Unit 1: Nature and Role of Financial Institutions in the Economy Nature of financial institutions Global economy and financial

al system Structure of financial institutions Functions of financial system Methods of moving loanable funds Types of financial intermediaries

Nature of Financial Institutions

Financial institution is the business firm whose principal assets are financial assets or claims (such as stocks bonds, loans) instead of real assets such as buildings, equipment, and raw materials.
Financial institutions provide financial services for its clients and most important financial services, probably, is financial intermediation, transferring funds from savers (investors) to users in need of those funds. Usually, household sectors are savers of funds and businesses and governments are demander of funds in financial system. Financial institutions also offer other variety of financial services ranging from insurance protection, selling retirement plans, safeguarding of valuables, mechanism of payment services, etc.

The intermediation and diversification are the key performed by financial institutions in financial system.

roles

Financial institutions are vital to economic well-being and future growth of a market-oriented economy.

Role of Financial Institutions

Transfer funds Funds

Surplus Generating Units

(Small amounts, Highly Liquid, low level of risk)

Financial Intermediaries
Direct claims Direct claims Direct claims

Deficit Facing Unit

(Large amount, less liquid, High level of risk)

Stock & bondholders in intermediary

Funds

Global Economy and Financial System

The economic system functions to allocate scarce resources: land, labor, management skill and capital equipment to produce goods and services needed by the society. The economic activities affect the payment behavior of the people as growing economy results in a rise in personal income. It functions to combine the various inputs to produce goods and services as output. The global economic system generates a flow of production in return for a flow of payments. The circular flow of production and income is interdependent and never ending.

The Economic System

Land and other natural resources

Flow of production

Labor and management skills

Capital equipment
Input

Flow of payments

Goods and services

Output

The flow of payments and production within the economic

system is a circular flow between producing units and the consuming units.

Circular Flow between Consuming and Producing Unit

Producing units
(mainly business firms and governments)

Consuming units
(mainly households)

The global economic system generates a flow of production in return for a flow of payments. The circular flow of production and income is interdependent and never ending process.

Financial System
The financial system is the collection of markets, institutions, laws, regulations, and techniques through which bonds, stocks, and other securities are traded, interest rates are determined, and financial services are produced and delivered around the world. The primary task of the financial system is to move scarce loanable funds from those who save to those who borrow to buy goods and services. It is essential to make investments in new equipment and facilities. Financial system helps to grow the global economy and thus

to increase the standard of living.

Economic system emphasizes economic growth and stability and financial system emphasizes the financial stability

Structure of Financial Institutions

Financial institutions are the group of firms that channel the savings of individuals, businesses, and government units into

loans and investment.

Classification of Financial Institutions Financial Intermediaries Other Financial Institutions Investment Bankers Security Dealers & Brokers

Financial Intermediaries

1. Depository Institutions
1.1 Commercial banks 1.2 Thrift institutions 1.2.1 Credit Unions

2. Non-depository Institutions 2.1 Contractual institutions Insurance companies Pension funds

1.2.2 Savings Institutions

Savings & Loan Associations (S&Ls) Savings banks

2.2 Investment institutions

Investment companies Finance companies

Financial intermediaries are the specialized financial firm that facilitates the transfer of funds from savers to demanders of capital. Such intermediaries can be categorized into three forms:
Depository Institutions Contractual Institutions Investment Institution

Depository institutions derive bulk of their loanable funds by

selling deposit accounts to the public. Commercial banks, saving & loan association, savings banks, and credit unions fall under this heading. The contractual institutions collect the funds by offering legal contracts such as selling insurance policy or pension plan to the saver to protect against risk. Insurance companies and pension funds can be taken as an example of such institution. Investment institutions are the institutions like investment companies, money market fund, finance companies, etc. that

sell shares to the public and use the proceeds to buy various types of financial assets such as stocks, bonds, and other short term debt instruments that are issued by other forms.

Depository Institutions in Nepal

Depository Institutions 1980 CB DB FC MFDB S&CC NGOs Total 4 5 7 44 2 2 1985 3 2 1990 5 2 1995 10 3 21 4 6 Mid-July 2000 13 7 45 7 19 7 98 2005 17 26 60 11 20 47 181 2006 18 28 70 11 19 47 193 2007 20 38 74 12 17 47 208 2008 25 58 78 12 16 46 235 2009 26 63 77 15 16 45 242 MidJan 2010 26 73 78 17 16 45 254

Source: Banking and Financial Statistics, 2010, NRB

CB = Commercial Banks, DB = Development Banks, FC = Finance Companies, MFDB = Micro-finance Development Banks, S&CC = Savings & Credit Co-operatives (limited banking activities), NGOs = Non Governmental Organizations (Financial Intermediaries)

Nepalese Financial Institutions Regulatory Bodies

S. No. 1 2 3 4 5 6 7 8 9 10 11 12 Financial Institutions Commercial Banks Development Banks Finance Companies Micro-Credit Development Saving and Credit Cooperatives Non-Governmental Organizations Co-operatives (Licensed under Nepal Government Government Postal Saving Banks Insurance Companies Investment Companies (Mutual Funds) Nepal Stock Exchange Security Businesspersons (Brokers, Dealers, Merchant Bankers) Employee Provident Funds Regulator NRB NRB NRB NRB NRB NRB Department of Co-operative Ministry of Finance Insurance Board SEBON SEBON SEBON Class A B C D Non-Classified Non-Classified Non-Classified Non-Classified Non-Classified Non-Classified Non-Classified Non-Classified

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Ministry of Finance

Non-Classified