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Introduction to the Financial System
What is financial system?
•
A financial system consist of institutional units and markets that interact, typically in a
complex manner, for the purpose of mobilizing funds for investment, and providing
facilities, including payment system, for financing of commercial activity.
•
The collection of markets, institutions, laws, regulations, and techniques through
which bonds, stocks, and other securities are traded, interest rates are determined,
and financial services are produced and delivered around the world.
•
The role of financial institutions within the system is primarily to intermediate between
those that provide the funds and those that need the funds, and typically involves
transforming and managing risk.
•
Financial markets provide a forum within which financial claims can be traded under
established rules of conduct, and can facilitate the management and transformation
risk. They also play important role in identifying market prices (price discovery).
(IMF(http//:IMF.ORG., Nov.2004)
•
Its primary task is to move scarce loanable funds from those who save to those who
borrow to buy goods and services and to make investments in new equipment and
facilities so that the global economy can grow and increase the standard of living
enjoyed by its citizens.
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Circular Flow of Income, Payments, and Production
in the Global Economic System
The basic function of the
economic system is to allocate
scarce resources – land, labor,
management skill, and capital –
to produce the goods and
services needed by society.
Producing units (mainly
business firms and
governments)
The circular flow of
production and income is
interdependent and never
ending.
Consuming units (mainly
households)
The global economy generates
a flow of production in return for
a flow of payments.
2
The Role of Markets in the Global Economic System
•
•
•
•
Most economies around the world rely principally upon markets to carry out
the complex task of allocating scarce resources.
The marketplace is dynamic. It determines what goods and services will be
produced and in what quantities through their prices.
Markets also distribute income by rewarding superior producers with
increased profits, higher wages, and other economic benefits.
There are essentially three types of markets within the global economic
system.



The factor markets allocate factors of production (land, labor, skills, capital) and
distribute income (wages, rent) to the owners of productive resources.
Consuming units use most of their income from factor markets to purchase goods
and services in the product markets.
The financial markets channel savings to those individuals and institutions needing
more funds for spending that are provided by their current incomes.
3
Types of Markets
Product markets
Financial markets
Producing units
(mainly business firms
and governments)
Flow of funds (savings)
Flow of financial
services, income, and
financial claims
Consuming units
(mainly households)
Factor markets
4
Transfer of funds in the financial system
Financial System
Returns
Funds
Financial
Market
Returns
Funds
Government
Involvement
Households
Firms
Government
Households
Savers
Firms
Government
Borrowers
Funds
Returns
Financial
Intermediaries
Funds
Returns
Infrastructure and
Environtment
Source: Hubbard (2005)
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The role of financial system
Risk
Sharing
Funds
Financial System
Financial
Market
Financial
Intermediaries
Returns
Household
s
Firms
Savers
Source: Hubbard (2005)
Funds
Returns
Governmen
ts
Issues:
•The Law of large number
•Pooled Information
•Free Riding
Liquidit
y
Households
Firms
Borrowers
Information
Governmen
ts
Issues:
•Asymmetric information
•Moral Hazard
•Adverse Selection
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The Global Financial System:
Channel for Savings and Investment
Demanders of
funds (mainly
business firms
and governments)
Flow of loanable funds (savings)
Flow of financial services,
incomes, and financial claims
Suppliers of funds
(mainly
households)
• Nature of savings
Households: current income – tax payments – consumption expenditures
Businesses: retained earnings
Governments: current revenues – expenditures
• Nature of investment
Households: purchase of a home
Businesses: expenditures on capital goods and inventories
Governments: building/maintaining public facilities
• The financial markets enable the exchange of current income for future income and the transformation of
savings into investment so that production, employment, and income can grow, and living standards can
improve.
•The suppliers of funds to the financial system expect not only to recover their original funds but also to earn
additional income as a reward for waiting and assuming risk.
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Functions Performed by the Global Financial System
and the Financial Markets
•
•
•
•
•
•
•
Savings function. The global system of financial markets and institutions
provides a conduit for the public’s savings.
Wealth function. The financial instruments sold in the money and capital
markets provide an excellent way to store wealth.
Liquidity function. Financial markets provide liquidity for savers who hold
financial instruments but are in need of money.
Credit function. Global financial markets furnish credit to finance
consumption and investment spending.
Payments function. The global financial system provides a mechanism for
making payments for goods and services, in the form of currency, checking
accounts, debit cards, credit cards, digital cash, etc.
Risk protection function. The financial markets offer protection against life,
health, property, and income risks, by permitting individuals and institutions
to engage in both risk-sharing and risk reduction.
Policy function. The financial markets are a channel through which
governments may attempt to stabilize the economy and avoid inflation.
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Financial Intermediaries
Commercial Banks
- Saving and Loan Products
- other fee based products
Securities Companies
(Investment Banks)
Brokerage, Trading and securities transaction, Underwriting,
investment management (including mutual fund), asset management,
financial advisory
Insurance
- Life Insurance
- General insurance
- Reinsurance
Pension Fund
- Defined Benefit and Defined Contribution
Multifinance
- Leasing, Consumer Financing, credit cards, and Factoring
Microfinance
- SME Financing, personal financing
Pawn Shop
- Personal Financing
Source: Chatterji (2001)
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Types of financial markets
Money market vs Capital market
Primary vs secondary markets.
(Financial capital is raised when new securities are sold in the primary markets. Security trading in the secondary
markets then provides liquidity for the investors)
Open vs Negotiated markets
(In open markets, financial instruments are sold to the highest bidder, and they can be traded as often as is
desirable before they mature.In negotiated markets, the instruments are sold to one or a few buyers under private
contract.)
Spot vs Futures, Forward, and Option markets
(In the spot market, assets are traded for immediate delivery (usually within one or two business days). A futures
or forward market is designed to trade contracts calling for the future delivery of financial instruments. Options
markets enable contracts that grant the right to buy or sell certain securities at specific prices within a certain time
to be traded
Organized vs Over-the-counter markets
Stock vs debt (fixed income) markets
Foreign exchange markets
International vs domestic markets
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Financial market instruments
•Capital market instruments - long-term maturity (more than 1 year)
- corporate stock
- corporate bonds
- government bonds
- municipal bonds
- eurobonds
- mortgages
Money market instruments – short-term maturity (less than 1year)
- treasury bills (T-Bills)
- negotiable certificate of deposits (NCDs)
- bankers’ acceptance
- commercial paper
- federal funds
- eurocurrencies
- Sertifikat Bank Indonesia
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Factors Tying All Financial Markets Together
•
Credit, the common commodity. The shifting of borrowers among markets
helps to weld the financial system together and to balance the costs of
credit in the different markets.
•
Speculation and arbitrage. Speculators who gamble on their market
forecasts and arbitrageurs who watch for profitable arbitrage opportunities
help to level out prices and maintain price consistency among the markets.
•
Perfect and efficient markets. There is some research evidence
suggesting that financial markets are closely tied to one another due to
their near perfection and efficiency.
•
Financial markets in the real world. In the real world however, market
imperfection and information asymmetry exist.
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Types of Financial
Intermediaries
in the US
13
Sistem Keuangan di Indonesia
Otoritas Moneter
Bank Indonesia
Bank Umum
Perbankan
Sistem Moneter
BPR
Sistem
Keuangan
Modal Ventura
Leasing
Di luar
Sistem Moneter
Lembaga
Pembiayaan
Factoring
Kartu Kredit
Pembiayaan
Konsumen
Asuransi
Dana Pensiun
Pasar Modal
Lembaga
Lainnya
Pefindo
Pegadaian
Pialang Pasar Uang
Kantor Pos
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Ratio of Assets of Financial Intermediaries
to GDP of several countries
Indonesia
Assets
US$
billion
Malaysia
Thailand
US$
billion
Singapore
% of
GDP
US$
billion
% of GDP
US$ billion
% of GDP
138
56%
166
160%
172
115%
213
233%
10
4%
20
20%
5
3%
46
50%
Mutual funds
8
3%
21
20%
18
12%
18
20%
Pension funds
4
2%
58
56%
7
5%
60
66%
Stock market
capitalization
55
22%
168
162%
119
79%
148
162%
4
2%
7
7%
n/a
n/a
Commercial
banks
Insurance firms
Funds raised
through capital
market
GDP
Exchange rate
247
104
150
91
8.441
4
39,7
1,7
Source: Srinivas, PS (2004)
% of GDP
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Structure of Assests of Nonbank Financial Institutions in Indonesia
2001
Investasi
Amount
2002
%
Amount
2003
%
Amount
%
Pension Funds
- Bank deposits
23
69
28
69
27
57
- SBI
0
1
0
0
1
1
- Shares
2
5
2
4
2
4
- Corporate bonds
3
10
5
12
9
19
- Government bonds
0
0
0
0
2
4
- Direct investment
2
7
0
0
2
5
- Land & Buildings
2
7
2
6
2
3
- Mutual funds
0
1
1
1
2
4
- Others
0
1
3
7
1
3
34
100
40
100
47
100
31
59
37
58
35
44
- SBI
1
3
1
1
1
1
- Shares
1
2
3
4
4
5
- Bonds
5
9
10
16
21
27
- Direct investment
4
7
4
6
5
6
- Land & Buildings
1
2
2
3
2
2
- Mutual funds
4
7
1
2
3
4
- Others
6
11
6
9
8
11
53
100
64
100
80
100
Total
Insurance
- Bank deposits
Total
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Source: Srinivas, P.S. (2004)
Banks’ dominance of Indonesia’s Financial System
Tahun 2001
Tahun 2002
Tahun 2003
Keterangan
Asset
Kontribusi
Asset
Kontribusi
Asset
Kontribusi
1,099.7
88.0%
1,112.2
86.4%
1,213.5
85.1%
Bank Perkreditan Rakyat
4.7
0.4%
6.4
0.5%
9.1
0.6%
Perusahaan Asuransi
64.8
5.2%
77.6
6.0%
94.1
6.6%
Dana Pensiun
34.9
2.8%
41.2
3.2%
49.4
3.5%
Perusahaan Pembiayaan
37.3
3.0%
39.9
3.1%
47.2
3.3%
Perusahaan Sekuritas
6.7
0.5%
7.8
0.6%
10.0
0.7%
Pegadaian
1.8
0.1%
2.4
0.2%
2.7
0.2%
1.249,9
100%
1.287,5
100%
1.426,0
100%
Bank Umum
Total
Source : BI, MoF.
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