Introduction to the Financial System

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Defining the Financial System

This course is made possible through the generous financial support of the Arab Gulf Program for Development (AGFUND). _For more information visit the Global Platform on Financial Inclusion _

Course Objectives By the end of this course, you should be able to: Define the financial system. Describe the elements that make up the financial system. Elucidate the allied (non-principal) financial bodies / entities that assist in facilitating the flow of funds and securities in a financial system. Name and define the sectors of the economy that constitute the non-financial lenders and borrowers.

Defining the Financial System

Every scholar on the financial markets has attempted a definition of the financial system.

Our Definition of the Financial System is: The financial system is a set of arrangements / conventions embracing the lending and borrowing of funds... by non-financial economic units and the intermediation of this function by financial intermediaries in order to facilitate the transfer of funds, to create additional money when required, and to create markets in debt and equity instruments (and their derivatives) so that the price and allocation of funds are determined efficiently.

Elements and Participants of the Financial System | Part 1

In our definition of financial systems, there are six essential elements. This lesson will take you through the six essential elements.

Essential Element Four The Creation of Money The creation of money when required, i.e., the unique money creating ability of banks is essential element four.

Elements and Participants of the Financial System | Part 2

Five key participants are: Brokers and Dealers Fund Managers Financial Exchanges Credit Rating Agencies Financial Regulators

Participant ThreeThe Financial Exchanges The financial exchanges that allow the broker-dealers to facilitate trading in securities, and create the mechanism for clearing and settlement of trades in a risk-minimising manner.

What is the responsibility of the credit rating services?

The Financial System Overview

When a bank makes a new loan, a new deposit is created; this requires a topping up of reserves (R), and this is provided by the central bank.

The money creation element of the financial system is a crucial one in terms of the supply of capital / funding when required by economic agents and of course in terms of monetary policy.

Key Interest rate:

Non-Financial Lenders and Borrowers

It is highly improbable that the savings of (non-financial) economic units will be matched by desired investment.

Some economic units will find that their savings out of income will exceed their planned investment, while others will find themselves in a situation where their savings are insufficient to meet desired internal investment.

For purposes of these accounts, central banks usually define these four sectors as follows: Household Sector Corporate Sector Government Sector Foreign Sector

Household Sector This sector consists of individuals and families, but also includes private charitable, religious and non-profit bodies serving households.

It includes unincorporated businesses such as farmers, retailers and professional partnerships, as the transactions of these businesses cannot be separated from the personal transactions of their owners.

Corporate Sector This sector comprises all companies not classified as financial institutions and therefore covers business enterprises directly or indirectly engaged in the production and distribution of goods and services.

Government Sector This sector consists of the central government, provincial governments (where they exist), local authorities, and non-financial public enterprises.

Foreign Sector This sector comprises all organisations, persons and assets resident or situated in the rest of the world.

Which of the following are considered to be in the government sector?

Introduction to the Financial System: Summary

Non-financial lenders and borrowers

Financial intermediaries

Financial instruments

Creation of money

Financial markets

Price discovery

In addition, there are also allied participants / players / entities in the system, without which the system would not function efficiently.

Participants In The Financial System Brokers and dealers (collectively: broker-dealers) Fund managers Credit rating agencies Financial exchanges Financial regulators

Non-financial lenders and borrowers

Household sector

Government sector

Corporate sector

Foreign sector

Introduction to the Financial System: Quiz