What Role Do Financial Intermediaries Play in the Domestic Financial System - Assignment Example

What role do financial intermediaries play in the domestic financial system? Organizations indulging in the acts of maintaining flow of funds betweeninvestors and the monetary market by the means of various financial schemes and secured, unsecured loans diversifying the funds into different markets reducing the risk factor of investor’s money are known as financial intermediaries. Commercial & Retail Banks, Credit Unions, Insurance Companies are the some popular classifications of Financial Intermediaries. Financial Intermediaries lead domestic financial system with an optimistic path of growth as they boost the savings Investment process and provide liquidity for important domestic sectors similar to Agriculture, real estate e.t.c. which is undoubtedly major reasons for the growth in Domestic Financial System. Financial Intermediaries diversify their investor’s money in various sectors helping in expansion of the markets resulting in generating high employment, high productivity and strength of competition. Banks as financial intermediaries provides solutions for the investors who choose to put their money at reliable source with low risk factor. In financial terms, Investors are recognized by the people with surplus of money wanting it to lend for the sake of interest gain and good returns whereas the borrowers are the units which are facing deficiency of money to expand capacity or their productivity. Financial Intermediaries enhances the effectiveness of Domestic financial systems as they provide their investors with good returns, a reduced risk of money loss, exploring new resources to bring in money hence, bringing economic stability to the monetary policies. Increasing flow of liquidity in markets create more employment, increased productivity of industries stabilizing Economic conditions and expansion which improves the lifestyle of people and mentality to save surplus resulting in growth rate of financial cycles Financial Intermediaries like banks, insurance companies encourages savings habit in the people by launching attractive and worthy deposit schemes. The banking institutions play key role in maintaining the domestic finances by ensuring smooth flows of liquidity redistribution , maturity conversion, execution of fiscal policies, scheming payment channels and taking necessary initiatives as per the requirement of national economy for growth. Financial intermediaries influence domestic financial system growth by the means system consisted of two factors. Growth in percentage of savings turning investments. Expansion of capital distribution in market ventures. Increasing flow of liquidity in markets create more employment, increased productivity of industries stabilizing Economic conditions and expansion which improves the lifestyle of people and mentality to save surplus resulting in a cycle of fund flowing through savings. Banks utilizes these savings to redistribute capitals in different market ventures which reduces the risk of money loss and due to high volumes of investments in different sectors if, a sector fails to show the result assumed the loss of money is covered through the rate of interest and profits made from other markets. Modern Banking system is developed in such a way that it provides a form of insurance through the withdrawal provision in depository contracts Due to competition financial intermediaries explore new resources for investors by entering into global markets inspiring them to invest in domestic markets as foreign funds began to flow in the market the opportunities of entrepreneur expands with the advanced technologies and schemes usually comes with exposure to global markets which causes great positive impact on the domestic financial system. As an alternate, financial intermediaries introduced security markets as a substitute for raising funds to invest where the financial intermediary issues security certificates to the investors directly. Breeding of huge sums of money through securities issued to investors in open market is recognized as “Underwriting” which call for precisely expert process. Financial intermediaries dealing in securities in order to promote securities market also have a provision to raise funds by reselling on the virtue of their client investors. Chief reason of promoting direct securities is to reimburse investors for risk admittance. Usually financial intermediary’s offers deuce flow of money into the market which can be recognized in the form of: Debt funds Equity funds Debt funds Money lending with provisions including repayment schedules for a specific tenure based on the credit worthiness of borrower by acquiring of collateral or without collateral securities is known as Debt funds. In Debt funds, returns are fixed with high interest rates and it can vary in short term loan or long term loans. Financial institutions have to incur less cost on debt funds as compared to the costs of equity funds. Financial institutions refer debt funds for the rendering earnings and for conserving assets. Debt funds are time bound contracts between the lender and issuer. Equity funds Stocks are the general term used in market for equity. Focusing Investors money on a specific market through procuring a share in business organization or industry with a perception of long term growth in the future by the progress of business is known as equity funds. Costs in equity funds are much higher as the market experts are required to understand market trends and identify the units which can yield profits if they are provided with the additional working capital. The risk sharing ratio is higher in equity funds in comparison of debt funds as no provision exists for the repayment or fixed income. The income earned depends on the profitability or losses to be occurred in the future of business. Selecting the appropriate business sectors to invest is a major function of Financial Intermediaries. This selections process impact on the revenues earned of financial intermediary if the financial intermediaries has to function in bounding regulations regulated by central bank on the other hand in the open markets not regulated by central banks intermediaries play key roles in selection process as the distribution of savings according to prices is not promising at all times. Discuss three key functions of a central bank and show how a reduction in base rates affects mortgages and the price of bonds in the capital markets. A Financial organization solely owned by the government of country with full authority to monitor and issue required currency flow, monitor impact of interest rates on economy, establishment of monetary policies, responsibility of maintaining forex exchange rates in foreign markets and for the regulation of commercial & retail banks is known as Central Bank. In the year 1694, The Bank of England was established by the government to act as UK’s Central Bank under the supervision of Bank of England’s first governor Sir John Houblon {1694-1697} with the authorities to manage the UK’s national currency, debts and to stabilize the UK’s financial system. Formulation of Monetary policy, promoting financial stability and promotion of UK’s financial efficiency are the three core functions of Bank of England. 1. Formulation of monetary policy – Through monetary policy the Bank of England organizes the circulation according to demand of national currency (Euro) in domestic sectors, monetary policy regulates the rise or fall of interest rates to stabilize the growth of UK’s financial system. Bank of England manipulates the flow of currency according to the requirements of the euro economy by intensifying or toning policies stand. Expanding of monetary policy results in escalating the availability of funds in open markets of UK which is usually implemented when economy is suffering from high unemployment rate encouraging interest rates to fall so that the entrepreneurs can expand creating new employments on the other hand, suction of currency from the open market results in high interest rates to calm an agitated financial system or economy. The chief motive of formulating Monetary Policy is to stabilize prices as stable prices have an optimistic impact on the UK financial system. Source: Bank of England Through Monetary policy the Bank of England conveys stable prices. Further, stable prices enhances effective operations of economy, it also enhances growth rate of UK’s economy by an assortment of resources. With the help of monetary policy, the Bank of England, provides protective cover to the genuine buying control of banknotes and also give cover to the household’s disposable income. Formulation of monetary policy provides extra boost to working of markets and recovers market from the wave of dubiety arising from the impact of soaring impulsive inflation. Stabilized prices in United kingdoms markets encourage citizens to focus on business operations instead of planning short term strategies to defend their assets from the impact of inflation. Promoting financial stability– an economy capable & anticipating of holding up against impacts of fluctuating financial system for a long term can be said as a financial stable economy. Bank of England formulates guidelines for administration of banking sector, catastrophe management, and depository cover. Practically, the bank has many dimensions when it comes to stability roles undertaken by bank. Risk Evaluation – Bank of England in general monitors the links involved in Global financial market & Economies and carry out the assessment of risk to UK economy. Risk diminution – The Bank of England recurrently evaluates concerns to regulate the financial intermediaries. Payment & Settlement systems – the payment and settlement system is core of any financial system. Bank of England ensures the smooth flow of UK’s payment systems. Catastrophe management – Bank of England has entered into an MOU with FSA and HM treasury for the data and records sharing to manage the future crisis efficiently and to implement policies to reduce risk on United Kingdom’s financial system. Source: www.ecb.int 2. Promoting United Kingdoms Financial Efficiency – in past years, the distribution of policy rates to the operational banks lending rates in UK had witnessed increase of velocity as well as in the financial zone of UK due to the Bank of England’s decision of implication of monetary policy as discussed earlier monetary policy effects both the financial stability and financial efficiency by conserving stable prices. It improvises the financial efficiency system by escalating the effect of conduction of shock of policy rates on interest tariffs and asset prices significant for assessment of financing, funds investing and money savings. Bank of England’s increased deregulation, incorporation and modernization has also played a key role improving the financial sectors efficiency. Impact of decreased base rates on mortgages: Decision of reduction in base rates affects mortgages as it tends to encourage the citizens or entrepreneurs to take more loans and motivates people on spending more money than usual spending limit. Base rate reduction also effects on financial statements of lending institutions as the revenue earned decreases from the interest payments to be collected from Mortgages. It also affects banks income as the amount of savings decreases. Due to the base rate cuts the prices in real estate sector grows up and borrowers enjoys the price rise of their properties. It is assumed that reduced base rates affects a existing borrower in a positive manner as there will be an increase in the borrowers disposable income due to lower repayment amounts and motivates borrower for additional remortgages and top-up loans because of price rise of assets or opt for various loan products. When a reduction in base rates is expected the requests for tracker mortgages rises instead of fixed rate mortgages in the real estate sector. Source: news.bbc.co.uk The affect of Bonds prices in the capital market Due to reduction of base rates. Rate of interest and bonds prices mutually shares very strong relation among them. When a cut in the base rates is announced by a central bank the bond prices in the capital markets starts escalating. The bonds price tendency is hereby illustrated with the help of an example such as a Company offers 7 % on its bonds coupon and after 2 years due to inflation central bank revises the base rates and the new interest rate of 5 % comes in effect, then the company is able to raise funds from capital market through bonds while it has to pay less interest rate (5%) on the currently issued bonds. In this scenario, the price of bonds issued two years earlier climbs and investors selling bonds in open market prior to maturity earns premium as previously issued bonds yields more interest than the currently issued. Bibliography Barbara Casu, Claudia Giradone, Philip Molyneur. Introduction to Banking. prentice hall financial times. 2006. Bryant, Ralph C. International Financial Intermediation. Brookings Istitution Press, 1987. Canals, Jordi. Universal Banking : International Comparisons. Oxford University Press, 1997. Masciandaro, Donato. Handbook of Central Banking and Financial Authorities in Europe. Edward Elger Publishing, 2005. Mike Buckle, John L, Thompson. The UK financial system: theory and practices. Manchester University Press, 2004. Spajiac, Luke Drego. Financial Intermediation in Europe. springer, 2002. www.bankofengland.co.uk. www.bbc.co.uk. www.ecb.int. Read More