2. Finance Terms
• Finance: The proper management of
money.
• Money: The current medium of
exchange or means of payment.
• Credit or Loan: A sum of money to be
returned normally with interest.
3. Classification of finance
1. Public finance
– It studies the sources of funds of public
authorities such as states, local self-governments
and the Central Government.
– It is concerned with the income and expenditure
of public authorities and with the adjustment of
one to another.
Contd…
4. • Private finance
– An individual
– Profit-seeking business organizations
• External finance (outside sources)
– Direct financing (through issuing securities)
– Indirect financing (through middlemen)
• Internal finance (ploughing back of profits)
– A non-profit organization
Classification of finance
5. A set of institutions, instruments and
markets which promote savings and
channel them to their most efficient
use.
Financial system
Contd…
7. Financial Institutions
• Banking
– These are participate in the economy’s payments
mechanism
– Their deposit liabilities constitute a major part of
the national money supply
– They can, as a whole, create deposits or credit,
which is money
8. • Non-Banking
– Lend only out of resources put at their disposal by
the savers.
– LIC, UTI, IDBI
Financial Institutions
9. Financial Markets
• These are the centers or arrangements that
provide facilities for buying and selling of
financial claims and services.
• These are classified into
– Primary and secondary markets
– Money and capital markets
10. Primary and Secondary Markets
• Primary Markets
– deal in the new financial claims or new securities
(new issue markets)
– these are mobilize savings and they supply fresh
or additional capital
• Secondary Markets
– deal in securities already issued or existing or
outstanding.
– these do not contribute directly to the supply of
additional capital
11. Money and Capital Markets
• Both are perform the same function of
transferring resources to the producers.
• Money markets deals short-term claims
• Capital markets deals long-term claims
12. Financial Instruments and Services
• Financial asset
– A sum of money sometime in future
(repayment of principal) and/or a period
(regular/intervals) payment in the form of
interest or dividend.
• Financial instruments
13. Technology in Financial System
• Financial Services will be provided by a wide
variety of institutions.
• Small financial service firms will be able to obtain
access to the technologies they will require to
remain viable.
• Large number of small, specialized financial
service organizations will prevent the few from
dominating the market.
• Networks are permitting electronic fund transfers
from the merchant’s counter.
• Systems providing access to funds from virtually
any place in the Nation and are likely to be in use
in the next few years.
Contd…
14. Technology in Financial System
• Advanced communication technologies including
satellite relays, video cable, fiber optics and cellular
radio will find wide application in the financial service
industry.
• Decreasing computer costs will create the opportunity
for large numbers of individual consumers and
managers of small businesses to take advantage of
technology in using financial services.
• Large computers will be used to support the data
bases.
• Computers that accept voice inputs and recognize
fingerprints may become cost effective for financial
service delivery.
15. Financial System instability
• Increased cross-border integration and the
presence of large international financial
institutions facilitate the dissemination of
financial shocks across countries.
• Financial innovation in products and markets,
together with the existence of large financial
companies facilitate the transmission of
financial shocks in domestic financial
markets.
• Strong growth in asset prices and the growing
importance of household credit are potential
sources of financial instability.
16. Financial System Stability
• Monitoring and analysis of financial system
developments
• Designing and building up financial system safety nets
• Regulation of the banking system
• Market Infrastructure
• Safety Buffers
• Adoption of Common International Standards
• Corporate Bonds and Securities Market
• Risk management
• Market discipline (through prudential regulation and
supervision)
17. Development Finance Institution (DFI)
• It refers to a range of alternative financial
institutions including microfinance institutions,
community development financial institution
and revolving loan funds.
• These institutions provide a crucial role in
providing credit in the form of higher risk
loans, equity positions and risk guarantee
instruments to private sector investments in
developing countries.
• The purpose of DFIs is to ensure investment in
areas where otherwise, the market fails to
invest sufficiently.
18. Subsidies
• There are three main forms of subsidies in the
operations of DFIs in practice
– High level of liquidity;
– An ability to access technical assistance funds; and
– Subsidies passed on directly to beneficiaries.
19. Universal Banking
• Universal banking is a combination of Commercial
banking, Investment banking, Development
banking, Insurance and many other financial
activities.
• It is a place where all financial products are
available under one roof.
• A universal bank is a bank which offers
commercial bank functions plus other functions
such as Merchant Banking, Mutual Funds, Credit
cards, Housing Finance, Auto loans, Retail loans,
Insurance, etc.
23. Financial Institutions
• Provider of financial services such as
– transforming financial assets in terms of maturity of
liquidity (these are financial intermediaries)
– trading financial assets for themselves and others
– creating financial assets and then selling those assets
on the behalf of customers
– giving professional investment advice to others
– managing investment portfolios for others
• Depository institutions acquire most of their
funds through accepting deposits
• Non depository institutions receive funds from
other sources
24. Role of Financial Intermediaries
• Make direct investments by purchasing
bonds, stocks or making loans. These are their
assets
• Raise money for these investments by issuing
their own financial assets such as deposits,
insurance policies, mutual fund shares. These
are liabilities for the intermediary and
are indirect investments for the investors.
25. Asset/Liability Management
• Not all liabilities of financial intermediaries are
created equal! They differ in terms of the
certainty of their amount and timing
– Type I liabilities: timing and amount are certain
• example: bank fixed rate CD. Bank knows how much it
owes the depositor and when.
– Type II liabilities: amount is certain but timing is
not
• example: term life insurance policy. Insurance
company knows amount of policy but uncertain when
the policy holder will die.
26. Asset/Liability Management
– Type III liabilities: amount is not certain but timing is
• example: variable rate Certificate of Deposits (CD). Bank
knows the maturity date, but the interest owed is not known
when the CD is issued.
– Type IV liabilities: time and amount are uncertain
• example: auto insurance policy. The timing and payout for
an auto accident is not known when the policy is issued.
• The type of liabilities created by a financial
intermediary will determine how they invest their
funds (i.e. the type of assets that they hold)
27. Financial Innovation
• What is it?
– creation of new financial assets or new ways to use
financial assets
• Why does it happen?
– changing circumstances: increased instability in interest
rates, stock prices and exchange rates led to the
development of derivative securities
– advances in technology make new trading strategies
feasible
– competition among institutions for unique products and
strategies
– desire to avoid regulations or tax laws
