MFS Module 1
MFS Module 1
Management of Financial
Institutions
Module I: Introduction
Financial
Institutions
and
economic
development, Types of Money, Process of
Capital Formation, Technology of financial
systemsPooling,
Netting,
Credit
substitution & Delegation.
Banks
A bank is a commercial or state institution
that provides financial services, including
issuing money in various forms, receiving
deposits of money, lending money and
processing transactions and the creating
of credit.
1. Central Bank
A central bank, reserve bank or
monetary authority, is an entity
responsible for the monetary policy of its
country or of a group of member states,
such as the European Central Bank (ECB)
in the European Union, the Federal
Reserve System in the United States of
America, State Bank in Pakistan.
1. Central Bank
Its primary responsibility is to maintain the
stability of the national currency and
money supply, but more active duties
include controlling subsidized-loan interest
rates, and acting as a lender of last
resort to the banking sector during times
of financial crisis
2. Commercial Banks
A commercial bank accepts deposits from
customers and in turn makes loans, even
in excess of the deposits; a process
known as fractional-reserve banking.
Some banks (called Banks of issue) issue
banknotes as legal tender.
3. Investment Banks
Investment banks help companies and
governments and their agencies to raise
money by issuing and selling securities in
the primary market. They assist public and
private corporations in raising funds in the
capital markets (both equity and debt), as
well as in providing strategic advisory
services for mergers, acquisitions and
other types of financial transactions.
4. Saving Banks
A savings bank is a financial institution
whose primary purpose is accepting
savings deposits. It may also perform
some other functions.
6. Islamic Banks
Islamic banking refers to a system of
banking or banking activity that is
consistent with Islamic law (Sharia)
principles and guided by Islamic
economics. In particular, Islamic law
prohibits usury, the collection and payment
of interest, also commonly called riba in
Islamic discourse.
7. Specialized Banks
1. ZTBL
The Zarai Taraqiati Bank Limited It is
also
known
as
Agricultural
Development
Bank
of
Pakistan
(ADBP).
It is the premier financial institution
geared towards the development of the
agricultural sector through the provision
of financial services and technical knowhow.
7. Specialized Banks
2. IDBP
Industrial Development Bank of Pakistan
is one of Pakistan's oldest development
financing institution created with the
primary objective of extending term
finance
for
investment
in
the
manufacturing sector and SME Sector of
the economy.
7. Specialized Banks
3. SME Bank
Promote the business.
Positive impact on Financial environment.
Financing of projects.
Tell revenue generation schemes to
entrepreneurs.
8. Non-banking financial
company
Non-bank financial companies (NBFCs)
also known as a non-bank or a non-bank
bank, are financial institutions that provide
banking services without meeting the legal
definition of a bank, i.e. one that does not
hold a banking license.
8. Non-banking financial
company
Operations are, regardless of this, still
exercised under bank regulation. However
this depends on the jurisdiction, as in
some jurisdictions, such as New Zealand,
any company can do the business of
banking, and there are no banking
licenses issued.
8. Non-banking financial
company
Non-bank institutions frequently acts as
suppliers of loans and credit facilities,
supporting investments in property,
providing services relating to events within
peoples lives such as funding private
education, wealth management and
retirement planning
8. Non-banking financial
company
however they are typically not allowed to
take deposits from the general public and
have to find other means of funding their
operations
such
as
issuing
debt
instruments. In India, most NBFCs raise
capital through Chit Funds.
9. Investment company
Generally, an "investment company" is a
company (corporation, business trust,
partnership, or limited liability company)
that issues securities and is primarily
engaged in the business of investing in
securities.
9. Investment company
An investment company invests the
money it receives from investors on a
collective basis, and each investor shares
in the profits and losses in proportion to
the investors interest in the investment
company.
Mutual Fund
An investment which is comprised of a
pool of funds collected from many
investors for the purpose of investing in
securities such as stocks, bonds, money
market securities and similar assets.
Conclusion
To review, we have looked at the
relationship between institutions and
Financial Markets. This growing field of
research may offer us a new insight into
the dynamics of economic growth within
and among various economies.
Chapter 3
What Is Money?
34
Meaning of Money
Money (money supply)anything that is
generally accepted in payment for goods or
services or in the repayment of debts; a stock
concept. Money supply is the total amount of
money available in the economy. (stock)
Wealththe total collection of pieces of
property that serve to store value (stock)
Incomeflow of earnings per unit
of time (flow)
35
Functions of Money
37
Checks
Electronic Payments: EFTs, wire
transfers.
E-money: Debit cards (POS), etc.
Types of Money
Broad Money
Narrow Money
Fiat Money
Others:
a) Gold & Silver Coins (Ginni)
b) Metal Money
c) Paper Money
d) Plastic Money
e) Virtual Money
Definitions of Money
From most liquid (narrow) to the least
liquid (broad), M0, M1, M2, M2Y, M3..
M0 = paper currency and coins
M1 = M0+ Checking Accounts+ Traveler
Checks
M2 = M1 + Savings Accounts
M2Y = M2 + Forex Accounts
40
41
M2Y
1,000,000,000
100,000,000
10,000,000
1,000,000
100,000
M2Y
10,000
1,000
100
10
42
900000
800000
700000
600000
500000
M2Y (1987=100)
GDP DEFLATOR (1987=100)
400000
300000
200000
100000
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
43
Dollarization and Monetary Transmission in Turkey, Erdem BAI Vice Governor Central Bank of
Turkey December 2006
Monetary Policy
90
80
70
60
50
40
30
20
11/09/06
04/05/06
23/12/05
16/08/05
11/04/05
02/12/04
23/07/04
17/03/04
03/11/03
27/06/03
05/02/03
23/09/02
15/05/02
02/01/02
10
44
Asset Dollarization
Share of FX-Denominated Deposits in Total Deposits
43
41
39
37
35
33
31
29
Sep -0 6
Ju n - 0 6
M ar-0 6
D ec-0 5
Sep -0 5
Ju n - 0 5
M ar-0 5
D ec-0 4
Sep -0 4
Ju n - 0 4
M ar-0 4
D ec-0 3
25
Sep -0 3
27
Dollarization and Monetary Transmission in Turkey, Erdem BAI Vice Governor Central Bank of Turkey
45
Introduction
A financial system plays a vital role in the
economic growth of a country. It intermediates
with the flow of funds b/w those who save a part
of their income to those who invest in productive
assets.
It mobilizes & usefully allocates scarce resources
of a country.
A financial system is a complex, well-integrated set
of sub-systems of financial institutions, markets,
instruments, and services which facilitates the
transfer & allocation of funds, efficiently &
effectively.
INDIAN
FINANCIAL
SYS.
REGULATORS:
MoF,
SEBI, RBI,
IRDA
FIANANCIAL
INST.
(INTERMEDIARIES)
FORMAL
FINANCIAL
SYS.
INFORMAL
FINANCIAL
SYS.
FINANCIAL
MKT.
Moneylenders
Local Bankers
Traders
Landlords
Pawn Brokers
FINANCIAL
INSTRUMENTS
FINANCIAL
SERVICES
Financial
Inst.
(Intermediaries)
Banking Inst.
Scheduled
Commercial
Banks
Scheduled
Cooperative
Banks
Non-Banking
Inst.
Non-Banking
Finance
Co.
Development
Financial
Inst.
Mutual Funds
Public
Sector
Pvt.
Sector
Insurance
&
Housing
Finance co.
Scheduled
Commercial
Banks
Public
Sector
Banks
Private
Sector
Banks
Foreign
Banks
In
India
Regional
Rural
Banks
Development
Financial
Inst.
All-India Financial
Inst.: IFCI, IDBI, IIBI,
SIDBI, IDFC,
NABARD
EXIM Bank, NHB
State-level
Inst.:
SFCs, SIDCs
Other
Inst.:
ECGC, DICGC
Financial
Mkt.
Capital
Mkt.
Equity
Mkt.
Domestic
Mkt.
Debt
Mkt.
Secondary
Mkt.
NSE,BSE
OTCEI,ISE
Regional
Stock Exchanges
Primary Mkt.
-Public issues
-Private
placement
International
Mkt.
Money
Mkt.
Treasury Bills,
Call Money mkt.
Commercial Bills,
Commercial papers,
Certificates of Deposit
Term Money
Capital Formation
Capital Formation The "capital stock" is one of
the basic determinants of an economy's ability to
produce income for its members. Composed of
equipment, buildings and intermediate goods not
themselves directly consumed.
"Capital formation" is simply the enlargement of
the capital stock. The higher the rate of capital
formation, the more rapid is the growth of the
economy's productive capacity and, hence, the
more rapid the growth of aggregate income.
A
term
used
to
describe
net capital
accumulation during
an accounting
period.
Capital formation refers to net additions of capital
stock such as equipment, buildings and other
intermediate goods. A nation uses capital stock
in combination with labour to provide services
and produce goods; an increase in this capital
stock is known as capital formation.
When
prices
rise,
they
reduce consumption and
thus
divert
resources from current consumption to
investment. Besides, the government
can increase savings by establishing and
running
public
undertakings
more
efficiently so that they earn larger profits
which are utilised for capital formation.
Pool
In capital budgeting, the concept that investment
projects are financed out of a pool of bonds,
preferred stock, and common stock, and a
weighted-average cost of capital must be used
to calculate investment returns.
In insurance, a group of insurers who share
premiums and losses in order to spread risk.
In investments, the combination of funds for the
benefit of a common project, or a group of
investors who use their combined influence to
manipulate prices.
Cont
Netting
Reducing transfers of funds between subsidiaries
or separate companies to a net amount.
Netting is a process the National Securities
Clearing Corporation (NSCC) uses to streamline
securities transactions.
To net, the NSCC compares all the buy and sell
orders for each individual security and matches
purchases by clients of one brokerage firm with
corresponding sales by other clients of the firm.
U.K.
parent
100m
60m
200m
German
U.S.
100m
subsidiary
subsidiary
German
subsidiary
U.K.
parent
140m
U.S.
subsidiary
Netting
Basic
Technology
Techniques of
Financial
System
Credit
Substitution
Pooling
Delegation
Credit Substitution
Pooling
Netting
Delegation
Rather than doing the things oneself, one can
assign some one else to the work on his behalf
This is being done mostly to reduce costs and
make the operations more efficient.
Examples: indirect lending
* Consumer lending through dealers / suppliers
* Lenders delegating to underwriter task of
setting up a loan & documentation
* In forward trx, traders delegate to Futures EX.
Credit Substitution
Replacement of credit of one party to a transaction with the
(superior) credit of a financial institution.
In many cases delegation combined with credit substitution.
eg. A bank substitutes its own credit for the credit of the
borrower: depositors lend to the bank rather than to the
ultimate borrower.
Credit substitution works because the promise of bank,
insurance company or future exchange is more acceptable
than the promise of the ultimate trading partner. This is due
to following two reasons:
* Reputation of FI
* FIs resources and capabilities in fulfilling the promise.
POOLING
Pooling is a resource management term that refers to the
grouping together of resources (assets, equipment,
personnel, effort, etc.) for the purposes of maximizing
advantage and/or minimizing risk to the users. The term is
used in many disciplines.
Pooling is combination of assets & liabilities in ways that
reduce risk or improve liquidity.
Pooling makes the liabilities of an FI (the promises it
makes) safer and more liquid than its assets (the promises
to it). Eg. pooling makes bank depositors safer and more
liquid than assets.
One reason pooling works is diversification, other is netting.
Securitization
Intergovernmental risk pool
Pooling of interests is a mergeraccounting method that was taken out of
the market in the United States by
the Financial
Accounting
Standards
Board on June 30, 2001.
NETTING
Netting is offset of one trx. against another, to
reduce the number of trx.s that actually need to
be executed.
Executing a trx. is costly. Netting lowers costs by
offsetting one trx. against another.
Example: clearing of checks, by netting banks
obligations to one another reduces the need for
physical transfer and thereby reduces costs.
DEFINITION of 'Netting'
Consolidating the value of two or more transactions,
payments or positions in order to create a single value.
Netting entails offsetting the value of multiple positions,
and can be used to determine which party is owed
remuneration in a multiparty agreement.
Netting is a general concept that has a number of more
specific uses. In a case in which a company is filing for
bankruptcy, parties that do business with the defaulting
company will offset any money owed to the defaulting
company with any money owed by the defaulting company.
Netting
Netting also creates liquidity eg. Bank can
hold relatively illiquid assets because it
can meet withdrawals out of new deposits,
without having to liquidate the underlying
assets. By netting new deposits and
withdrawals, it reduces the need to buy
and sell the underlying assets.
Secondary markets work in much the
same way.