percent in 2002. This reflects that the market
remains illiquid and the free float of listed companies in the PSE still limited.

Mutual funds, with market size likewise smallest in Asia,5 are managed by broker-
dealers and investment companies where largest of them in terms of asset size are
either subsidiaries or affiliates of banks.
History of Financial System

1754 The first credit institution in the Philippines, "The ObrasPias" was started
by Father Juan Fernandez de Leon

1820 ended

1851 first Philippine Bank was established, the "Banco Espanol-Filipino de Isabela
II". Banco Español-Filipino de Isabela II is now known as Bank of the
Philippine Islands.

It is the oldest standing bank in the Philippines and in the whole of Southeast
Asia

It was established on August 1, 1851 and named after the mother of then
Spanish King Alfonso XII. Her mother's name was Isabella.

The bank only came into being after 23 years after Spanish Monarch
Ferdinand VII decreed that a public bank was to be established in the
Spanish colonized country of the Philippines
History of Financial System

1852 The bank began its operations and was the honor of being the first to
issue paper money

1906 "First Agricultural Bank of the Philippines" was established

1916 all of its assets and liabilities were transferred to the newly organized
Philippine National Bank.
Functions of Financial Institutions
-the general function of financial institutions is to facilitate the transfer
of funds from the savers to the users.

Specific functions of financial institutions:

 Matching supply and demand for funds

 Investigation and credit analysis

 Provisions of liquidity

 Provides payments system

Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
A. Private Banking Institutions
1. Universal Bank (UB) or Expanded Commercial Bank (EB)
Any commercial bank, which performs the investment house function in addition to its
banking authority, It may invest in equities of allied and non-allied enterprise. Allied enterprise
may either be financial or non-financial.

2. Commercial Bank or Domestic Bank (KB)

Is any commercial bank that is confined only to commercial bank function such as accepting
drafts and issuing letter of credit, discounting and negotiating promissory notes, drafts and
bills of exchange, and other evidence of debt, accepting or creating demand deposits, receiving
other types of deposits and deposits substitute, buying and selling foreign exchange, and gold
silver bullions. Acquiring marketable bonds and other debt securities, and extending credit
subject to such rules that the Monetary Board may promulgate.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
A. Private Banking Institutions
3. Thrift Banks (TB)
shall include savings and mortgages banks, stocks savings and loan associations and private
development banks. Their function is to accumulate the savings of depositors and invest them
together with their capital, loans, secured by bonds. Mortgages in real estate and insured
improvements thereon, chatter mortgages.

other forms of
1. security or loans for personal
2. household finance, whether secured or unsecured
3. financing for home building and home development;
4. readily marketable debts securities
5. commercial papers
6. Account Receivables
7. drafts, bills of exchange
8. acceptance or notes arising out of commercial transactions
9. other investment and loans which the Monetary Board may determine as necessary in the
furtherance of national economic objective.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
A. Private Banking Institutions
3. Thrift Banks (TB)
a. Stock Savings and Mortgage (SSMBfi)
any corporation organized for the purpose of accumulating the savings of depositors and investing them,
together with its capital, in readily marketable bonds and debt securities; checks, bills of exchange,
acceptances or notes arising our of commercial transactions or in loans secured by bonds, mortgages or
real estate and insured improvements thereon and other forms of security or in loans for personal or
households finances whether secured or unsecured, and financing for home building and home
development.

b. Private Development Bank-PDB (Planters Development Bank-Plantersbank)

is a bank that exercise all the powers and assumes all the obligations of the savings and mortgages bank
as provided in the General Banking Act except as otherwise stated. The private development bank helps
construct, expand and rehabilitate agriculture and industrial sectors. The Development Bank of the
Philippines is the counterpart of the Private Development bank and helps the private development banks
augment their capitalization as provided under RA 093 as amended.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
A. Private Banking Institutions
3. Thrift Banks (TB)
c. Stock Savings and Loan Association (SLA)
is any corporation engaged in the business of accumulating the savings of its members or stockholders
and using such accumulated funds, together with its capital for loans and investment in securities of
productive enterprise or in securities of the government and its instrumentalities, provided that they
are primarily engaged in servicing theThe Philippines
needs uses the Torrens
of households system of personal
by providing land finance and long term
registration. Under this system, a Torrens title is
financing for home building and development
conclusive against third parties, including the
4. Rural Bank (RB) government. A holder of a Torrens title in good
faith ispurchased
FRIAR LANDS. Were guaranteedby
that
thehis/her title is
any bank authorized by the Central Bank to accept deposits andimprescriptible.
make credit available to farmers.
government forindefeasible,
sale to actualunassailable
occupantsandunder
businessmen and cottage the industries
provisions ofin
Actthe rural
1120 areas.
or the Loans maybe granted by the rural
Friar Lands
bank on the security of land without
Act. These landsTorrents titlelands
are not public where but the owner of private property
privatepeaceful
can show five (5) years or more and patrimonial lands of the
continuous and uninterrupted possessions
government.
of the land in the concept of ownership.
This will include portions of friar land estate or other lands administered by the Bureau of
Lands that are covered by sale of contracts and purchases and have paid at least five (5)
installment thereon, without the necessity of prior approval and consent of the Director
of Land or portions of other estates under the administration of the Department of
Agrarian Reform.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
A. Private Banking Institutions
5. Cooperative Bank
are banks established to assist the various cooperative by lending those funds at
reasonable interest rates.
B. Government Banks or Specialized Government Bank
1. Development Bank of the Philippines
a. Provides loans for development purposes
b. Gives loans to the agricultural sector, commercial sector and the industrial sector.
2. Land Bank of the Philippines
Provides Financial support in the implementation of the agrarian Reform Program
(CARP) of the government.
3. Al-Amanah Islamic Investment Bank
Republic Act no. 6048
-Authorized the bank to promote and accelerate the socio-economic development of Autonomous
Region of Muslim Mindanao by performing banking, financing and investment operations and to
establish and participate in agriculture, commercial and industrial ventures based on the Islamic concept
of banking
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
Non-banking Institutions- Private Institutions
1. Investment House- any enterprise which engages in underwriting of securities of other corporation.
-generates Income from sales of investments in securities.

2. Investment Bank – do not take in deposits and until very recently lent directly to households provide
advice to firms issuing stocks and bonds or considering mergers with other firms.
- Underwriting>Guarantee a price to a firm issuing stocks or bonds and then makes
a profit by selling the stocks or bonds at a higher price.

3. Financing Company- any business enterprise where the primary purpose is to extend credit facilities
to consumers and to industrial, commercial or agricultural industries, either by
discounting or factoring commercial papers or accounts or by buying installment
contracts, leases, chattel mortgages, or other evidence of indebtedness or by
by leasing motor vehicles, heavy equipment and industrial machineries and
business and office equipment, appliance and other movable properties.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
Non-banking Institutions
4. Securities Dealer- Any person or entity engaged in the business of buying and selling securities for his
own or it’s client.
-making profit from the difference between the purchase prices and selling prices
of securities.
5. Savings and Loan Associatoin (SLAs)– Traditionally served individual savers and residential and
commercial mortgages borrowers, accumulate funds of many small savers, and
then lend this money to home buyers and other types of borrowers.
- Most significant economic functions: “create liquidity”
- reduce transaction costs and increase the availability of real estate loans.

6. Pawnshops – persons or entities engaged in the business of lending money with personal property,
jewelry and other durable goods and COLLATERAL for the loans given.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
Non-banking Institutions
7. Lending Investor- Any person or entity engaged in the business of affecting securities transactions
giving loans and earns interest from them.

8. Pension Funds – retirement plans funded by corporation or government agencies for their workers
and administered primarily by the trust department of commercial bank or by life
insurance companies.
- invest primarily in bonds, stocks, mortgages and real estate

9. Trust Department/Companies – persons

Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
Non-banking Institutions
10. Insurance Companies- take savings in the form of annual premium, then invest these funds in
stocks, bonds, real estate, and mortgages, and finally make payments to
beneficiaries.

11. Credit Unions – Cooperative association whose members have a COMMON BOND
- CHEAPEST source of funds available to individual borrowers.
Structure of the Philippine Financial System
Bangko Sentral ng Pilipinas
Non-banking Institutions- Government
1. Government Service Insurance System (GSIS)
Provides retirement benefits, housing loans, personal loans, emergency and calamity loans to
government employees.

2. Social Security System (SSS)

Provides retirement benefits, housing loans, personal loans, emergency and calamity loans to
employees who are working in private companies.

3. PAG-IBIG
provides housing loans to both government and private employees.
THE EVOLVING PHILIPPINE FINANCIAL SYSTEM
The Financial System continues to experience growth against a backdrop of strengthening domestic
economy.
Political reforms , i.e. tax reforms and greater infrastructure spending are projected to drive the domestic
growth as these lead to higher spending by both government and household.

The domestic economy is also seen to gain from momentum of global economic recovery.

However, despite the positive outlook for the Philippines, there are internal and external development
that pose downside risk to the domestic financial system.

To counteract the downside risk and smooth functioning of the Philippines financial system more
stringent initiatives are being pursued by the three regulatory agencies, namely:

1. Bangko Sental ng Pilipines (BSP)

2. Securities and Exchange Commission (SEC)
3. Insurance Commission (TC)
 Bangko Sentral Ng Pilipinas

The Bangko Sentral ng Pilipinas (English: Central Bank of the Philippines;

sometimes, Spanish: Banco Central de Filipinas) and abbreviated as BSP is the
central bank of the Philippines
Chronology of Events: Central Banking in the Philippines

1900 Act No. 52 was pas​sed by the First Philippine Commission placing all banks
under the Bureau of Treasury. The Insular Treasurer was authorize​d to supervise
and examine banks and banking activities.

February 1929 The Bureau of Banking under the Department of

Finance took over the task of banking supervision.

1939 A bill establishing a central bank was drafted by

Secretary of Finance Manuel Roxas and approved
by the Philippine Legislature. However, the bill was
returned by the US government, without action, to
the Commonwealth Government.
Chronology of Events: Central Banking in the Philippines

1946 A joint Philippine-American Finance Commission was

created to study the Philippine currency and banking
system. The Commission recommended the reform of
the monetary system, the formation of a central bank
and the regulation of money and credit.

The charter of the Central Bank of Guatemala was chosen

as the model of the proposed central bank charter.

August 1947 A Central Bank Council was formed to review the

Commission’s report and prepare the necessary
legislation for implementation.
Chronology of Events: Central Banking in the Philippines

February 1948 President Manuel Roxas submitted to Congress a bill

“Establishing the Central Bank of the Philippines, defining
its powers in the administration of the monetary and
banking system, amending pertinent provisions of the
Administrative Code with respect to the currency and the
Bureau of Banking, and for other purposes.

15 June 1948 The bill was signed into law as Republic Act No. 265
(The Central Bank Act) by President Elpidio Quirino.
Chronology of Events: Central Banking in the Philippines

3 January 1949 The Central Bank of the Philippines (CBP) was

inaugurated and formally opened with Hon. Miguel
Cuaderno, Sr. as the first governor.

The broad policy objectives contained in RA No. 265

guided the CBP in the implementation of its duties and
responsibilities, particularly in relation to the promotion of
economic development in addition to the maintenance of
internal and external monetary stability.
Chronology of Events: Central Banking in the Philippines

November 1972 RA No. 265 was amended by Presidential Decree No.

72 to make the CBP more responsive to changing
economic conditions.

PD No. 72 emphasized the maintenance of domestic

and international monetary stability as the primary
objective of the CBP. Moreover, the CBP’s authority
was expanded to include not only the supervision of
the banking system but also the regulation of the entire
financial system.

January 1981 Further amendments were made with the issuance

of PD No. 1771 to improve and strengthen the
financial system, among which was the increase in
the capitalization of the CBP from P10 million to
P10 billion.
Chronology of Events: Central Banking in the Philippines

1986 Executive Order No. 16 amended the Monetary

Board membership to promote greater harmony and
coordination of government monetary and fiscal
policies.

3 July 1993 Republic Act No. 7653 was passed establishing the
Bangko Sentral ng Pilipinas (BSP), replacing CBP as
the country's central monetary authority.

14 February 2019 Republic Act No. 11211 was passed amending RA

No. 7653. The charter amendments bolster the
capability of the BSP to safeguard price stability
and financial system stability.
 Bangko Sentral Ng Pilipinas - Roles and Responsibilities
As prescribed by the New Central Bank Act, the main functions of the Bangko
Sentral are:
1.Liquidity Management, by formulating and implementing monetary policy aimed at influencing
money supply, consistent with its primary objective to maintain price stability,

2.Currency issue; the BSP has the exclusive power to issue the national currency. All notes and
coins issued by the BSP are fully guaranteed by the Government and are considered legal tender
for all private and public debts,

3.Lender of last resort, by extending discounts, loans and advances to banking institutions for
liquidity purposes,

4.Financial Supervision, by supervising banks and exercising regulatory powers over non-bank
institutions performing quasi-banking functions,

5.Management of foreign currency reserves, by maintaining sufficient international reserves to

meet any foreseeable net demands for foreign currencies in order to preserve the international
stability and convertibility of the Philippine peso,

6.Determination of exchange rate policy, by determining the exchange rate policy of the
Philippines. Currently, the BSP adheres to a market-oriented foreign exchange rate policy, and

7.Being the banker, financial advisor and official depository of the Government, its political
subdivisions and instrumentalities and GOCCs.
Financial Reforms

In 1980, a series of laws were introduced amending the:

 General Banking Act
 Savings and Loan Associations Act
 Private Development Banks Act
 Charter of the Development Bank of the Philippines
 Investment Houses Act
 Central Bank Act

These package of reforms in the financial system are part of the recommendations of IMF-
CB Group in 1972.
The objectives of the 1980 financial reforms are:
 To attain greater efficiency through increased competition and scale of economies
 To obtain greater availability and use of long-term funds

To achieve such objectives, the following reforms became necessary for implementations:
 Introduction of universal banking
 Removal of most ceilings on interest rates of deposits and loans
 Increase of the powers and functions of quasi-banks
 Elimination of all functional distinctions between private development banks and saving
banks
 Minimization of the difference between banks and quasi-banks
What is Money?
Money is ANYTHING that is commonly used and generally accepted as a medium of
exchange or as a standard of value.

Functions of Money
1. Medium of exchange
Barter- refers to the exchange of goods with goods or services. A term used
when money is no money.

2. Standard of Value
a. Money measures the value of a product or service. Such economic values are stated in
monetary terms as prices.
b. Exchange of goods or services can only take place if the value of goods and services has
been established.
Functions of Money

3. Store of Value
Money which is not spent constitutes savings. It is retained for a number of days, weeks or
even years. It does not lose its value or purchasing power – except for inflation. During
inflation, many people are discouraged to keep or save their money. They prefer to buy
jewelry, appliances or real states. A great increase in prices of goods and services
automatically decrease the value of money or its purchasing power.
The Development of Money

With the discovery of the properties of metals, man invented a superior kind of monetary medium
such as gold, silver, copper, tin and iron.

The first known coins – those of Lydia in Asia Minor – were composed of gold and silver and
believed to have been struck about the year 700 B.C.

Paper money first appeared in China about the beginning of the 8th century. However, issues
similar to paper money were used even long before the invention of paper by China during the
2nd century.

In Philippines, earlier coins were the gold “piloncito” of pre-Spanish times and the famous
Spanish “Pieces of Eight” of pirate lore used in the Galleon Trade.

At present, we have the Central Bank Security Printing Plant, Mint and Gold Refinery Complex. It
prints paper money, bank notes, checks, and other related security instruments; it mints coins
(including LRT token coins) and it refines gold and silver.
Monetary Standards
Is the Philippine peso backed by gold?
After the United States took control of the Philippines,
the United
The monetary standards of a country States Congress
are synonymous passedmoney.
with its standard the Philippine
The monetary
Coinage
system of a country is usually described Actofofits1903,
in terms established
standard money. If the unit of currency
the standard monetary
to be a theoretical gold peso (not coined) consisting of
unit is gold, the country is said to have a gold standard. If the standard money is silver, it is silver
12.9 grains of gold 0.900 fine (0.0241875 XAU),
standard. If the standard money is theequivalent
inconvertible
to paper
₱2,640 or managed
as of 22 currency,
December it is2010.
inconvertible
standard or managed currency standard.

Money Supply

Money supply refers to money in circulation. It is the money which is used in purchasing
goods and services. This forms of money are cash, checks, and other liquid financial
instruments. Money supply is composed of:
 Currency circulation ( paper money and coins issued by the Central Bank)
 Demand deposit or checking account (checks)
 Savings and time deposits
 Large negotiable certificates of deposits (CDs) at commercial banks.
Monetary Theory

Monetary theory analyzes the role of money in the economic system. A monetary theory
explains the causes of the rise or fall of prices.

Monetary theory is simply the theory of the value of money. Value of money refers to its
purchasing power. There is a popular monetary theory which is the quantity theory of
money of the classical economists.

Such theory is explained in the ff. equation of exchange:

MV = PQ

M is the quantity of money or money supply

Q is the number of goods and services

P is the average price level of goods and services

V is the income velocity of money or the number of
times money us spent in one year.
Monetary Theory

The classical economists believed that velocity is stable. Therefore, if money supply (M)
increases with velocity being stable, total spending on goods and services will increase
(PQ). So according to the classical economists, money is the key determinant of aggregate
demand or total demand. Based on this theory, an increase in money supply leads to an
increase in purchases of goods and services. Such conditions stimulates more investments
and then employment and production. Eventually, it will be economic prosperity
Credit Credit is a vital tool of economic development for both individuals
and countries.

Credit is not only favorable to the borrowers but it also benefits other
individuals and eventually the whole economy and society.

Nevertheless, the most important point in the administration of credit

is its social impact.
Bases of Credit

Credit

-means trust. Credit refers to the ability to acquire

Latin word creditum something of value like goods, services, money or
securities at the present time in return for a promise to
pay at a certain future time.
Credit

In granting credit owners to borrowers, there are bases in evaluating their ability to pay and willingness
to pay:
 Character- refers to the personal integrity of the borrower
 Capacity-this has something to do with the managerial ability of the borrower
 Capital-refers to the resources owned by the borrower such as priorities
 Collateral- this is a safety measure for the payment of the loan
 Condition- conditions in the community, industry or the whole economy affect the ability of
borrowers to pay their loans.
Credit
Advantages of a Credit Economy

1. Allows business firms to acquire cash loans by using their machines or buildings as security, instead of selling
a part of their physical properties to obtain money.

2. Dynamic and enterprising men have the opportunity to put up their enterprises through credit.

3. Government projects or programs can be funded through bonds or loans.

4. Credit accelerates production, employment, income and consumption.

5. Permits low-income consumers to enjoy the consumption of goods and services sooner, like
house and lot, appliances, and other consumer products.
Credit
Disadvantages of a Credit Economy
1. Heavy borrowing by the governments my likely lead into inflation.
2. Borrowing by the government may result to extravagance and
inefficiency.
3. Business errors in the use of credit funds have unfavorable chain effects
on the whole economy.

4. Excessive loans from other countries by the government may likely to be a

burden to future generation, unless such loans are wisely invested in the
economy for the benefits of the masses

5. In some cases, credit reduces future consumptions of debtors.

Money Market

refers to the network of

corporations, financial
institutions, investors and
governments which deal with
the flow of short-term capital.
Money Market
When a business needs cash for a couple of
months until a big payment arrives, or when
a bank wants to invest money that
depositors may withdraw at any moment, or
when a government tries to meet its payroll
in the face of big seasonal fluctuations in tax
receipts, the short-term liquidity
transactions occur in the money market.
Money Market
Investors can place their money on
deposit with investment companies that
offer competitive interest rates without
requiring a long-term commitment.

Many borrowers can sell short-term

debt to the same sorts of entities,
also at competitive rates, rather than
negotiating loans from bankers
Money Market
The money markets are the mechanism that
brings these borrowers and investors together
without the comparatively costly
intermediation of banks. They make it possible
for borrowers to meet short-run liquidity
needs and deal with irregular cash flows
without resorting to more costly means of
raising money
Money Market
There is an identifiable money market for
each currency, because interest rates
vary from one currency to another. These
markets are not independent, and both
investors and borrowers will shift from
one currency to another depending upon
relative interest rates
Money Market

However, regulations limit the ability of

some money-market investors to hold
foreign-currency instruments, and most
money-market investors are concerned to
minimize any risk of loss as a result of
exchange-rate fluctuations. For these
reasons, most money-market transactions
occur in the investor’s home currency
Money Market
The money markets do not exist in a particular
place or operate according to a single set of rules.
Nor do they offer a single set of posted prices, with
one current interest rate for money. Rather, they
are webs of borrowers and lenders, all linked by
telephones and computers. At the centre of each
web is the central bank whose policies determine
the shortterm interest rates for that currency
Money Market
Arrayed around the central bankers are the treasurers
of tens of thousands of businesses and government
agencies, whose job is to invest any unneeded cash as
safely and profitably as possible and, when necessary,
to borrow at the lowest possible cost. The connections
among them are established by banks and investment
companies that trade securities as their main
business. The constant soundings among these diverse
players for the best available rate at a particular
moment are the force that keeps the market
competitive.
Money Market–Financial Crisis 2007
felt strongly in the money markets.

Money-market investors tend to be highly risk averse; that is,

they value the absolute safety of their funds more than the
higher return they would receive for taking risks

As many banks and industrial companies showed signs of

financial distress, investors became concerned about the
accuracy of their accounts and were reluctant to extend credit
even on an extremely short-term basis

The “freezing” of the money markets blocked normal lending

activity in the United States and much of Europe for an
extended period, helping drive those economies into
recession
Money Market–Financial Crisis 2007
Data from the Bank for International
Settlements, which compiles statistics
gathered by national central banks, indicate
that around $13 trillion of money-market
instruments were in circulation worldwide in
2012. This represented a significant drop from
the $14 trillion outstanding in December 2008,
but was still far above the $6 trillion figure at
the end of 2001
What money markets do
There is no precise definition of the money markets, but the
phrase is usually applied to the buying and selling of debt
instruments maturing in one year or less

The money markets are thus related to the bond markets, in

which corporations and governments borrow and lend
based on longer-term contracts.

Similar to bond investors, money-market investors are

extending credit, without taking any ownership in the
borrowing entity or any control over management
What money markets do
A well-functioning money market facilitates the
development of a market for longer-term securities.
Money markets attach a price to liquidity, the availability
of money for immediate investment

The interest rates for extremely short-term use of money

serve as benchmarks for longer-term financial
instruments.

If the money markets are active, or “liquid”, borrowers

and investors always have the option of engaging in a
series of short-term transactions rather than in longer-
term transactions, and this usually holds down
longerterm rates
What money markets do
In the absence of active money markets to set
short-term rates, issuers and investors may have
less confidence that longer-term rates are
reasonable and greater concern about being
able to sell their securities should they so choose

For this reason, countries with less active

money markets, on balance, also tend to have
less active bond markets
Investing in money markets

Short-term instruments are often unattractive to

small investors, because the high cost of learning
about the financial status of a borrower can
outweigh the benefits of acquiring a security with
a life span of three months.

For this reason, investors typically purchase

money-market instruments through funds,
rather than buying individual securities directly.
 Money-Market Funds

Pools of money-market securities, allowing

investor to diversify risk among the various
company and government securities held
by the fund.

Retail money-market funds cater- INDIVIDUAL

Institutional money-market- serve
CORPORATIONS, FOUNDATION, GOVERNMENT
AGENCIES AND OTHER LARGE INVESTORS
Money-Market Funds
are also able to perform the role of intermediation at
much lower cost than banks, because money market
funds do not need to maintain branch offices, accept
accounts with small balances and otherwise deal
with the diverse demands of bank customers..

money-market funds typically are not required to set

aside a portion of investors’ funds to cover possible
losses on investments, enabling them to pay higher
interest rates to investors than banks can
Money-Market Funds
are also able to perform the role of intermediation at
much lower cost than banks, because money market
funds do not need to maintain branch offices, accept
accounts with small balances and otherwise deal
with the diverse demands of bank customers..

money-market funds typically are not required to set

aside a portion of investors’ funds to cover possible
losses on investments, enabling them to pay higher
interest rates to investors than banks can.
Money-Market Funds

The spread between the rate money-market funds pay

investors and the rate at which they lend out these
investors’ money is normally a few tenths of a
percentage point, rather than the spread of several
percentage points between what banks pay depositors
and charge borrowers.
 Money-Market Funds-GFC
The same phenomenon led investors in many countries to
reduce their holdings of money-market assets after 2008,
as interest rates fell to the extent that many money-
market funds were paying annual interest rates well
below 1%.
 STABLE VALUE

money-market funds have attracted investors by

promoting the idea that while interest rates may
fluctuate, the fund’s shares have a fixed value

In the United States, money-market funds typically

maintain a value of $1 per share. This fixed value
makes money-market funds attractive relative to
bank deposits, whose value does not fluctuate from
day to day
 STABLE VALUE
The difficulty with promoting stable value is that the
values of money market securities owned by a fund
may fluctuate. In particular, short-term securities
issued by a company may lose much or all of their
value if the issuer encounters financial distress or
declares bankruptcy.

In such cases, the money-market fund may be able

to maintain its stable value only if the investment
company that operates it puts in sufficient money
to make up for the diminished value of the
securities the fund owns; otherwise, the pershare
value of the fund will need to fall, causing losses for
investors
STABLE VALUE-GFC
The vulnerability of money-market funds proved to be
a problem in 2009, when the failures of certain banks
destroyed the value of their securities held by some
money-market funds.

In some of these cases, funds recognised the losses by

reducing their per-share value below the normal level
– an event known in the United States as “breaking the
buck”.
STABLE VALUE-GFC
Central banks feared that panicked investors would
flee the funds, causing even greater losses to investors
as funds dumped securities and endangering
businesses that routinely sold money-market
securities to meet their cash needs

The US Federal Reserve and some other central banks

stepped in to guarantee the value of money-market
funds for limited periods, effectively giving money-
market investors the same protection generally
accorded to bank depositors
INDIVIDUAL SWEEP ACCOUNTS
The investment companies that operate equity funds
and bond funds usually provide money-market funds
to house the cash that investors wish to keep available
for immediate investment.
 INDIVIDUAL SWEEP ACCOUNTS

People with large amounts of assets often invest in

money-market instruments through sweep accounts.

-These are multipurpose accounts at banks

or stockbrokerage firms,

-with the assets used for paying current bills

-investing in shares and buying mutual

funds
-overnight investments at the end of each day, in
order to earn the highest possible return.
 INSTITUIONAL INVESTORS
Money-market funds are by no means the only investors in money-market
instruments. All sizeable banks maintain trading departments that actively
speculate in short-term securities

1. Investment trusts (mutual funds) that mainly hold bonds or

equities normally keep a small proportion of their assets in
money-market instruments to provide flexibility
 INSTITUIONAL INVESTORS
Money-market funds are by no means the only investors in money-market
instruments. All sizeable banks maintain trading departments that actively
speculate in short-term securities

1. Investment trusts (mutual funds) that mainly hold bonds or

equities normally keep a small proportion of their assets in
money-market instruments to provide flexibility
 INSTITUIONAL INVESTORS

2. Pension funds and insurers, which typically invest with long

time horizons, also invest a proportion of their assets in
moneymarket instruments in order to have access to cash at any
time without liquidating longterm positions
 INSTITUIONAL INVESTORS
Businesses in the United States owned $575 billion of money-
market instruments, including commercial paper and shares in
money-market funds, at June 2013. Certain types of
moneymarket instruments, particularly bank certificates of
deposit, are often owned directly by individual investors.
 INTEREST RATES

Most money-market securities pay interest at a fixed rate, which

is determined by market conditions at the time they are issued.

Some issuers prefer to offer adjustable-rate instruments, on

which the rate will change from time to time according to
procedures laid down at the time the instruments are sold
 INTEREST RATES
Because of their short maturities, most money-market
instruments do not pay periodic interest during their
lifetimes but rather are sold to investors at a discount to
their face value

The investor can redeem them at face value when they

mature, with the profit on the redemption serving in
place of interest payments
INTEREST RATES
 INTEREST RATES

The value of money-market securities changes inversely to changes in

short-term interest rates. Because money-market instruments by nature are
short term, their prices are much less volatile than the prices of longer-
term instruments, and any loss or gain from holding the security in the
short time until maturity rather than investing at current yields is small.
MONEY MARKET INSTRUMENTS
MONEY MARKET INSTRUMENTS
Commercial paper

is a short-term debt obligation of a private-sector firm or a government-

sponsored corporation. In most cases, the paper has a lifetime, or maturity, greater
than 90 days but less than nine months

Commercial paper is usually unsecured, although a particular commercial paper issue

may be secured by a specific asset of the issuer or may be guaranteed by a bank
 MONEY MARKET INSTRUMENTS
Banker’s Acceptance
Were the main way for firms to raise short-term funds in the money markets. An
acceptance is a promissory note issued by a non-financial firm to a bank in return
for a loan. The bank resells the note in the money market at a discount and
guarantees payment. Acceptances usually have a maturity of less than six months.

They do not bear interest; instead, an investor purchases the acceptance at a

discount from face value and then redeems it for face value at maturity

Investors rely on the strength of the guarantor bank, rather than of the issuing
company, for their security
 MONEY MARKET INSTRUMENTS
Treasury Bills

often referred to as T-bills, are securities with a maturity of one year

or less, issued by national governments. Treasury bills issued by a
government in its own currency are generally considered the safest
of all possible investments in that currency. Such securities account
for a larger share of money-market trading than any other type of
instrument
 MONEY MARKET INSTRUMENTS
Negotiable Certificate of Deposits

Time deposits, another name for certificates of deposit or CDs, are

interest-bearing bank deposits that cannot be withdrawn without
penalty before a specified date. Although time deposits may last for
as long as five years, those with terms of less than one year compete
with other money-market instruments. Time deposits with terms as
brief as 30 days are common. Large time deposits are often used by
corporations, governments and money-market funds to invest cash
for brief periods.
 MONEY MARKET INSTRUMENTS
Repos

Repurchase agreements, known as repos, play a critical role in the

money markets. They serve to keep the markets highly liquid,
which in turn ensures that there will be a constant supply of buyers
for new money market instruments.
 MONEY MARKET INSTRUMENTS
Repos

A repo is a combination of two transactions. In the first, a securities

dealer, such as a bank, sells securities it owns to an investor,
agreeing to repurchase the securities at a specified higher price at a
future date. In the second transaction, days or months later, the repo
is unwound as the dealer buys back the securities from the investor.
The amount the investor lends is less than the market value of the
securities, a difference called the haircut, to ensure that it still has
sufficient collateral if the value of the securities should fall before
the dealer repurchases them.
 MONEY MARKET INSTRUMENTS
Repos

For the party selling the security and agreeing to repurchase it in the future, it
is a repo; for the party on the other end of the transaction, buying the security
and agreeing to sell in the future, it is a reverse repurchase agreement.
 How Trading occurs?
Trading in money-market instruments occurs almost entirely over
telephone links and computer systems. The banks and non-bank
dealers in money- market instruments sign contracts, either with
one another or with a central clearing house, committing
themselves to completing transactions on the terms agreed.
 Central bank interest rates

In many countries, central banks can also lend directly to the

money markets by providing credit to financial institutions at
posted rates.

Such loans are mainly for the purpose of helping institutions that
have experienced sudden withdrawals of funds or otherwise face a
lack of liquidity
 Central bank interest rates

Central bank loan rates are often less attractive than those
available in the private sector, so as to encourage financial
institutions to borrow in the money markets before turning to the
central bank
Central bank rates change much less frequently than rates in the
money markets. The main central bank loan rate in the United
States and Japan is called the discount rate.
Watching short-term interest rates
Central banks, governments and investors pay close attention
to short-term interest rates.

Spread

In particular, spreads, the differences in interest rates on

different instruments, are highly sensitive indicators of market
participants’ expectations.
Watching short-term interest rates
Spread-Repos

As repos are fully collateralized, there is almost no risk that

repayment will be disrupted..
Spread- Uncollateralized loans

are at risk if a bank should fail.

The spread between these two types of lending thus reflects

perceived creditworthiness.
Watching short-term interest rates
Overnight Rates

Rates paid on overnight bank deposits also receive close

attention. In some countries this is known as the call rate; in
the euro-zone countries it is called Eonia (euro overnight index
average).

Differences in rates for money-market instruments of different

maturities are among the most sensitive economic indicators.
Watching short-term interest rates
The Prime Rates

The prime rate was established decades ago as the interest rate
charged by banks in the United States to their best corporate
borrowers.

Although big corporate borrowers are no longer affected by the

prime rate, it is the basis for some variable-rate consumer credit,
including creditcard loans and home-equity loans.
Watching short-term interest rates
The Prime Rates

Thus a rise in the prime rate often curtails consumer spending.

The rate, however, changes only infrequently and by increments
of 0.25%, rather than daily in response to immediate money-
market conditions.