FINANCIAL SYSTEM

 A financial system is a set of laws, rules and physical structures and procedures that govern
and facilitate all kinds of financial transaction in an economy.
 A well-organized financial system is a pre-requisite to an efficient and well-functioning
economy. Its main purpose is to provide sufficient liquidity that will make the flow of
unhampered business transactions possible.
 A financial system is said to be efficient if people are able to withdraw their deposits through
checks issuance, over-the-counter, or through ATM; if firms do not have to wait for time in
transferring their funds from one account to another; if credit cards are well accepted
instruments in making purchases; if banks have the full trust and confidence of the
depositors.
 FINANCIAL MARKETS
 The essential economics function of channeling funds from savers to net users is performed
by the financial market. It is a reality that some individuals have the ability to save surplus
funds by spending less than their current income.
 The principal lender-savers are households. But business enterprises and governments,
including foreigners and foreign governments, can also turn out to be lender-savers.
Business and governments are the most important borrower spenders, but households also
borrow to make current purchases that are greare on their current income.
 Why is it important to facilitate the flow of funds from savers to users because more often
than not, those who save are not the same individual who have the opportunity and the
entrepreneurial spirit to go into business profitable investments.
STRUCTURE OF FINANCIAL MARKETS
 Debt and Equity Markets. The debt market is the system by which debt instruments maybe bought and
sold. Debt instruments include bonds, commercial papers and others. They normally pay fixed interest earnings
to their holders, and they can be redeemed in full at the date of maturity. A debt instrument is said to be short
terms it its maturity is one year or less; and long-term if its maturity is ten years or more. If it is between more
than one year and less than ten years, then called medium-term debt instruments. Most 1OU's are short-term,
most bonds are long-term, and most commercial papers are medium-term debt instrument.

 The equity market is the system by which equity instruments may be bought and sold. Equity instruments
include shares of stocks (common stocks and preferred shares). Common shares or common stocks are equity
instruments that give holder privilege to fully participate in the earnings, losses and policies of a particular
firm. On the other hand, preferred shares provide its holders with fixed earnings similar to the features of a
debt instrument but they have no maturity, as the debt instruments have. A preferred stock is an evidence of
part-ownership of a firm; a debt have instrument is not.
STRUCTURE OF FINANCIAL MARKETS
 Primary and Secondary Markets. The primary market is the system whereby original or
first time issues of debt and equity instruments are sold to initial buyers by private firms or
government entities that are raising funds directly from the public. The so-called IPO's
(INITIAL PUBLIC OFFERINGS) conducted by private firms prior to their official listing in
the stock exchange is an example of a primary market. An original offering of a newly-issued
bond to the public is another example of primary market. Investments bankers or
underwriters play an important role in working out the mechanics and facilitating primary
issue.

 The secondary market is the system whereby debt and equity instruments that have been
previously 1ssued are actively traded. Securities brokers and dealers play an important role
in facilitating the flow of secondary issues.
 STRUCTURE OF FINANCIAL MARKETS
 Securities and Over the Counter Markets. Securifies Exchange is the place where trading or debt and equity
instruments are made. It haş its own system and rules of trading. Brokers and dealers normally hold its own
office within the vicinity of this place. The Philippines Stock Exchange is an example of this. It has one single
system of trading, but has two trading floors in Ortigas and Ayala.

 An over-the-counter (OTC) market is a system whereby the buyers and sellers of securities meet personally In
one location, normally in the office facilities of a brokerage firm, where they do their buying and selling
activities without formally passing through the facilities and system of the organized securities exchange.

 Money and Capital Markets. Based on the maturity of the securities traded, money market is the system
whereby only short-term debt instruments are traded (e.g., bonds, commercial papers, preferred and common
stocks).
 FINANCIAL INTERMEDIARIES
 The financial intermediaries makes possible indirect finance, as they stand between lender-savers and
borrower-spenders and facilitate the transfer or funds from one to another. This process is called financial
intermediaries. This is the primary route in transferring funds from lender to borrowers.
 Financial intermediaries lower transaction cost, the cost of carrying out financial transaction between lender
and borrower, through the economies- of-scale. This is made possible by huge volume of transaction acted on
then, thus, lowering unit-transaction cost. For example, a commercial bank can hire a lawyer what can draft a
good loan contract which can be used again-and- again by a bank in its lending transaction, or an accountant
who can design an accounting system, that is more or less permanent, in recording its lending and collection
activities. Because of the big volume of transactions, unit cost reduced in both cases.
 Aside from banks, other financial intermediaries include financing companies, investment houses, savings and
loans, lending investors, which normally come from the interest differential between their borrowing and
lending interest rates.
 GROUP OF FINANCIAL INTERMEDIARIES
Financial intermediaries fall under the general supervision of Central Bank and the Securities and Exchange
Commission. Financial intermediaries maybe classified into three major groups:
1. Deposit-Accepting institutions. These are financial intermediaries whose primary function is to accept
deposits from the public to lend funds to households and businesses m exchange for fees in the form of
interests on loans. Examples of these are universal banks. Law allows them to accept from depositors and other
similar deposit-creating accounts.
2. Contractual Savings Institutions. This includes companies, non- life insurance companies, provident fund
companies and other allied businesses.
 Life insurance companies insure people against death and disabilities. Life collect premium payments from policy holder. Unlike in
banks, policy holders cannot just withdraw their savings without the pain of penalty charges. This is because an insurance is a contractual
agreement between the firm and the insured, such that the purpose of premium payments is to protect the holder of policy from death and
disability and not a stand by fund that can be withdrawn anytime at the wishes of the policy holder.

 Non-life insurance companies insure properties and other physical assets of an individual either owned by a person on a company, or
government entity. Premiums paid are also not easily withdrawable.

 Provident fund companies are financial intermediaries that provide for the future needs and benefits of member-savers (e.g., retirement
pension, housing loans, medical benefits, etc.). funds are generated normally by contribution of member-savers. Examples are SSS,
GSIS. private independent provident funds and company-based provident funds.
 GROUP OF FINANCIAL INTERMEDIARIES
Financial intermediaries fall under the general supervision of Central Bank and the Securities and Exchange
Commission. Financial intermediaries maybe classified into three major groups:
3. Investment Intermediaries. These are financial intermediaries that collect funds from small investors to be
pooled together for investments in debt or equity instruments that would otherwise be unaffordable to Small
investors. These include close-end and open-end mutual funds and finance companies.
 Mutual funds, either open-ends or close-end acquire funds by selling shares to individuals and using the
proceeds to buy a well- diversified portfolio of investments in bonds and stocks. The buyers of mutual funds
benefit through a lower transaction cost and expert investment decisions. The values of each fund share is
dependent upon the values of investment portfolio where the funds are invested.
 Open-end funds are redeemable anytime and their values are dependent on the asset value of their
underlying investment portfolio. On the other hand, close-end funds are not redeemable but are freely traded
in the organized market. Their price maybe traded above or below their asset value.
 FINANCIAL SYSTEM
REGULATION OF THE FINANCIAL SYSTEM
Financial systems all over the world are the most heavily regulated sector
government regulates financial markets for three important reasons
1. To increase the information available to investors
2. To ensure soundness of the financial intermediaries
3. To ensure the control of monetary policy
 FINANCIAL SYSTEM
SOUNDNESS OF FINANCIAL INTERMEDIARIES

To protect the investors and the general public, and to maintain financial stability, governments generally implement six types of regulations as
follows:

1. Stringent regulatory requirements to determine individuals and entities who may be allowed to establish and operate a financial intermediary

2. Stringent reporting requirements (e.g.. prescription of government- designed bookkeeping and accounting reports) to make sure that Sufficient
information is made available to the public

3.Putting restrictions on the investing and lending activities of different financial intermediaries, specifying what types of activities of investment
instruments they can put their funds on (e.g., banks, are given strict limitations in risky ventures and in holding risky assets).

4. Insure bank deposits to mitigate financial losses to the public in case of bank failure. In the Philippines, the Philippine Deposit Insurance
Corporation (PDIC) has this mandate. In the US, it's the Federal Deposit Insurance Corporation (FDIC).

5. Restrictions in the bank's bank-branching activity. This is made avoid cutthroat competition among banks, which could lead to Da failures.

6. Restrictions as to the level of interest rates in both the deposit-accepting activity and lending operation. Again, this is done to discourage unbridled
competition among banks, hence, ensure their soundness
 BANKING REGULATION
CATEGORIES OF BANKING REGULATION
There are principally seven categories of banking regulations implemented all over the world. These are as
follows:
 Government Safety Net. Bank depositors, basically do not know the background and personality of borrowers,
only the lending bank does. This creates an asymmetry of information between the bank and its depositors.

 Limits on Competition. An unlimited competition may increase moral hazard for banks to take on more risks to
beat the competition, which in effect may be detrimental to the depositors.

 Separation of Banking and Securities Dealing. Banks are not allowed to underwrite nor to double as securities
dealer or broker. the reason being that securities dealing and brokering are riskier businesses, which may tempt
banks to do moral hazard because of the possibilities 0r greater payoff again to the detriment or depositors.
 BANKING REGULATION
 Capital Requirements and Asset Holdings. Restrictions on the banks capital requirements and asset holdings
are all designed to minimize he possible moral hazard of too much risk-taking by banks.
 Bank Supervision. Banks are supervised by regulations. As to who can operate a bank and how it should be
operated are all part and parcel of the banks regulatory arrangement.
 Requirements for Disclosure. The existence of "free riders in the market, in a way, reduces the incentive for
investors to buy private information about the quality of the assets the bank holds.
 Consumer Protection. The Truth in Lending Act requires banks and other financial intermediaries to provide
100 percent information on cost of borrowing which includes interest loan charges and penalty charges. No
hidden charges are allowed.
 CONTROL OF MONETARY POLICY
 Banks play a central role in the government's monetary policy implementation. They are the conduit in the
government's effort to determine money supply. Hence, numerous regulations are made in this respect. For
example, through the banking system, the Central Bank implements the reserve requirement regulation. It
makes it a legal requirement for banks to set aside a specific portion of their deposit liabilities as cash buffer"
to ensure the Servicing of withdrawals.
 With the Central Bank, the government can increase or decrease the banks Serve requirement based on the
level of business activities and financial transactions in the economy. O In tandem with the Central Bank, the
Philippine Deposit Insurance Corporation (PDIC) (or in the US, the FDIC) gives confidence to the depositors
which can preclude bank-runs and similar events from happening that would girt the financial system and
damage the economy.
 PHILIPPINE GOVERNMENT REGULATION
 In line with the common regulations that are being implemented by other governments to control and regulate their respective
financial systems, the Philippines implements its own set of rules and regulations to maintain the liquidity, stability, and
reliability of its own financial system.
 The primary overseer of the Philippine Financial System is the Bangko Sentral ng Pilipinas that came into being upon the
approval of Republic Act 7653 in 1993.
 As envisioned in the law, it 1is an independent government body Whose mission is to provide liquidity, stability, and reliability of
the local financial system by implementing rules and regulations that will govern and guide the system. It directly supervises
banks and non-banks, and quasi-bank financial institutions (NBQBs). The PDIC has the mandate to insure deposits up to a
certain level (T 500,000 as of this writing).
 The Insurance Commission controls and regulates life and on-life insurance companies, ensuring that the insuring public is
amply protected from fraud and other possible illegal acts of these companies. It promulgates rules and regulations designed to
provide the industry with enough liquidity so that it may be able to settle its financial obligations to the customers at all time.
 The above agencies are the vanguards in the government's effort at ensuring public confidence in the Philippine Financial
System. Specific laws on all existing financial transactions in the Philippines supplements the control and regulatory functions
of these government agencies. These laws are implemented through the mechanism of the Philippine Legal System, and
specially enforced by the Philippine courts.