The Spanish Financial System: A Comprehensive Guide

Unit 1: The Spanish Financial System

The Role of the Financial System

The fundamental objective of any market is the exchange of goods and services. Without money, this exchange is done through bartering. The Financial System facilitates contact between those with surplus money (savers) and those who need it (borrowers), enabling the channeling of funds.

2. Concept, Functions, and Composition

2.1. Concept

The Financial System encompasses the institutions, media, and markets that channel savings from surplus economic units (savers) to deficit economic units (investors).

Therefore:

  • Economic Units with Surplus: Spend less than they earn.
  • Economic Units with Deficit: Spend more than they earn.

2.2. Functions

  • Encourage saving.
  • Capture savings and channel them into investment.
  • Offer products adapted to the needs of savers and investors.
  • Achieve monetary and financial stability by adapting financial institutions to economic changes.

2.3. Composition

  • Financial Assets
  • Financial Intermediaries
  • Financial Markets

3. Financial Assets

3.1. Concept and Functions

Financial Assets are securities issued by economic units. They represent a right (asset) for the owner and an obligation (liability) for the issuer. They drive savings into investment.

Essential roles of financial assets:

  • Transfer of funds: Channel savings from savers to investors.
  • Transfer of risk: The issuer shifts some investment risk to the asset owner.

3.2. Features

  • Liquidity: Ease and certainty of converting an asset into cash.
  • Risk: Probability that the issuer defaults on payment. Types of risk include:
    • Credit Risk: Wasted investment.
    • Interest Rate Risk: Not achieving expected return.
    • Market Risk: External factors causing a drop in share value.
    • Country Risk: Regulatory changes affecting investment.
    • Exchange Rate Risk: Similar to interest rate risk.
  • Profitability: Ability to generate interest or income for the buyer, compensating for the transfer of funds and risk-taking. Profitability is inversely related to liquidity and directly related to risk.

3.3. Classification

  • By Issuance:
    • Primary Assets: Issued directly by deficit economic units.
    • Secondary Assets: Created by financial intermediaries.
  • By Issuer:
    • Public: Issued by public agencies.
    • Private: Issued by private companies.
  • By Liquidity:
    • Cash: Immediately accessible.
    • Short Term: Maturity less than one year.
    • Long Term: Maturity exceeding one year.
    • Perpetual: Not amortized.

4. Financial Intermediaries

4.1. Concept

Financial intermediaries reconcile the needs of deficit and surplus economic units. They bridge the gap between those seeking funds (e.g., for a mortgage) and potential lenders, considering factors like time, risk, and return.

4.2. Classification

  • Bank Financial Intermediaries: Can create money through core assets (e.g., current accounts).
    • Central Bank
    • Commercial Banks
    • Savings Banks
    • Credit Unions
    • Banco de Credito Oficial (ICO)
    • Electronic Money Institutions (EDE)
  • Non-bank Financial Intermediaries: Facilitate transactions without creating money.
    • Financial Credit Establishments (EFC):
      • Loans and credit (consumer, mortgage, commercial)
      • Factoring
      • Leasing
      • Credit card issuing and management
    • Investment Funds and Companies
    • Insurance Institutions
    • Reciprocal Guarantee Societies

4.3. Advantages

  • Mediation
  • Reconciling interests
  • Risk reduction
  • Market information access
  • Reduced transaction costs
  • Faster payment processing

4.4. Disadvantages

  • Risk of bankruptcy or insolvency
  • Potential for monopolies

5. Financial Markets

5.1. Concept

Financial markets are mechanisms where financial assets are exchanged, and their prices are determined.

5.2. Operation

  • Connect market participants
  • Set prices
  • Provide asset liquidity
  • Reduce transaction time and costs

5.3. Features

  • Transparency: Easy access to market information.
  • Freedom: Easy entry and exit for buyers and sellers.
  • Depth: Numerous buy and sell orders at various prices.
  • Size: Large volume of traded assets.
  • Flexibility: Adaptability to changing market conditions.

5.3. Classification

  • By Operation:
    • Direct: Direct exchange between fund suppliers and demanders.
    • Intermediate: Involvement of a financial intermediary.
  • By Asset Negotiation:
    • Primary Market: New financial assets are issued.
    • Secondary Market: Existing financial assets are traded.
  • By Asset Properties:
    • Money Market: Short-term, liquid, low-risk assets.
    • Capital Market: Long-term investments and financing.
  • By Regulatory Intervention:
    • Free Markets: Driven by supply and demand.
    • Regulated Markets: Prices or asset quantities are administratively controlled.
  • By Term:
    • Spot Markets: Immediate settlement.
    • Term Markets: Future settlement.
  • By Formalization:
    • Organized Markets: Formalized trading with rules and regulations.
    • Over-the-Counter (OTC) Markets: Flexible trading with less formal rules.