This document provides an overview of the key components of the financial system. It discusses the six main parts of the financial system: money, financial instruments, financial markets, financial institutions, regulatory agencies, and central banks. It then describes the core principles of money and banking. Finally, it outlines the structure of the financial industry, including depository institutions like banks, and non-depository institutions like insurance companies, investment banks, and mutual funds.

1. Lecture 1
Introduction to Banking Systems
1-1

2. Six Parts of the Financial
System
1. Money
To pay for purchases and store wealth.
2. Financial Instruments
To transfer resources from savers to investors and to transfer
risk to those best equipped to bear it.
3. Financial Markets
To buy and sell financial instruments.
4. Financial Institutions
To provide access to financial markets, collect information &
provide services.
5. Regulatory Agencies
To provide oversight for financial system.
6. Central Banks
To monitor financial Institutions and stabilize the economy.
1-2

3. Six Parts of the Financial
System
1. Money
◦ Money has changed from gold/silver
coins to paper currency to electronic
funds.
◦ Cash can be obtained from an ATM any
where in the world.
◦ Bills are paid and transactions are
checked online.
1-3

4. Six Parts of the Financial
System
2. Financial instruments
◦ Buying and selling individual stocks
used to be only for the wealthy.
◦ Today we have mutual funds and other
stocks available through banks or
online.
◦ Putting together a portfolio is open to
everyone.
1-4

5. Six Parts of the Financial
System
3. Financial Markets
◦ Once financial markets were located in
coffeehouses and taverns.
◦ Then organized markets were created,
like the New York Stock Exchange.
◦ Now transactions are mostly handled by
electronic markets.
 This has reduced the cost of processing
financial transactions.
◦ There is a much broader array of
financial instruments available.
1-5

6. Six Parts of the Financial
System
4. Financial Institutions
◦ Banks began as vaults, developed into
institutions, to today’s financial
supermarket.
◦ Offer a huge assortment of financial
products and services.
1-6

7. Six Parts of the Financial
System
5. Government regulatory agencies
◦ Government regulatory agencies were
introduced by federal government after
the Great Depression.
◦ Government regulatory agencies provide
wide-ranging financial regulation - rules
and supervision.
◦ Government regulatory agencies examine
the systems a bank uses to manage its
risk.
◦ The 2007-2009 financial crises has led
governments to consider greater
regulation.
1-7

8. Six Parts of the Financial
System
6. Central banks
◦ Central banks began as large private
banks to finance wars.
◦ Central banks control the availability of
money and credit to ensure low inflation,
high growth and stability of financial
system.
◦ Today’s policymakers strive for
transparency in their operations.
1-8

9. Five Core Principles of
Money and Banking
1. Time has value.
2. Risk requires compensation.
3. Information is the basis for
decisions.
4. Markets determine prices and
allocation resources.
5. Stability improves welfare.
1-9

10. Five Core Principles of
Money and Banking
A. Core Principle 1: Time has value
◦ Time affects the value of financial
instruments.
◦ Interest is paid to compensate the
lenders for the time the borrowers have
their money.
◦ Chapter 4 develops an understanding
of interest rates and how to use them.
1-10

11. Five Core Principles of
Money and Banking
B. Core Principle 2: Risk requires
compensation
◦ In a world of uncertainty, individuals will
accept risk only if they are
compensated.
◦ In the financial world, compensation
comes in the form of explicit payments:
the higher the risk the bigger the
payment.
1-11

12. Five Core Principles of
Money and Banking
C. Core Principle 3: Information is the
basis for decisions
◦ The more important the decision, the
more information we gather.
◦ Collection and processing of
information is the foundation of the
financial system.
1-12

13. Five Core Principles of
Money and Banking
D. Core Principle 4: Markets determine
prices and allocate resources.
◦ Markets are the core of the economic
system.
◦ Markets channel resources and
minimize the cost of gathering
information and making transactions.
◦ The better developed the financial
markets, the faster the country will
grow.
1-13

14. Five Core Principles of
Money and Banking
E. Core Principle 5: Stability improves
welfare.
◦ A stable economy reduces risk and
improves everyone's welfare.
◦ Financial instability in the autumn of 2008
triggered the worse global downturn since
the Great Depression.
◦ A stable economy grows faster than an
unstable one.
1-14

15. Financial Institutions
 Firms that provide access to the financial markets,
both
◦ to savers who wish to purchase financial instruments
directly and
◦ to borrowers who want to issue them.
 Also known as financial intermediaries.
◦ Examples: banks, insurance companies, securities firms,
and pension funds.
 Healthy financial institutions open the flow of
resources, increasing the system’s efficiency.
3-15

16. Financial institutions are businesses
which offer multiple services in banking
and finance.
The services customers receive may
include savings and checking accounts,
loans, investments, and financial
counseling.
The benefits consumers gain by using
financial institutions includes
convenience, cost savings, safety, and

17. The Role of Financial
Institutions
 To reduce transaction costs by
specializing in the issuance of
standardized securities.
 To reduce the information costs of
screening and monitoring borrowers.
◦ They curb asymmetries, helping
resources flow to most productive uses.
 To give savers ready access to their
funds.
3-17

18.  Financial intermediation and leverage in
the US have shifted away from
traditional banks and toward other
financial institutions less subject to
government regulations.
◦ Brokerages, insurers, hedge funds,
etc.
 These have become known as shadow
banks.
◦ Provide services that compete with
banks but do not accept deposits.
◦ Take on more risk than traditional
banks and are less transparent.
3-18

19.  The rise of highly leveraged shadow banks,
combined with government relaxation of
rules for traditional banks, permitted a rise of
leverage in the financial system as a whole.
◦ This made the financial system more vulnerable
to shocks.
 Rapid growth in some financial instruments
made it easier to conceal leverage and risk-
taking.
3-19

20.  The financial crisis transformed
shadow banking.
◦ The largest US brokerages failed,
merged, or converted themselves into
traditional banks to gain access to
funding.
 The crisis has encouraged the
government to scrutinize any financial
institution that could, by risk taking,
pose a threat to the financial system.
3-20

21. The Structure of the Financial
Industry
 We can divide intermediaries into two
broad categories:
◦ Depository institutions,
 Take deposits and make loans
 What most people think of as banks
◦ Non-depository institutions.
 Include insurance companies, securities firms,
mutual fund companies, etc.
3-21

22. The Structure of the Financial
Industry
1. Depository institutions take deposits and
make loans.
2. Insurance companies accept premiums,
which they invest, in return for promising
compensation to policy holders under
certain events.
3. Pension funds invest individual and
company contributions in stocks, bonds,
and real estate in order to provide
payments to retired workers.
3-22

23. The Structure of the Financial
Industry
4. Securities firms include brokers, investment
banks, underwriters, and mutual fund
companies.
◦ Brokers and investment banks issue stocks
and bonds to corporate customers, trade
them, and advise customers.
◦ Mutual-fund companies pool the resources of
individuals and companies and invest them in
portfolios.
◦ Hedge funds do the same for small groups of
wealthy investors.
3-23

24. The Structure of the Financial
Industry
5. Finance companies raise funds
directly in the financial markets in
order to make loans to individuals
and firms.
◦ Finance companies tend to specialize in
particular types of loans, such as
mortgage, automobile, or business
equipment.
3-24

25. The Structure of the Financial
Industry
6. Government-sponsored enterprises
are federal credit agencies that
provide loans directly for farmers and
home mortgagors.
◦ Guarantee programs that insure loans
made by private lenders.
◦ Provides retirement income and
medical care through Social Security
and Medicare.
3-25

26. Nondepository Financial Institutions
 Are financial intermediaries that do not
accept deposits but do pool the payments
of many people in the form of premiums or
contributions and either invest it or provide
credit to others.
 Nondepository institutions include pension
funds, securities firms, government-
sponsored enterprises, and finance
companies.

27. Insurances Companies
 Insurance companies may be
classified as
1. Life insurance companies,
which sell life insurance, annuities and
pensions products.
2. Non-life or general insurance
companies, which sell other types of
insurance.

28.  There are also smaller non depository
institutions, such as pawnshops that
make loans based on the value of
property such as jewelry, electronics, or
other valuable items.
 Pawnshops charge much higher fees
than other lending institutions.

29. Mutual Fund
An investment which is comprised of a pool
of funds collected from many investors for
the purpose of investing in securities such
as stocks, bonds, money market securities
and similar assets.

30. Brokerage Houses
Stock brokers assist people in investing,
online only companies are called 'discount
brokerages', companies with a branch
presence are called 'full service brokerages'
or 'private client services.

31. Investment company
 Generally, an "investment company" is a
company (corporation, business trust,
partnership, or limited liability company)
that
 Issues securities
and
 Is primarily engaged in the business of
investing in securities.

32. Depository institutions
Figure 13.3. Where Our Money Is
Deposited

33. Banks
 A bank is a commercial or state institution
that provides financial services, including
issuing money in various forms, receiving
deposits of money, lending money and
processing transactions and the creating of
credit.

34. 1. Central Bank
 A Central Bank, Reserve Bank or Monetary
Authority, is an entity responsible for the
monetary policy of its country or of a group of
member states, such as the European
Central Bank (ECB) in the European Union,
the Federal Reserve System in the United
States of America,

35. 1. Central Bank
 Its primary responsibility is to maintain the
stability of the national currency and money
supply, but more active duties include
controlling subsidized-loan interest rates, and
acting as a “lender of last resort” to the
banking sector during times of financial crisis

36. 2. Commercial Banks
 A commercial bank accepts deposits from
customers and in turn makes loans, even in
excess of the deposits; a process known as
fractional-reserve banking. Some banks
(called Banks of issue) issue banknotes as
legal tender.

37. Size, structure and
composition
 From1985 to 2016 the number of banks
decreased as a result of merges and
acquisitions.

38. Small banks
1,5
0,1
0,6
0,5
7,3
Sales
C.i
credit cart
consumer
other
real estate

39. Large banks
5,3
2
1,1
0,7
0,9
Sales
REAL ESTATE 53%
C&I
OTHER
CREDIT CARD
CONSUMER

40. 3. Investment Banks
 Help companies and governments and their
agencies to raise money by issuing and
selling securities in the primary market. They
assist public and private corporations in
raising funds in the capital markets (both
equity and debt), as well as in providing
strategic advisory services for mergers,
acquisitions and other types of financial
transactions.

41. 4. Saving Banks
 A saving bank is a financial institution whose
primary purpose is accepting savings
deposits. It may also perform some other
functions.

42. 5. Micro Finance Banks
 For the purpose of poverty reduction program,
such kind of banks are working in the different
countries with the contribution of UNO or
World Bank.

43. 6. Islamic Banks
 Islamic banking refers to a system of
banking or banking activity that is consistent
with Islamic law (Sharia) principles and
guided by Islamic economics. In particular,
Islamic law prohibits usury, the collection and
payment of interest, also commonly called
riba in Islamic discourse.

44. 9. Leasing Companies
 A lease or tenancy is the right to use or
occupy personal property or real property
given by a lessor to another person (usually
called the lessee or tenant) for a fixed or
indefinite period of time, whereby the
lessee obtains exclusive possession of the
property in return for paying the lessor a
fixed or determinable consideration
(payment).

45. Federal Reserve System
 Established to supervise and regulate
member banks
 All national banks are required to join the
Federal Reserve System
 Banks that join the system are called
“member banks”

46. The functions of the Central Banks
 Cashes checks for banks
 Makes loans to banks
 Wires money
 Collect checks for banks
 Supervise all national banks
 Supervises other members of the
system
 Raises and lowers interest rates
 Attempts to control inflation

47. Money Supply
 A bank holds on to only a fraction of the
money that it takes in—an amount called its
reserves—and lends the rest out to
individuals, businesses, and governments.
 In turn, borrowers put some of these funds
back into the banking system, where they
become available to other borrowers.
 The money multiplier effect ensures that the
cycle expands.

49. Conclusion
 Financial institutions serve as financial
intermediaries between savers and
borrowers and direct the flow of funds
between the two groups.