Understanding Financial Systems: Institutions, Markets, and Assets
Concept of the Financial System
A country’s financial system comprises institutions, media, and markets. Its objective is to facilitate resource allocation between economic units saving and those investing.
Composition of the Financial System
Institutions
Entities or agencies mediating between savers and investors, enabling resource transfer.
Media
Financial instruments (services or products) offered by intermediaries to facilitate fund transfers from savers to investors.
Markets
Venues where financial intermediaries trade financial assets, determining their prices.
Financial Intermediaries
Financial intermediaries are entities and agencies mediating between savers and investors. This mediation is their core function. They convert funds from savers into financial products meeting investor needs, significantly reducing costs.
Classes of Financial Intermediaries
Bank Financial Intermediaries
These intermediaries offer deposits accessible by check, accepted as payment, effectively creating bank money. Examples include banks, thrifts, credit unions, and insurance companies.
Nonbank Financial Intermediaries
These entities mediate between capital suppliers and demanders but generally do not accept deposits. They differ from banks as they do not create money. Categories include investment securities firms, finance companies, insurance brokers, and financial intermediaries financing specific activities. Primary intermediaries (brokers, commission agents) do not transform assets.
Functions of Financial Intermediaries
- Mediation: They gather resources from savers, transform them into various products, and offer them to investors.
- Economic Enhancement: They encourage savings and facilitate investment.
- Risk Reduction: Product diversification enhances safety and reduces risks.
Financial Markets: Definition and Characteristics
Financial markets are physical locations and mechanisms for negotiating and pricing financial assets. Effective markets require a multitude of tradable assets, minimal entry barriers, and readily available, low-cost information. The asset market is considered imperfect, fragmented, and subject to price variations. Financial asset prices are often influenced by monetary policy.
Classification of Financial Markets
Markets require pricing and compliance mechanisms to ensure agreed-upon interest is paid.
- Direct Market: Transactions occur directly between buyers and sellers without intermediaries. Savers bear the risk directly, and information may be limited.
- Intermediated Market: Intermediaries facilitate transactions due to varying needs and amounts between savers and borrowers. Mediation occurs through brokers, dealers, etc.
- Money Market: Trading involves money or assets readily convertible to cash.
- Capital Markets: Trading involves medium- and long-term assets with higher risk and lower liquidity than money markets. Transactions include debt and equity.
- Free Market: Prices and quantities are determined by supply and demand.
- Regulated Market: Prices and quantities are set by the state.
- Primary Market: Newly created assets are issued and sold for the first time.
- Secondary Markets: Existing financial assets are traded without creation, often involving specialist agents (e.g., Stock Exchange, Public Debt market).
- Organized Markets: Standardized asset types, operators, and operations.
- Unorganized Markets: No standardized conditions for exchanges.
- Centralized Markets: Transactions occur in a physical location, leading to faster reactions and better price discovery.
- Decentralized Markets: Transactions occur in multiple locations, potentially leading to multiple prices.
- Public Markets: Created and regulated by public authorities (in Spain, all markets are public).
- Private Markets: Created and regulated by private entities.
Financial Assets
Financial assets are instruments issued by entities needing resources, offered for purchase to those with excess resources. They represent the counterpart to the supply of savings.
Classes of Financial Assets
- According to the Broadcast:
- Primary Assets: Issued directly by entities needing funds.
- Secondary Assets: Created by intermediaries to raise funds.
- According to Maturity:
- At Sight: Expensed upon presentation.
- Short Term: Maturity less than one year.
- Long Term: Maturity exceeding one year.
- Perpetual: No depreciation.
- According to the Issuer:
- Public: Issued by the state, regions, municipalities, or other public bodies.
- Private: Issued by companies or private entities.
- According to the Quote:
- Trading: Assets traded on markets (stock or other types).
- Listed: Assets traded on organized markets.
- Unlisted: Assets not traded on organized markets.