“… the institutional mechanism established by society to produce and deliver financial- services and allocate resources, consisting of the business firms supplying financial services, the customers of financial- service firms, and government regulatory authorities that enforce the rules prevailing within the financial sector.”

“… the instruments, institutions, markets, and rules governing the conduct of trade that expedite the routing of funds from buyers to sellers and from savers to lenders.”

“ in which funds are traded between borrowers and lenders.”

Functions of Financial System

Is supplied by the financial system to three types of borrowers: (1) consumers. (2) business, and (3) government.

Takes the forms of currency, checking accounts, and various transactions

Is artificially created by the financial system through the services, of supplying credit and providing a mechanism for making payments.

The financial system serves as a venue for saving. This is made through the means of accepting deposits and loan agreements with the use of various financial instruments.

Are the evidences of debt that are brought and sold in the market. They consists of money, loans (debts), and ownership shares.

Consisting of financial markets and financial institutions;

Is a mechanism by which savings in one sector of the economy flows to another sector.

Is an organization through which funds in the form of money or claims in money are assembled and transferred from individuals with surplus funds to other individuals and firms needing extra funds.

Components of Financial System

Financial Sector

Are two important segments of the economy. The services provided by intermediaries in the financial system make the interactions more brisk and productive.

Income comes from wages, dividends, royalties and interest paid by firms.

The money borrowed by firms is added to their own available funds to be spent on goods and services as investment expenditures.

The ___ have its income coming from taxes paid by households and firms. They also borrow money to purchase buildings, equipment or supplies.

Four sectors of the economy which are engaged in borrowing and lending are:

Refers to lending by ultimate borrowers with no intermediary.

Methods of Direct Financing

Refers to the selling of securities by private negotiation directly to insurance companies, commercial banks, pension funds, large-scale corporate investors, and wealthy individual investors.

Is one who acts as an intermediary between buyers and sellers but does not take title to the securities traded.

Is one who is in the security business acting as a principal rather than an agent.

Is a person who provides financial advise and who underwrites and distributes new investment securities.

Also called financial intermediation. refers to lending by an ultimate lender to a financial intermediary that then relends to ultimate borrowers. Financial intermediaries include commercial banks, mutual savings banks, credits unions, life insurance companies, and pension funds.

The Benefit of Financial Intermediation

Can substantially reduce transaction costs. This happens because they have developed expertise in lowering costs and also because the large number of transactions provide economies of scale.

As individual borrowers may engage in undesirable activities after taking the loan, the lenders who directly provide funds will be at a disadvantage. Such risk of not getting paid back because of changes in the behavior of borrowers is called moral hazard.

Several kinds of intermediation performed by financial intermediaries:

This refers to the intermediation performed by financial intermediaries where the large-denomination claims in the form of loans and securities are accepted from borrowing customers while simultaneously issuing relatively low-denomination financial instruments to savers to attract as many savers as possible and pool their funds to make the large-denomination loans requested by the borrowing customers.

This refers to the intermediation performed by the financial intermediary where risky claims in the form of loans and securities are accepted against borrowing customers while simultaneously issuing relatively safe financial instruments to savers to attract their funds.

This refers to the practice of borrowing comparatively short-term funds from savers and making long-term loans to borrowers who require a lengthy commitment of funds.

Refers to the process by which financial intermediaries substitute their skill in the marketplace for that of savers who frequently have neither the time nor the access to relevant information about market conditions and investment opportunities.

Categories of Financial Intermediaries

They are called as such because the sources of their loanable funds (secondary securities) consist of deposits received from businesses, households, and governments included in this group are commercial banks, credit unions , savings and loans associations, and savings banks.

This type enter into contracts with their customers to promote saving and/or financial protection against loss of life or property.

These are called as such because they depend heavily on other financial intermediaries like commercial banks for loanable funds.

This type offers the public securities that can be held indefinitely as a long-term investment and which can be sold quickly when the customer needs his funds returned. ___ include mutual stock funds, bond funds, and money market funds.