MONEY, CREDIT AND BANKING

CHAPTER 3

BASIC ELEMENTS
OF THE
FINANCIAL SYSTEM
FINANCIAL SYSTEM DEFINED
Cargill:
“In which funds are traded between borrowers and lenders.”
Kaufman:
“The instruments, institutions, markets, and rules governing the
conduct of trade that expedite the routing of funds from buyers to sellers
and from savers to lenders.”
Rose, Kolari, and Fraser:
“The institutional mechanism established by society to produce and
deliver financial services and allocate resources, consisting of the
business firm supplying financial services, the customers of financial
service firms, and government regulatory authorities that enforce the rules
prevailing within the financial sector.”
 CREDIT

FUNCTIO
NS OF
SAVINGS
THE PAYMENTS

FINANCI
AL
SYSTEM
MONEY
CREATION
CREDIT
Credit is supplied by the financial system to three(3) Types of Borrowers:
1. Consumers
2. Businesses And these
3. Government Purchases
firms can
When they make
now
Borrowers strengthen
provide
provided the firms
many
w/ funds,
And make they
Thus,
employme
various patronize;
these firms
nts;
products pay taxes
and to the
services Governme
PAYMENTS

A mechanism for making payments is supplied by the FINANCIAL SYSTEM. The payments
system takes the form of CURRENCY, CHECKING ACCOUNTS, and VARIOUS
TRANSACTION MEDIA.

Financial Institutions lately have developed NEW PAYMENT SERVICES such as:

• Money Market
• Negotiable Order of Withdrawal (NOW) accounts
• All types of Interest-bearing Checking accounts
• Tuition Fee and Phone-paying Services
• Electronic Machines that accept deposits and dispense cash (i.e. ATM)
MONEY CREATION
Money is artificially created by the Financial System through the services of supplying
credit and providing a mechanism for making payments.

Even if the government provides currency for circulation, additional money is created by
the banking system by facilitating the use of other means of payment like CHECKS.

“Financial Institutions (i.e. Banks) create money, out of people's money.”

SAVINGS
The Financial System serves as a VENUE for savings. This is made through accepting
deposits and loan agreements with the use of various financial instruments.

The Financial System relieves the individual savers' “burdensome” task of finding willing
borrowers.
COMPONENTS OF THE FINANCIAL SYSTEM
• Are evidences of debt that are brought and
Financial sold in the market
Instruments • Consist of money, loans and ownership
shares

• Is a mechanism by which savings in

Financial one sector of the economy flows to
Markets another sector
FINANCIAL
• Is an organization thru which funds in
SYSTEM the form of money are assembled and
Financial transferred from individuals with
Institution surplus funds to another needing extra
funds.

1. Pertinent laws concerning financial institutions;

2. Memoranda, circulars and issuances;
Governing
Rules 3. Pertinent ordinances of local government units;
4. Customs and traditions inherent to the area where
the financial institution is situated
CONNECTING BORROWERS WITH LENDERS
Borrowers and Lenders are two most important segments of the ecomony.
Interactions between them drums-up economic activity.
The services provided by the “intermediaries” of financial system make the interaction ore
brisk and productive.

4 SECTORS OF THE ECONOMY ENGAGED IN

BORROWING AND LENDING

HOUSE GOVERFOREIG
FIRMS
HOLDS NMENT NERS
THE FINANCIAL SYSTEM AND THE FLOW OF FUNDS

FIRM'S EXPENSE HOUSEHOLD INCOME

FIRMS HOUSEHOLDS
HOUSEHOLD
FIRM'S REVENUE EXPENDITURE

INVESTMENT EXCESS
EXPENDITURE FUNDS

FINANCIAL
BORROWING SYSTEM LENDING
THE FINANCIAL SYSTEM AND THE FLOW OF FUNDS INCLUDING THE GOVERNMENT

WAGES, DIVIDENDS, INTERESTS

FIRMS HOUSEHOLDS
PURCHASES

SAVINGS
PURCHASING

TAXES

THE FINANCIAL
GOVERNMENT SYSTEM
BORROWING LENDING
WHY HOUSEHOLDS SAVE AND LEND

The needs of households vary from day-to-day, month-to-month, and year-to-year. For instance, a
newly married couple will need a place/house to stay. If there are no apartment or houses available for
rent in the area where they work, they may need to purchase/construct one, including a vehicle.
At this point, their incomes may not be enough to make capital expenditures.
So, the couple may decide to save a part of their monthly income to put up enough funds to construct a
house and buy a car.

As the household grows older, its income will tend to grow faster than its expenses. It will then have
excess (surplus) funds. The household wil now consider saving the excess for the use in the future
when income will be less than thier needs.

Putting the saving in a vault in the house of the saver has the advantage of liquidity. As the saved
money could be spent as fast the need arises.

However, the disavantage is the possible loss of purchasing power due to inflation and the
opportunity make income from investment.
RELATIONSHIP BETWEEN HOUSEHOLD INCOME AND SPENDING AT
VARIOUS STAGES

Stage in the Life Cycle of the Income Financial Decision

Household

NEW Smaller than expenses Spend savings or borrow

MIDDLE AGE Bigger than expenses Build up savings and liquidate

borrowings

RETIREMENT Smaller than expenses Spend savings

WHY FIRMS INVEST AND BORROW

Firms, at one time or another,are affected by deficiency in CAPITAL. It happens when

opportunities for investment come by. Additional investment may bring additional income or
economies in operation.

A drug retailing firm for instance, may expand by opening branches in various places. The
IMMEDIATE ADVANTAGES that may be derived are as follows:

1. Quantity discounts for bulk purchases granted by suppliers;

2. Additional revenue from sales.

When the owners of the firm cannot provide additional capital, they will resort to borrowing. This
situation happens not only to SMALL FIRMS but to
EXAMPLE OF FIRMS WHICH BORROWED OR INTEND TO BORROW FROM
THE FINANCIAL SYSTEMS IN 2014

BUSINESS FIRM AMOUNT BORROWED /

INTEND TO BORROW

SM Prime Holdings P 25 BILLION

JG Summit Holdings (Robinsons, URC) P 30 BILLION

PLDT (Philippine Long Distance Telephone) Company P 15 BILLION

ABS CBN (Alto Broadcasting System and Chronicle

P 10 BILLION
Broadcasting Network)

Filinvest Development Corporation P 10 BILLION

TRANSFER OF FUNDS FROM LENDERS TO BORROWERS
INDIRECT FINANCE

FINANCIAL
INTERMEDIARIES

LENDERS-SAVERS BORROWERS-SPENDERS

1. Households 1. Households
FUNDS FINANCIAL FUNDS
2. Business Firms 2. Business Firms
MARKETS
3. Government 3. Government
4. Foreigners 4. Foreigners

DIRECT FINANCE
TRANSFER OF FUNDS FROM LENDERS TO BORROWERS
METHODS OF DIRECT FINANCING

MEANS DESCRIPTION

Refers to selling of securities by private negotiation directly to insurance

PRIVATE PLACEMENTS companies, commercial banks, pension funds, large-scale corporate
investors and wealthy individual investors.
Is one who acts as intermediary between buyers ans sellers but does not
BROKER take titles to the securities traded.
Is one who is in the security business acting as a principal rather than an
DEALER agent. He makes profit by selling his inventory of securities at a price
higher than the acquisition cost.
Is a person who provides financial advise and who underwrites and
INVESTMENT BANKER distributes new investment securities.
TYPES OF DIRECT FINANCE
Comm
ercial • Indirect finance (also called as Financial
Intermediation) refers to lending by an
Banks ultimate lender to a financial intermediary
Pensio Mutual that then relends to ultimate borrowers.

n INDIRECT
Saving • The inefficiencies of Direct Financing
brought to the fore the services of Indirect
Funds FINANCE Banks Financing or Financial Intermediaries.

Life • Direct claims with one set of

characteristics are purchased from
Insura borrowers, then transformed into indirect
Credit claims with different set of characteristics
nce and then sold to lenders.
Unions
Comp
anies
BENEFITS OF FINANCIAL INTERMEDIATION

1. Financial
Intermediaries can
substantially
reduce transaction 2. Reduction of Moral
cost Hazard
 DEMO
KINDS OF FINANCIAL INTERMEDIATION
NINATI
ON
INTER
INFOR MEDIA DEFAU
MATIO TION LT
N RISK
KINDS
INTER INTER
MEDIA MEDIA
MATU
TION TION
RITY
INTER
MEDIA
4 CATEGORIES OF FINANCIAL INTERMEDIATION

DEPOSITORY CONTRACTUAL
INTERMEDIATION INTERMEDIATION

SECONDARY INVESTMENT
INTERMEDIATION INTERMEDIATION
REGULATION OF THE FINANCIAL SYSTEM
General Banking Act
The Revised Securities Act
Philippine Deposit Insurance Law
The Thruth in Lending Act
Offshore Banking Law
Uniform Currency Act
Corporation Code
Negotiable Instruments Law
Financing Company Act of 1998

SECOND AREA FOR MONITORING & CONTROLLING FINANCIAL SYSTEM

Bangko Sentral ng Pilipinas
Monetary Board
Securities and Exchange Commission
FINANCIAL INTERMEDIARIES AND THEIR SOURCES OF FUNDS

Commercial Banks Deposits (Checking, Savings, and Time)

Savings and Loan Association Deposits (Checking, Savings, and Time)
Mutual Savings Banks (For Cooperatives) Deposits (Checking, Savings, and Time)
Credit Unions Deposits (Checking, Savings, and Time)
Life Insurance Companies Premiums from Policyholders
Non-life Insurance Companies Premiums from Policyholders
Pension Fund Companies, GSIS, SSS Employer and Employee contributions
Finance Companies Issues of Commercial paper, Stocks and Bonds
Mutual Funds Issues of Shares
Money Market Mutual Funds Issues of Shares