Session_2.pdf

8/14/2019 Session_2.pdf

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Overview of the Financial System

Fintmed Session 2

Second Term

Academic Year 2013 - 2014

Recall: Function of Financial Markets

Allows transfers of funds from person orbusiness without investments to one who hasthem

Improves economic efficiency.

Recall: The Financial System

Demander offunds

(mainly firms andgovernments)

Supplier offunds(mainly

households and

businesses)

Flow of financial securities

Incomes, and financial claims

Flow of funds (savings)

Recall: The Financial Intermediation Process

FinancialSystem

IndividualsBusinessesInstitutionsGovernment

IndividualsBusinessesInstitutionsGovernment

Funds Funds

Returns Returns

Suppliers

Lenders

Borrowers

UsersRisk management,

liquidity, andinformation

Source: Santos, Essentials of Investments


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Alternative View of Financial Markets

FinancialIntermediaries

Financial Markets

Funds

FundsFunds

Borrower-Spenders1. Business Firms2. Government3. Households4. Foreigners

Lenders-Savers1. Households2. Business Firms3. Government4. Foreigners

Funds Funds

INDIRECT FINANCE

DIRECT FINANCE

Structure of Financial Markets

Debt and Equity Markets Defined

Ways a firm or an individual can obtain funds in a

financial market:

1. Issue a debt instrument (bond or mortgage)

2. Issuing equities (common stock)

Structure of Financial Markets

Primary and Secondary Markets Defined

Primary new issues of security such as a bond or

stock are sold to initial buyers

Secondary securities which have beenpreviously issued can be resold

Classifications of Financial Markets

1. Debt Markets1.1 Short-Term (maturity < 1 year) Money Market

1.2 Long-Term (maturity > 1 year) Capital Market

2. Equity Markets2.1 Common Stock


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Transactions Costs

Financial intermediaries make profits byreducing transactions costs

Reduce transactions costs by developingexpertise and taking advantage of economies of

scale

Asymmetric Information

An inequality brought about when one party does

not know enough about the other party to make

accurate decisions.

For example: banks and financial institutions

spend time and resources through credit/

background information of the borrower to

ascertain whether to lend or not

Problems Created by Asymmetric Information

Adverse Selection

The problem created by asymmetric selection

before the transaction occurs

Potential borrowers most likely to produceadverse outcomes are ones most likely to seek

the loan and be selected

Problems Created by Asymmetric Information

Moral Hazard

The problem created after the transaction

(loosely described as conflict of interest)

Hazard that the borrower has incentives toengage in undesirable (immoral) activities

making it more likely that it wont pay the loan

back


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Financial Intermediation Process

The trick should be that financial intermediaries

reduce adverse selection and moral hazard

problems, enabling them to make profits.

Ensuring Soundness of Financial Intermediaries

Restrictions on Entry

Disclosure Restriction on Assets and Activities Deposit Insurance Limits on Competition Restriction on Interest Rates

Investment Houses

Involved in underwriting of securities, financial consultancy(issue management and underwriting of public offering ofdebt and equity securities, loan syndication and financialpackaging and advisory for corporate mergers, acquisitionsand restructuring) among others.

Enabling laws: PD 129 series of 1973 and RA 8366 seriesof 1997.

May be allowed to perform quasi-banking functions asapproved by the Monetary Board

Minimum capital requirement of P 300 M Foreign ownership allowed up to 60%

Financing Companies

Enabling law: RA 8556, amending RA 5980 'Financing companies' hereinafter called companies, are

corporations, except banks, investments houses, savingsand loan associations, insurance companies, cooperatives,and other financial institutions organized or operatingunder other special laws, which are primarily organized forthe purpose of extending credit facilities to consumers and

to industrial, commercial, or agricultural enterprises, bydirect lending or by discounting or factoring commercialpapers or accounts receivable, or by buying and sellingcontracts, leases, chattel mortgages, or other evidences ofindebtedness, or by financial leasing of movable as well asimmovable property;


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Financing Companies

Financing companies shall be organized in theform of stock corporations at least forty percent

(40%) of the voting stock of which is owned bycitizens of the Philippines and shall have a paid-up capital of not less than Ten million pesos(P10,000,000) in case the financing company islocated in Metro Manila and other first classcities, Five million pesos (P5,000,000) in otherclasses of cities and Two million five hundredthousand pesos (P2,500,000) in municipalities:

Securities Dealers

Buying and selling of securities

Minimum capital of P 5.0 M Mostly members of the Philippine Stock

Exchange

Lending Companies/Lending Investors

Enabling law: RA 9474 series of 2007 Lending Company shall refer to a corporation engaged in

granting loans from its own capital funds or from fundssourced from not more than nineteen (19) persons. It shallnot be deemed to include banking institutions, investmenthouses, savings and loan associations, financing companies,

pawnshops, insurance companies, cooperatives and othercredit institutions already regulated by law. The term shallbe synonymous with lending investors.

Minimum capital requirement: P 1.0 M

Investment Companies

Sells its own securities to the public and invest the

proceeds in stocks and bonds (bond fund)


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Insurance Companies

Engaged in property-liability (non-life), lifeinsurance, and/or multiple-line products

Minimum capital of P 100 M. Recent regulationallow for adjustment of risk

Regulated by the Insurance Commission Sellers (agents) are carefully screened

Pre-Need Companies

Sells pension, education, memorial plans subject to theapproval of the SEC and the Insurance Commission

Capital Requirements: Minimum paid-up capital of P 100M. Existing pre-need companies shall comply with thefollowing minimum unimpaired paid-up capital:

P 100M for companies selling at least three (3) types ofplan;

P 75 M for companies selling two (2) types of plan; P 50M for companies selling a single type of plan. Existing pre-need companies with traditional education

plans shall have a minimum unimpaired paid-up capitalP 100M

Regulation of Financial MarketsThree Main Reasons

Increase Information to Investors Decreases adverse selection and moral hazard

problems

Forces corporations to disclose information Ensuring the Soundness of Financial Intermediaries

Prevents financial panic Chartering, reporting requirements, restrictions onassets and activities, deposit insurance, and anti-

competitive measures

Improving Monetary Control Reserve requirements Deposit insurance to prevent bank panic

Documents

Session_2.pdf