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The financial system is a set of organized institutional set-up through which surplus units transfer their funds to deficit units. Define a financial system fair narrowly, to consist of a set of markets, individuals and institutions, which trade in those markets and the supervisory bodies responsible for their regulation. The end-users of the system are people and firms whose desire is to lend and to borrow. A financial system is a system that to channels funds from lenders to borrowers, to create liquidity and money, to provide a payments mechanism, to provide financial services such as insurance & pensions and to offers portfolio adjustment facilities. In Finance, the financial system is the system that allows the transfer of money between savers and borrowers. It comprises a set of complex and closely interconnected financial institutions, markets, instruments, services, practices and transactions. An economys financial system exists to organize the settlement of payments, to raise and allocate finance and to manage the risks associated with financing and exchange. So, the government sector and the corporate sector are the users of financial surplus of household sector and that the financial sector performs this vital function of intermediation. Empirical evidence shows that the growth of financial markets and development of the economy are complementary to each other. A developed financial system is one that has a secure and efficient payment system, security market and financial intermediaries that arrange financing and derivative markets & financial institutions that provide access to risk management instruments. Thus, A financial system consists of a set of organized markets and institutions together with regulators of those markets and institutions. Their main function is to channel funds between end users of the system: from lenders (surplus units) to borrowers (deficit units). In addition, a financial system provides payments facilities, a variety of services such as insurance, pensions and foreign exchange, together with facilities, which allow people to adjust their existing wealth portfolios. STRUCTURE OF FINANCIAL SYSTEM IN BANGLADESH Background of financial system in Bangladesh: The financial system in Bangladesh includes Bangladesh Bank (the Central Bank), scheduled banks, non-bank financial institutions, Microfinance institutions (MFIs), insurance companies, co-operative banks, credit rating agencies and stock exchange. Among scheduled banks there are 4 Nationalised commercial banks (NCBs), 4 state owned specialized banks (SBs), 30 domestic private commercial banks (PCBs), 9 foreign commercial banks (FCBs) and 31 non-bank financial institutions (NBFIs) as of December 2006 after that total number of institutions are increasing rapidly. However, Rupali Bank, an NCB is being sold to a foreign buyer, and once this transaction is completed, the country will have only 3 NCBs., which are being corporative. Over and above the institutions cited above, four development financial institutions namely 1)House Building Financial Corporation(HBFC) 2) Palli Karma Sahayak Foundation(PKSF) 3) Samabay Bank 4) Grameen Bank
They are operating in Bangladesh, all of which are state owned. The financial system of Bangladesh is mainly bank dependent. Though in the recent years, a number of non-banking financial institutions (leasing and merchant banks) have been established, yet the banking sector still captures the lion share of the financial market.
Financial Institutions/Intermediaries:
An organization which borrows funds from lenders and lends them to borrowers on terms which are better for both parties than if they dealt directly with each other. Financial institutions as intermediaries: As a general rule, financial institutions are all engaged to some degree in what is called intermediation. Rather obviously intermediation means acting as a go-between for two parties. The parties here are usually called lenders and borrowers or sometimes-surplus sectors or units, and deficit sectors or units. As a general rule, what financial intermediaries do is: to create assets for savers and liabilities for borrowers which are more attractive to each than would be the case if the parties had to deal with each other directly. There are two general consequences of financial intermediation. The first is that there will exist more financial assets and liabilities than would be the case if the community were to rely upon direct lending. The second general consequence of the intervention of financial institutions is that lending and borrowing have become easier. It is now no longer necessary for savers to search out borrowers with matching needs. In this sense financial intermediaries have lowered the transaction costs of lending and borrowing.
Banks
Banking is essentially based on the debtor-creditor relationship between the depositors and the bank on the one hand and between the borrowers and the bank on the other. Interest is considered to be the price of credit, reflecting the opportunity cost of money. The commercial banking system dominates Bangladesh's financial sector. Bangladesh Bank is the Central Bank of Bangladesh and the chief regulatory authority in the sector. The banking system is composed of four Public commercial banks, five specialized development banks, thirty private commercial Banks and nine foreign commercial banks. Out of 6562 scheduled bank branches operating in the country, up to end December 2006 the NCBs operate 3384 branches, of which 2146 are in rural areas and 1238 are in urban areas; SBs have 1354 branches of which 1200 are in rural areas and 154 are in urban areas; PCBs have 1776 branches of which 488 are in rural areas and 1288 are in urban areas; and FCBs have 48 branches exclusively in urban areas. Out of 30 PCBs, 7 have been operating as Islamic banks. After the year 2006 that total number of branches are increasing rapidly up to 2009. List of All types of banking sectors are: 1) Central Bank 2) Private Commercial Banks 3) Public Commercial Banks 4) Foreign Commercial Banks 5) Specialized Development Banks
Investment:
NBFIs are investing in different sectors of the economy, ut their investments are mostly concentrated in industrial sector. In June 2012 the different sectors in which the NBFIs invested were industry (42.6%), real estate (18.5%), trade and commerce (10.4%), merchant banking (1.4%), agriculture sector (1.3%) and others (17.8%)
Liabilities and equity: The aggregate liability of the industry in 2011 increased to
Taka 235.7 billion from Taka 206.8 billion in 2010 while equity increased to Taka 52.7 billion in 2011 compared to Taka 44.7 billion in 2010 showing an overall increase of 14.0 and 17.9 percent respectively. Total liabilities and equity were Taka 252.2 billion and Taka 56.8 billion respectively at end of June 2012
Deposits: Total deposits of the NBFIs in 2011 rose to Taka 112.6 billion (47.8% of total
liabilities) from Taka 94.4 billion (45.7% of total liabilities) in 2010 showing an overall increase of 19.3 percent. On 30 June 2012 total deposit stood at Taka 124.2 billion (49.2 percent of total liabilities)
a) Insurance Companies
The insurance sector is regulated by the Insurance Act, 1938 with regulatory oversight provided by the Controller of Insurance on authority under the Ministry of Commerce. A separate Insurance Regulatory Authority is being established. A total of 62 insurance companies have been operating in Bangladesh, of which 19 provide life insurance and 43 are in the general insurance field. Among the life insurance companies, except the state owned Jiban Bima Corporation (GBC) foreign owned American Life Insurance Company (ALlCO), and the rest of the private. Among the general insurance companies, state-owned Shadharan Bima Corporation (SBC) is the most active in the insurance sector
b) Security Firms
Financial institutions that underwrite securities and engage in related activities such as securities brokerage, securities trading and making a market in which securities can trade.
c) Investment Banks
It primarily helps net suppliers of funds transfer funds to net users of funds at a low cost and with maximum degree of efficiency.
d) Financial Companies
The primary function of finance companies is to make loans to both individuals and business. Finance companies provide such services as consumer lending, business lending and mortgage financing.
e) Mutual Funds
Mutual funds are portfolios of different securities such as stocks, bonds, treasuries, derivatives, etc. Mutual funds pool money of both individual and institutional investors allowing the funds to achieve: (i) economies of scale by reducing costs and increasing
investment returns; (ii) divisibility and diversification; (iii) active management with superior stock picking and market timing; (iv) reinvestment of dividends, interest and capital gains; (v) tax-efficiency; and (vi) buying and selling flexibility. There might be varieties of mutual funds that differ in terms of their investment objectives, underlying portfolios of shares, risks and returns, fees and expenses, etc. Mutual funds are professionally managed investment schemes that collect funds from small investors and invest in stocks, bonds, short term money market instruments, and other securities. This ensures a diversified portfolio for the investors at much less efforts than through purchasing individual stocks and bonds. Fund managers who undertake trading of the pooled money and are responsible for managing the portfolio of holdings usually manage mutual funds. Generally, mutual funds are organized under the law as companies or business trusts and managed by separate entities. Mutual funds fall into two categories: open-end funds and closed-end funds.
f) Pension Funds
Pension funds are analyzed as financial intermediaries using a functional approach to finance, which encompasses traditional theories of intermediation. Funds fulfill a number of the functions of the financial system more efficiently than banks or direct holdings. Their growth complements that of capital markets and they have acted as major catalysts of change in the financial landscape. Financial efficiency in this functional sense is not the only reason for growth. It is also a consequence of fiscal incentives and benefits to employers, as well as growing demand arising from the ageing of the population. Employers, such as companies, public corporations, and industry or trade groups, typically sponsor pension funds; accordingly, employers as well as employees typically contribute. Funds may be internally or externally managed. Returns to members of pension plans backed by such funds may be purely dependent on the market (defined contribution funds) or may be overlaid by a guarantee of the rate of return by the sponsor (defined benefit funds).
savers, so the soundness of the institution must be widely believed. This is accomplished through federal insurance or credit ratings.
3. Providing liquidity
Recall that liquidity refers to how easily and cheaply an asset can be converted to a means of payment. Financial intermediaries make is easy to transform various assets into a means of payment through ATMs, checking accounts, debit cards, etc. In doing this, financial intermediaries must many short term outflows and investments will long term outflows and investments in order to meet their obligations while profiting from the spread between long and short term interest rates. Again, economies of scale allow intermediaries to do this at minimum cost.
4. Diversifying risk
We have seen in chapter 5 how diversification is a powerful tool in minimizing risk for a given leven of return. Financial intermediaries help investors diversify in ways they would be unable to do on their own. Mutual funds pool the funds of many investors to purchase and manage a stock portfolio so that investors achieve stock market diversification for as little at $1000. If an investor were to purchase stocks directly, such diversification would easily cost over $15,000. Insurance companies geographically diversify in ways that a Gulf Coast homeowner cannot. Banks spread depositor funds over many types of loans, so the default of any one loan does not put depositor funds in jeopardy.
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4) Asset Quality Loans are the largest asset on a banks balance sheet, and consequently, they have the greatest potential to negatively impact a depository institutions capital if they go bad. For the failed banks, mostly had loan quality problems before failing. After loans, securities are the 2nd largest asset on a banks balance sheet. In contrast to loan quality, there are no standardized metrics which regulators use to assess securities quality. This is mainly due to the fact that investment securities are more complex. Yet, of the banks without loan quality problems, five failed banks had investment quality problems leading up to their failures. All in all, out of all the failed banks from 2008 to 2010, only three banks had sound loan and investment quality the quarters leading up to failure. 5) Earnings 6) Management a) Incompetency b) Dishonesty 7) Higher Competition Due to higher competition they often attract depositors with higher interest rates and go for risky investment and loan disbursement with a hope get higher return for greater profitability. Such higher risk often lead to bank failure.
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5) Limit on the size of loan any one borrower.(Hall Mark) Not making all the loans to a single borrower because if the borrower get in trouble the bank will have huge loan losses. If they diversify the loan the risk can be reduced. 6) Capital Requirements: Capital Adequacy ratio should be >=8% 7) Monitoring (CAMELS Rating)
From the banks side 1) Management: Due to incompetency the loan officers disburse loan in a small area without understanding the consequences or risk and can eventually fail and sometimes fraud. So it is necessary to have fair management practice. 2) Asset quality: Banks shouldnt make loan in a highly risky project and shouldnt invest in risky investment. This is the one single reason banks fail. Due to incompetence the managers fail to evaluate properly the project and without considering the project
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riskiness they disburse loans and eventually incur loss. Its necessary to diversify the loan. 3) Liquidity: Banks must enough liquidity. 4) Sensitivity: Banks should go for such investment where the banks is highly sensitive to the changes. If banks have so many long term loans then its good to sell some of them if possible. Or go for hedging.
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Conclusion:
For a healthy economy a good financial is very necessary. Without a strong financial system an economy dont flourish. To have a sound financial system it is necessary to financial institutions are working properly which can ensure the growth of the economy. So its vital to take all necessary actions to prevent failure of financial institutions which can lead to a healthy economy.
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