BBS 3 rd Year ( Finance Theory ) -New Syallabus

 

Chapter:1

Introduction

 

10-15 Marks Theory

 

 

·         Concept of Financial System

·        Components of Financial System with reference to     Nepalese Financial System

·       Size of Overall Nepalese Financial System

·       Structure of Nepalese Financial Sector

·   Process of Fund Transfer from Surplus unit to Saving     Units

·  Function and role of Financial Intermediaries in the   Financial System.

 

 

 

Concept and Components of Financial System 

In simple word, Financial System is system that allows transfer the fund from surplus unit to deficit unit in the economy. It is a network of financial institution, financial market, financial assets or instruments and financial services to facilitate the transfer of fund. These are the main components of financial system : financial institution, financial assets or instruments b financial market or services . We discuss all these components of financial system in Nepalese context below:

i)                    Financial Institution:

Financial Institutions are the major component of financial system. They provide different types of financial service. Financial institutes are broadly classified into depository financial institution and non-depository financial institutions. Depository financial institution are those institutions that accept deposit from general public. Commercial Bank, Development Bank, Finance Company, Saving and Credit Co-operative are depository financial institutions. Non- depository institutions are financial institutions that do not accept deposit from general public, Insurance company, Pension Fund, Provident Fund are the examples of non- depository financial institutions.

 

ii)                  Financial Assets:

Financial Assets are the instrument that are traded in the financial market. So, they are also called financial instrument. Financial assets are the means of transferring funds from surplus units to deficit units. For surplus units, Financial assets are the assets and deficit units they are liabilities. Common types of financial assets in Nepal are Share, Bond, Debenture etc.

 

 

iii)                Financial Market:

Financial assets are traded in the Financial Market. Market is the place or location where physical assets and financial assets exchange. Thus, financial market are those market where firms and government sales financial asssets to raise their fund and investor by financial assets to invest their money. Investors are the surplus unit and firms and government are the deficit unit. According to maturity of financial assets traded financial market are classified into money market and capital market. According to the issue of security they are classified into primary market and secondary market.

 

 

 

Size and Structure of Nepalese Financial System 

 

Banks and Institutions	Insurance Company	Securities Market Institutions	Others
Commercial Banks 27 (4753)	Insurance 39 ( 3706 )	Stock Exchange	Employee Providend Fund: 1
Development Banks 17 ( 1023 )	Reinsurance Companies: 2	Central Depositary Company: 1	Citizen Investment Trust: 1
Finance Companies 17 (222 )		Stock Broker and Dealers: 51	Postal Saving Bank : 1
Microfinance Financial Institution 70 (4685 )		Merchant Bankers : 30 Credit Rating Agencies: 2 Depository Participants: 79	Deposit & Credit Guarantee Fund: 1   Credit Information Centre Limited: 1

 

 

 

 

 

 

 

 

Process of Fund Transfer from Surplus Units to Saving Units 

Saving units need to mobilize their saving for productive sector and earn return in term of profit, interest and capital gain. Deficit units of the economy need fund to finance their current expenditure and capital expenditure. They finance their current and capital expenditure by borrowing fund from surplus units. These are two process of transferring funds from surplus units to deficit units  of the economy. The first one is direct transfer and the second one is indirect transfer of fund.

              i)     Direct Transfer Fund:

In direct transfer fund process, deficit units of the economy borrow the fund from surplus units directly without involving the financial intermediaries.

ii )   Indirect Transfer of Fund:

In indirect transfer process, surplus units lend the fund to financial intermidiaries and financial intermediaries lend the fund to deficit units. Financial assets flow from financial intermediaries to surplus units and deficit units to financial intermediaries.

                

Function and Role of Financial Intermediaries

 Financial Intermediaries is the primary route for moving fund from landers to borrowers. Financial intermediation is the process of channeling the funds from surplus units to deficit units in the economy. We discuss this function of financial intermediaries in the financial market.

 

i)                   Reducing Transaction Cost:

                                                    Investors need information about the issues and financial assets before investing their funds. Landers/ Surplus need information about the borrowers. Financial Intermediaries have professional staff to evaluate the target financial securities and evaluate the financial condition of borrowers. Thus, intermediaries have a key role in reducing the transaction cost of fund.

 

ii)                 Reducing Risk through Diversification:

                                  Individual investors have a small amount of fund for investment. They cannot invest their funds in many securities and diversity the risk in investment. So, it is almost impossible for the small investor to diversify and reduce the risk but the financial institutions. It is easy to reduce risk via diversification. So, this is the second basic function of intermediaries.

 

iii)               Transforming the financial assets :

                                  Financial Institution receives the funds from their customer and transform the funds into different assets. For example: Financial institutions receive the deposits from their customers and they invest in different financial assets or different product. Thus, financial institution transform the financial assets from one form to another one as per the needs of their market.

 

iv)               Alleviation of adverse selection and moral Hazard:

                                  Adverse selection of borrower and Moral Hazard increase the default risk. Borrowers can reduce the risk of adverse selection and Moral Hazard. If they would have more information about the borrowers. Financial intermediaries have different mechanism to get the correct information about the borrowers, relevant projects and securities. They can alleviate the problem of adverse selection of borrowers and Moral Hazard.

 

v)                 Maturity Intermediation:

                                  Maturity period for the funds demanded by deficit units may not match the maturity period of fund supplied by the surplus units. For example: A business firm needs Rs 3 mill loan for 3 years, but investors may be interested to invest for less than or more than 3 year. Hence, we can see there is problem in time period. So, in this case financial intermediaries or bank can solve the problem of this firm very easily by issuing claim against it and granting the loans for the firm for 3 years.

 

vi)               Providing Payment Mechanism:

                                  We always do not make payment in cash. In developed financial system, payment in cash are not often made. We make payments using cheques, credit cards, debit cards and electronic transfer of funds. These methods of payments are cheap and safe. Financial intermediaries provide the mechanism for these methods of payment.