Chapter 5

Financial System- comprising many different types of private sector financial institutions, including
banks, insurance companies, finance companies, mutual funds and investment banks, all of which
regulated by the government.
Nature and Objective of Financial System

 Financial system consists of all financial intermediaries and financial markets and their relations
with respects to the flows of funds

Indirect finance

Funds
Financial
Funds
Intermediaries

Funds
Lender-Savers Lender-Spenders
Funds Funds
1. Households Financial 1. Business
2. Business Market firms
firms 2. Government
3. Government 3. Households
4. Foreigners Direct Finance 4. Foreigners

Direct Finance- borrowers borrow funds directly from lenders in financial markets by selling them
securities (also called financial instruments).

Key Components of the financial system

1. Financial instruments
2. Financial markets and financial institutions
3. The central bank and other financial regulators

Function of the Financial System

 The main task of the financial system is to channel funds from sectors that have a surplus to
sectors that have a shortage funds.
3 key services that the financial system provides to savers and borrowers
1. Risk sharing

Risk- Is the chance that the value of financial assets will change relative what one expects.

 One advantage of using financial system is to match individual savers and borrowers is that
allows the sharing of risk.

Diversification- The splitting of wealth into many assets to reduce risk.

 The financial system provides risk sharing by allowing servers to hold many assets.
 The ability of financial system to provide risk sharing makes savers more willing to buy stocks,
bonds and other financial asset.

2. Liquidity
-is the ease with which asset can be exchanged for money which savers view as a benefit.
 Assets created by the financial system such as stocks, bonds or checking accounts, are more
liquid than are physical assets.
 Financial markets and intermediaries help make financial assets more liquid
 The financial system has increased the liquidity of many assets besides stocks and bonds through
the process of securitization.

3. Information
-The collection and communication of information or facts about borrowers and expectations to
returns on financial asset.
 Bank collect information on borrowers to forecast their likelihood of repaying loans.
 Financial markets convey information to both savers and borrowers by determining the prices of
stocks, bonds, and other securities.

The Problem of Adverse Selection and Moral Hazard

 A vital service of the financial system is the collection and communication of information or
facts about borrowers and expectations of returns in financial asset.
 Asymmetric information- Describe the situation in which one party to an economic
transaction has better information than does the other party.
2 problems arising from asymmetric information
1. Adverse selection- This is the problem investors experience in distinguishing low-risk
borrowers before making an investment.
2. Moral hazards- this is the problem investors experience in verifying that borrowers are
using finds as intended.

 Financial system helps overcome an information asymmetry between borrowers and lenders.
  An information asymmetry can occur before or after a financial contract has been agreed upon.

Nature and impact of transaction and information cost

Transaction cost- the cost of trade or a financial transaction; for example, the brokerage commission
charged for buying or selling a financial asset.
Information cost- the cost that savers incur to determine the creditworthiness of borrowers and to
monitor how they use the funds acquired.

How financial intermediaries Reduce “Adverse Selection”

1. Requiring borrowers to disclose material information on their financial performance and financial
position.
2. Collecting information in firms and selling that information to investor
3. Convincing lenders to require borrowers to pledge some of their assets as collateral which the
lender can claim if the borrower defaults.

How Financial Intermediaries Reduce Moral Hazard Problems

1. Specializing in monitoring borrowers and developing effective techniques to ensure that the funds
they loan are actually used for their intended purpose.
2. Imposing Restrictive Covenants
How financial Intermediaries Reduce Transaction Costs
1. Financial intermediaries take advantage of economic of scale, which refers to the reduction in
average cost that results from an increase in the volume of a good or service produces.
2. Financial intermediaries can also take an advantage of economies of scale in other ways.
3. Financial intermediaries also take an advantage of technology to provide financial services
4. Financial intermediaries also increasingly rely on sophisticated software to evaluate the credit
worthiness of loan applicants.

Chapter 6
The Philippines Financial System
Structure of the Philippine Financial System
I. Bangko Sentral Ng Pilipinas
II. Banking Institutions
A. Private Banking Institutions
1. Expanded commercial Banks/ Universal Banks (EKB/UB)
  Is any commercial bank, which performs the investment house function in
addition to its commercial banking authority.
2. Commercial Banks (KB)
 Is any commercial bank that is confined only to commercial bank functions
such as accepting drafts and issuing letters of credit, discounting and
negotiating promissory notes, drafts and bills of exchange and etc.
3. Thrift Banks
 Their function is to accumulate the savings of depositors and invest them
together with their capital, loans secured by bonds, mortgage in real estate
and insured improvements thereon, chattel mortgages and etc.
a. Stock Savings and Mortgage Banks (SSMB)
 Is any corporation organized for the purpose of accumulating savings of
depositors and investing them, together with its capital, in readily marketable
bonds and debt securities.
b. Private Development Banks (PDB)
 Is a bank that exercises all the powers and assumes all the obligations of the
savings and mortgage bank as provided in the General Banking Act except as
otherwise stated.
c. Stocks Savings and Loan Associations (SSLA)
 Is any corporations engaged in the business of accumulating the saving of its
members of stockholders and using such accumulated funds, together with its
capital for loans and investment in securities of productive enterprises, or in
securities of the government.
4. Rural Banks (RB)
 Is any bank authorized by the Central Bank to accept deposits and make
credit available to farmers, businessmen and cottage industries in the rural
areas.
5. Cooperative Banks
 Are banks established to assist the various cooperatives by lending those
funds at reasonable interest rates.
B. Government banking institutions
1. Development Bank of the Philippines (DBP)
 Provides loans for developmental purposes, gives loans to the agricultural
sector, commercial sector and the industrial sector.

2. Land bank of the Philippines (LBP)

 Is a government bank, which provides financial support in the
implementation of the Agrarian Reform Program (CARP) of the government.
3. Philippine Al-Amanah Islamic Investment Bank
 Republic Act No. 6048 provides for the charter of the Al- Amanah Islamic
Investment Bank.
III. Non-Bank Financial Institutions
A. Private non-bank financial institutions
1. Investment houses – any enterprise engages in undertaking securities of other
corporation
 2. Investment banks – provides advice to firms issuing stocks and bonds or
considering
mergers with other firms

3. Financing company – business enterprise primary purpose is to extend credit

facilities by discounting/factoring commercial papers/buying

installment contracts

4. Securities dealers/brokers – person or entity buying/selling securities

5. Savings and loan associations - an institution that accepts savings at interest and
lends money to savers chiefly for home
mortgage loans.
“create liquidity” = most significant economic function of S&Ls
6. Mutual funds - company that pools money from many investors and invests the
money
in securities such as stocks, bonds, and short-term debt. The combined
holdings of the mutual fund are known as its portfolio. Investors buy shares
in
mutual funds.
7. Pawnshops – persons/entities lending money with personal property, jewelry and
other durable goods as collateral for the loans given
8. Lending investor – persons/entities effecting securities transactions, giving loans,
and
earns interest from them
9. Pension funds – retirement plans funded by corporations or gov’t agencies for their
workers
10. Insurance companies - take saving in form of annual premiums, then invest these
funds in stocks, bonds, real estate and mortgages and finally make payments to the
beneficiaries of the insured parties
11. Credit union – cooperative associations whose members have a common bond, such
as being employee of the same firm.
- Often are the cheapest source of funds available to the individual
borrowers
B. Government Non-bank financial Institutions
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, funeral benefits,
housing loans, personal loans and calamity loans to employees who are working in
private companies and offers.
3. Pag-Ibig – provides housing loans to both gov’t and private employees. <3
The Evolving Philippine Financial System
The domestic economy is also to seen gain from the momentum of global economic recovery, based on
the upward revisions of growth projections by third party analyst. However, despite the positive outlook
for the PH, there are internal and external developments that pose downside risks to the domestic
financial sytem and to counteract the downside risks…. Here are the…
…4 Regulatory Agencies
1. Bangko Sentral ng Pilipinas (BSP)
2. Securities Exchange and commission (SEC)
3. Insurance Commissions (IC)
4. Philippine Deposit Insurance Commission (PDIC)
SIGNS OF GROWTH IN DOMESTIC MARKET
a. The Philippine banking system reported 11.3% increase at the end of March 2018 amounting to 15.3
trillion
b. Total assets of the insurance industry more than doubled from 2008-2016, posting an 11.2% increase
c. The bond market as of end-March 2018 grew by 7.1% to reach USD 117.2 billion
The securities market also exhibited growth. Equities market registered additional 12 companies bringing
the total listed companies to 268 equivalent to PHP 17.31 trillion market capitalization as of end-October
2017.
REGULATORY LANDSCAPE
A. Alignment with global standards
a. -(October 2017), Circular No. 975 was released by BSP
-(December 2017), Circular Nos. 984 and 985
-(September 2018), set target for banks to comply with the revised rules
b. –key priority of Insurance Commission (IC) is the adoption of the international
reporting
practices.
-IC requires keeping reserves to pay policyholders in the event of insolvency
c. -SEC also studying the ideal regulatory treatment of virtual currencies(VCs) from the
perspective of investor protection
d. –PDIC has entered into a cross-border partnership by way of a Memorandum of
Understanding (MOU) w/ 8 deposit insurance agencies from Asia, US and UK.

B. Deepening capital markets

Various financial products have been introduced to different segment of the
domestic market. These includes:
1. dollar-denominated securities
2. exchange-traded fund
 3. green bonds (upcoming)
4. Personal Equity and Retirement Account
5. PHP government fund forward
6. public-private partnership
7. real estate investment trust
C. Strengthening surveillance

 BSP has recently completed the requirements of becoming a BIS-reporting country

 The IC is in the process of building a database from the quarterly reports required from
insurance companies and developing analytical tools for data mining purposes.
FINANCIAL STABILITY ASSESSMENT OF THE PHILIPPINE FINANCIAL SYSTEM

 Financial stability is clearly understood to reflect a “well-functioning” financial market,

addressing the financial needs of a stakeholders and avoiding distortions.
 Current risks shows how outstanding debt level has grown rapidly
 Interest rates are rising
 Emerging market currencies have been depreciating versus the United States dollars (USD)
 Debt servicing is now at higher cost than in the past
 The central financial stability issue is the issue about having more outstanding debt

CURRENT RISK IN THE PHILIPPINE FINANCIAL SYSTEM

A. Repricing, refinancing, and repayment risks (3Rs)
Risks that heighten financial stability concerns:
1. The normalization of US monetary policy affects prices along the way
2. A slowdown in global growth and deceleration of international trade will
undermine the growth of many economies
3. Higher debt level across countries will continue to leave economies vulnerable
B. Developments in the credit market
- local intermediation continues to be peso-funded but with some support from
foreign currency (FCY) sources.
C. Continuous demand for credit by corporate enterprises and households is
evident in
the domestic economy
- rising debt-to-equity ratio, from about 45% in 2008 to 86% as of end-March
2018