CHAPTER 2:

AN OVERVIEW OF THE
FINANCIAL SYSTEM
 FUNCTION OF

FINANCIAL MARKET

AND FINANCIAL

INTERMEDIARIES
Function of Financial Markets
•Financial market- perform a function to channel
funds from people who have surplus funds to
people who have a shortage of funds.
•Who have saved are the lenders (surplus unit)
and those who borrow are borrowers (deficit
unit).
Flow of saving and investment in two
sector economy.
•Financial intermediation- institution (such as
banks, insurance companies, mutual funds,
pension funds and finance companies) that
borrow funds from people who have saved and
then make loans to others.
•Financial disintermediation- process the saver
take funds out of deposit account and invest
directly in bonds, stocks, etc.
Direct Finance and Indirect Finance
•Direct finance – funds are directly transferred
from lenders to borrowers.
•Indirect finance – financial intermediaries
receive funds from savers and lend them to
borrowers.
- Securities are assets for the holder and
liabilities for the issuer.
STRUCTURE OF FINANCIAL
MARKET
STRUCTURE OF FINANCIAL
MARKET
DEBT MARKETS

- contractual agreement

- 3 types of maturity

EQUITY MARKETS

- an instrument that issues by stock holder to claim on the earnings and assets
of the business

- dividends

- no maturity date.
STRUCTURE OF FINANCIAL
MARKET
PRIMARY MARKET

- the securities are created.

- Investment Banks underwrite securities in primary markets

SECONDARY MARKET
- Brokers and dealers work in secondary markets
 STRUCTURE OF FINANCIAL
MARKET
EXCHANGES

- The physical places where trading took place.

- NYSE, KLSE.

OVER-THE-COUNTER

- Dealers in computer contact and know the prices set by one

another.

- market very competitive

 STRUCTURE OF FINANCIAL
MARKET
MONEY MARKET
- Money markets deal in short-term debt instruments
- more liquid

CAPITAL MARKET
- Capital markets deal in longer-term debt and
equity instruments.
FINANCIAL MARKET
INSTRUMENTS
 FINANCIAL MARKET
INSTRUMENTS
 Primary market :
 Issuance of stocks and bonds for the first time (IPOs)

 Secondary market :
 Securities are bought or sold after the initial offerings.
 e.g : KLSE
CAPITAL MARKET INSTRUMENTS
>Equity instruments :
 Common stock
 Preferred stock
>Debt instrument
 Mortgages
 Corporate bonds
 Convertible bonds
 Junk bonds
MONEY MARKET INSTRUMENTS
 Non-government Paper
 Banker acceptances (BAs)
 Repurchase agreements (Repos)
 Negotiables instruments of deposits (NIDs or NCDs)
 Commercial papers (CP)
 Government Papers (scriptless)
 Malaysian Government Securities (MGS)
 Malaysian Government Treasury bills (MGTB)
 Cagamas Bond and Notes
 FINANCIAL
institutions and
INTERMEDIARIE
S
FINANCIAL INTERMEDIARIES

- Institutions that channel funds from

lenders to borrowers.
- Example : Banks and Finance Companies
FUNCTION OF FINANCIAL INTERMEDIARIES :
INDIRECT FINANCE
 Indirect finance : funds can move from lenders to
borrowers by second route, because it involves a
financial intermediary that stands between the
lender-savers and borrower-spenders and helps
transfer funds from one to the other.

 The process of indirect finance using financial

intermediaries is called financial intermediation.

 The primary route for moving funds from lenders to

borrowers.
 THE IMPORTANT IN FINANCIAL MARKETS ARE :

1.Transaction costs
- The time and money spent in carrying out financial
transactions, are a major problem for people who
have excess funds to lend.

- can reduce transactions costs because they have

developed expertise in lowering them and because
their large size allows them to take advantages of
economies of scale.
2. Risk sharing

- They create and sell assets with the risk

characteristics that people are comfortable
with and the intermediaries then use the funds
they acquire by selling these assets to
purchase other assets that may have far more
risk.
3. Asymmetric Information : Adverse Selection and
Moral Hazard

- Adverse selection : the problem created by

asymmetric information before the transaction
occurs.

- Moral hazard : the problem created by asymmetric

information after the transaction occurs.

- With financial intermediaries in the economy, small

savers can provide their funds to a trustworthy
intermediary.
4. Economies of Scope and Conflicts of Interest

- Can lower the cost of information production for

each services by applying one information
resources to many different services.

- Conflicts of Interest (moral hazard problem), arise

when a person or institution has multiple objectives
(interests) and as a result, has conflicts between
those objectives.

- Conflicts of Interest occur when a financial institution

provides multiple services.
FINANCIAL INSTITUTIONS
DEPOSITORY INSTITUTIONS

- Financial intermediaries that accept deposits from

individuals and institutions and make loans.

- Important because they are involved in deposit

creation, an important component of money
supply.

- Example : commercial banks , mutual savings

banks and credit unions.
 CONTRACTUAL SAVINGS INSTITUTIONS

- Financial intermediaries that acquire funds at

periodic intervals on a contractual basis.

- The liquidity of assets is not as important a

consideration for them as it is for depository
institutions, and they tend to invest their funds
primarily in long-term institutions.

- Example : Insurance Companies and Pension

Funds
INVESTMENT INTERMEDIARIES

- These institutions include :

 Finance Companies
 Mutual Funds
 Money Market Mutual Funds
STRUCTURE OF
MALAYSIA
FINANCIAL
SYSTEM
 THE
THE MALAYSIA
MALAYSIA
FINANCIAL
FINANCIAL SYSTEM
SYSTEM

Financial
FinancialInstitution
Institution Financial
FinancialMarket
Market

Banking
BankingSystem
System Non
NonBanking
BankingSystem
System

MONETARY INSTITUTION NON-MONETARY INSTITUTION

1) Central Bank Of Malaysia (BNM)

a) To issue currency and to safeguard the external value

of the currency
b) Banker to the government
> Management of Government Account
> Sources of Fund to Government
> Management of The National Debt
c) Banker to other banks
>Licensing of banks and non-banks
>Banking relationship
>Currency distribution
>Inspection and investigation of banks and non-
banks
>Lender of last resort
d) Holder of the country’s stock of gold and foreign
currency reserves.
> BNM manages the nation’s foreign exchange
reserves
> Implements the government exchange rate
e) Promote monetary stability of the country
> Control of credit and hence money supply as an
essential condition for continued.

2) Commercial Banks
a) The larges and main players in banking system
b) Under BAFIA 1989 means “any person who carries
banking business conduct receiving money or deposits ,
paying or collecting cheques & provision of finance.
3) Merchant Banks ( investment bank)

a) Act as catalyst in the corporate finance market

b) Not retail their services to general public or ordinary individuals

c) Usually their customer derive from commercial bank, finance company,

and other financial institutions.

d) Only receive large deposits and make loans to industry.

4) Mutual Savings Banks

a) Similar to saving account
b) Raise the funds by accepting deposit to make mortgage loans

5) Finance Companies
a) Compete directly with commercial and savings banks for deposits
b) More on hire purchase and housing loans
c) Mostly cost is higher then commercial banks
6) Discount Houses
a) Accept short-term funds
b) A ready avenue for customers to adjust their liquidity positions
rapidly

7) Saving Institutions
a) Encourage of small savings especially from lower fixed income
groups and the rural areas.

8) Provident and pension funds

a) Involve in long term funds usually for long-term stable investment.

9) Insurance Companies
a) Offer the clients coverage against risks for a fee.
b) Hold a significant amount of assets in the form of deposits in
the banking system.
10) Development Financial Institutions
a) Source of fund comes mainly from the government long-term loans
the commercial banks and Provident and pension fund

11) Malaysia Building Societies

a) Mainly from shareholder fund ,loan and deposits from the government,
the central bank, and the provident and pension funds.

12) Unit Trust

a) Specialize financial intermediaries in the corporate securities market.

13) The National Mortgage Corporation

a) To help lender in their liquidity management through purchases of
housing loan from primary lender by issuing bond and borrowing from
inter-bank market.
International Financial Institution
 It is a result of both large increases in the pool of
savings in foreign countries and the deregulation
of foreign financial market.

 It is to raise needed funds and for investment

opportunity abroad.

 It is a place in which flows of goods and

technology between countries are become more
common place.
 International Bond Market, Eurobonds, and
Eurocurrencies

 Foreign bonds.
 -Foreign bond are sold in a foreign country and are dominated in that country’s currency.
 -For example if a German automaker Porsche sells a bond in the United Stated dominated in
U.S. dollars, it is known as foreign bond.

Eurobond.
-A bond dominated in a currency other than that of the country in which it is sold.
-For example a bond dominated in U.S. dollars sold in London.
- Currently it is about 80% of the new issue in the international bond market are Eurobond.

A variant of the Eurobond is Eurocurrencies, it is a foreign currency deposited in banks outside

the home country.
-The most important of the Eurocurrency are Eurodollars, which are U.S dollar deposited in
foreign bank outside of the United States or in foreign branches of U.S banks.
-Because these short-term deposit earn interest they are similar to short term Eurobond..
 World Stock Market
The increase interest in foreign stocks has
prompted the development in the
development in the U.S of mutual funds
that specialize in trading in foreign stock
market.
THANK
YOU