Financial Markets and Institutions - Literature review Example

FINANCIAL MARKETS AND S of the Finance and Accounting Financial Markets and s Role and functions of the Financial Intermediaries A financial intermediary is any institution or organization that is able to move money from borrowers and savers. According to Allen and Gale (2000, chap 1), Financial intermediaries can be broadly classified into: deposit taking institutions such as banks, credit unions, savings and savings societies; Insurance schemes such as life insurance policies; investment ventures such as retirement benefits schemes and mutual funds. Financial intermediaries have played a major role the development and growth of the world’s economy. The financial institutions such as banks and other financial institutions such as microfinance institutions, investment ventures, and Sacco’s provide funds for the development of businesses operations. The Financial intermediaries help investors to save to improve their living conditions. For example, finance institutions give loans to small enterprises and individuals who make take less risky loans but give high returns in terms of interest rates. These returns are used to provide loans for other investors. Banks and credit unions take money that has been saved and use the money to give loans to investors; mutual funds take contributions from a group of investors and invest in a high investment requiring assets which individual investors would not have been able to invest in alone thereby spreading the risk. Financial intermediaries that encourage savings include retirement benefits institutions, housing finance institutions, insurance companies, and mutual funds where members of the public are encouraged to save for their old ages, investment purposes, and better housing. In a country where a culture of savings and borrowing is encouraged there is a significant change in the living standards of the citizens leading to development and growth of the country’s economy in general. The financial institutions encourage savings while using those savings to lend out to the individuals or the organizations that want to borrow money to invest. Financial intermediaries receiving capital from those willing to invest and in turn disbursing it to those willing to borrow capital achieve this. Allen and Santomero (1999, pp. 1-42) reported that financial intermediaries play a role in providing an avenue for organizations to access the financial markets. Financial intermediaries have been known to undertake underwriting and acting as agents to the stock exchange. When financial intermediaries undertake underwriting they are able to market the shares and other instruments on behalf of their clients as well as advise their clients on the best offer that they can attain maximum capital. The Financial intermediaries provide a channel to the financial market to their clients through underwriting. Financial intermediaries also play a role in providing credible information to their clients. The Financial intermediaries are able to represent their clients in the market by providing consultative services about the stock market. Most banks in the twenty first century have formed a different department that deals with stock market consultative services. The financial intermediary investigates for the best possible investment venture for its clients both individuals and organizations. This accrues a fee to the clients who pays the financial intermediary for the services offered (Allen & Santomero 1999, pp. 1-42). Consequently, Allen and Santomero (1999, pp. 1-42) documented that financial intermediaries reduce the lending risks upon utilizing its lending services. There are many syndicates and pyramids in the economy who want to exploit individuals and organizations by providing loans at very high rates. The financial intermediaries have been created by law and are governed by the government through the central bank. The law ensures that all financial intermediaries use a lending rate that does not exploit the members of the public and rates that ensure development and growth of a country’s economy. Furthermore, a financial intermediary is able to tell apart the viable loans from loans that will not materialize. This enables them to provide their clients with the best lucrative venture that has limited lending cost. Financial intermediaries are also able to spread the burden of their clients by diversifying their lending rates. Moreover, Allen and Santomero (1999, pp. 1-42) affirmed that financial intermediaries reduce the liquidity risk encountered by depositors. In commercial banks, mutual funds and financial institutions act as depositors for the public to deposit their money for greater investments that enables mitigation of risk. The investment ventures are further bestowed with the ability to transfer chattels to currency more quickly as compared to commercial banks. This is a benefit that can be exploited by organizations, which made deposits with the financial intermediaries, and are experiencing interim cash flow troubles. Most financial intermediaries are similar in functions; they all conduct their affairs by lending funds to agents after borrowing funds from other agents. Consequently, the large group of borrowers and lenders exhibits diversification. This is done to mitigate the loss that is accrued by having a limited investment opportunity as stated by Gorton and Winton (2002, pp. 1-141) .As pertains to their differences, Fuentelsaz, Gomez and Lucea (2006, pp. 14-17) Insurance companies design policies in contrast receive funds from the premiums they receive as a result of the policies taken by their clients. They thereafter use these funds to purchase government bonds and securities. The investment companies in their capacity receive funds through the sale of stocks, bonds, and commercial papers. They use their acquired funds to give business and consumer loans to their clients. Commercial banks play an important function in the economic activity of a country as reported by Allen and Santomero (1997, pp. 1461-85). Looking at the economic crisis of 2007 to 2009, banks were not the only players in the financial market but formed a major contribution to the economic crisis. In evaluation of the global 2007- 2008 financial crisis on the financial status of the economy, Arestis, Philip and Karakitsos (2009, pp.1-16) reported that banks played a major role in the financial crisis. The main factors that lead to the financial crisis were monetary modernization where it was possible to quick loans within a very short period due to advancement in technology, financial liberalization, and easy financial policies for the banks and other financial institutions in the United States. These factors were brought about by opening of monetary institutions, especially the banks, allowing them to dispose of their loans on the prudence of the public policy. The easy financial policies related to the mortgages created a loophole for risky owners to acquire mortgage loans from the bank. This culminated in the majority of them being unable to pay up their mortgages, leading to massive losses for the banks, translating to the global financial crisis. This crisis not only affected the commercial banks as financial intermediaries, but also affected other financial intermediaries the housing corporations and the investment ventures. This is as a result of the heavy investment pooled into the commercial banks in form of mortgage loans as affirmed by Arestis, Philip and Karakitsos (2009, pp.1-16). Arestis, Philip and Karakitsos (2009, pp.1-16) reported that for the commercial banks to compensate themselves from the liquidity losses experienced in the 2007-2008 global financial crises, they increased their lending costs, stiffened their lending standards, and lowered their credit availability. They also accumulated money balances, and they could only recover from this financial crisis with government bonds without investing in other investment ventures. This will mean that banks will not offer loans even to business with viable ventures in bid to get out of this financial crisis. According to Gorton and Winton (2002, pp. 1-141), due to lack of financial availability, companies retrenching their employees to cut on labor costs, reducing production, and limiting their investment opportunities. In the end, the global financial crisis will have not only affected the banking sector, but will also affect the consumers and the companies. Conclusion Financial intermediaries have been able to help individuals and organizations to spread financial investment risks over a wider group of investments and investors. The financial intermediaries have also helped to provide liquidity to the investors and organization for their money in investments as well as provide guidance and information to investors. Financial intermediaries can affect the growth of an economy by affecting the rate of savings and investment patterns of economy (Winton,2002, pp. 1-141) .Financial intermediaries play a paramount role in ensuring a favorable allotment of the financial income in the financial system of any country as well as the national wealth of a country. Allen and Santomero (1997, pp. 1461-85) assert that Financial Intermediaries are important in the production prospective of a nation with the capability of mitigation to its borrowing and investing of the available capital. It is important to note that commercial banks are a component of the greater financial intermediary bracket as affirmed by Gorton and Winton (2002, pp. 1-141). Taking a genesis from the 2007-2008 global financial crises, all the financial intermediaries especially the investment and commercial banks played a critical role. It is indeed prudent to conclude that commercial banks are not more important than other financial intermediaries are, but all financial intermediaries complement each other. References Allen F. and Gale D 2000, Comparing Financial Systems, Cambridge, MA: MIT Press. Allen, F and Santomero, A 1997, The Theory of Financial Intermediation,” Journal of Banking & Finance, Vol. 21, pp. 1461-85. Allen, F and Santomero, A 1999, “What do Financial Intermediaries Do?” Financial Institutions Center, pp. 1-42. Arestis, Philip and Karakitsos Elias 2009, “Subprime Mortgage Market and Current Financial Crisis,” Cambridge Centre for Economy and Public Policy, pp. 1-16. Fuentelsaz, L., Gomez, J., and Lucea, V 2006, “Do Commercial Banks, Savings Banks, and Credit Unions Compete?” International Journal of Business and Economics, vol. 5, no.1, pp17-27. Gorton, G and Winton, A 2002, “Financial Intermediation,” Financial Institutions Center, vol. 2, no. 28, pp. 1-141. Read More