Understanding the Financial System

• A healthy economy relies on a financial system that channels funds from savers to productive investments
• Developed economies depend on financial markets and institutions for efficient fund transfers
• The financial system impacts individuals, families, businesses, and governments

Nature and Objective of the Financial System

• The financial system includes financial intermediaries, markets, and their relationships
• It directs funds between households, governments, firms, and foreigners, alongside financial infrastructure
• Directing funds to productive uses via a well-functioning financial system is crucial for economic development
• Lender-savers are those who save and lend funds
• Borrower-spenders need to borrow to finance their spending
• Direct finance involves borrowers selling securities in financial markets to lenders
• Securities are claims on a borrower's future income or assets
• Securities are assets for purchasers and debts for issuers

Key Components of the Financial System

• Financial instruments are a key component
• Financial markets and institutions
• The Central Bank and other financial regulators

Functions of the Financial System

• The financial system channels funds from surplus sectors to those with shortages
• Banks, insurance companies, mutual funds, and stockbrokers compete to offer financial services

Risk Sharing

• Risk is the possibility of financial asset values changing from expectations
• By enabling savers to hold diverse assets, the financial system offers risk sharing
• It increases savers' willingness to invest in stocks and bonds
• It enhances borrowers' ability to raise funds

Liquidity

• Liquidity refers to the ease of exchanging an asset for money, appealing to savers
• Assets like stocks, bonds, and checking accounts are more liquid than assets like cars or real estate
• Securitization has increased the liquidity of many assets, allowing to buy and sell securities based on loans

Information

• The financial system collects and communicates borrower information and return expectations
• Banks gather data on borrowers to predict loan repayment likelihood
• Financial markets inform savers and borrowers by setting prices for stocks, bonds, and other securities
• This information helps individuals decide whether to maintain or sell investments

Structure of the Philippine Financial System

• Bangko Sentral ng Pilipinas is a central component
• Banking institutions
• Non-bank financial institutions

Private Banking Institutions

• Expanded Commercial Banks/Universal Banks perform investment house functions with commercial banking authority
• Commercial Banks/Domestic Banks focus on commercial bank functions
• Thrift Banks accumulate savings and invest in bonds, mortgages, and loans
• Savings and Mortgage Banks accumulate savings from depositors and invest along with its capital
• Private Development Banks exercise powers and obligations of savings and mortgage banks
• Stock Savings and Loan Associations accumulate savings from members and use funds for loans and investments
• Rural Banks accept deposits and provide credit to farmers, businessmen, and cottage industries in rural areas
• Cooperative Banks assist cooperatives by lending funds at reasonable rates

Government Banking Institutions

• Development Bank of the Philippines (DBP) provides development loans to the agricultural, commercial, and industrial sectors
• Land Bank of the Philippines (LBP) supports the Agrarian Reform Program (CARP)
• Philippine Al-Amanah Islamic Investment Bank promotes socio-economic development in the Autonomous Region of Muslim Mindanao (ARMM)

Private Non-Bank Financial Institutions

• Investment houses engage in underwriting securities and generate income from investment sales
• Investment banks advise firms on stock/bond issuance and mergers
• They engage in underwriting
• Financing companies extend credit through discounting, factoring, buying installment contracts, or leasing
• Securities dealers/brokers buy and sell securities for profit
• Savings and loan associations gather funds from savers
• Lend to home buyers and others
• Mutual funds accept money from savers and invest in stocks, bonds, or debt instruments
• Reduce risks through diversification
• Pawnshops lend money with personal property as collateral
• Lending investors effect securities transactions, give loans, and earn interest
• Pension funds are retirement plans funded by corporations or government
• Invest in bonds, stocks, mortgages and real estate
• Insurance companies take savings as premiums and pay beneficiaries
• Credit unions are cooperative associations where member savings are loaned to other members

Government Non-Bank Financial Institutions

• Government Service Insurance System (GSIS) provides benefits, including government employee loans
• Social Security System (SSS) provides benefits such as retirement and housing loans to private employees
• Pag-ibig/ Home Development Mutual Fund (HDMF) provides housing loans to government and private employees

Bangko Sentral ng Pilipinas (BSP)

• BSP’s primary objective is to maintain price stability
• It aims to promote and preserve monetary stability and currency convertibility Responsibilities:
• Liquidity management involves monetary policy
• Currency issuance is the BSP's exclusive power, with notes and coins guaranteed by the government
• To provide banking institutions with liquidity, BSP provides lender of last resort services through discounts, loans, and advances
• BSP supervises banks and regulates non-bank financial activities
• Management of foreign currency reserves occurs
• They maintain sufficient international reserves
• Policy determination of exchange rate
• The BSP primarily ensures orderly market conditions based on a market-oriented approach
• It acts as the government's banker, advisor, and official depository

BSP as a Fiscal Agent

• Acting as fiscal agent, it represents the government to financial entities
• It acts as the depository banker
• It acts as the financial advisor
• It manages public debts

Monetary Board

• The Monetary Board issues necessary rules and regulations and oversees BSP's management and operations
• A Governor is required to administer the MB policies
• It is responsible for the regulation of banks and other-BSP supervised financial institutions

Instruments on Central Bank Actions: Legal Bank Reserve Requirement

• The BSP uses the legal bank reserve to expand or contract money supply
• BSP increases reserve requirements during inflation
• Reduces loanable funds and restricts credit
• BSP decreases reserve requirements during deflation

Instruments on Central Bank Actions: Loans

• Control of the Discount and Rediscount Rates on Loans controls and earns income.
• Purchases and Sales of Government Securities empowers the Monetary Board to buy and sell in the open market.
• Open Market Operation places indebtedness of the Bangko Sentral.
• Collaterals Required on Bank Loans increase collaterals required on loans
• Loan value decreases.
• Portfolio Ceiling Imposition places on upper limit on the loans
• Loans and investments limit that the bank is able to have.

Instruments on Central Bank Actions:

• Minimum Capital Ratio may be prescribed
• Margin Requirements against Letter of Credit may be prescribed
• Moral Suasion uses persuasive power to support credit policies.

Philippine Deposit Insurance Corporation (PDIC)

• The PDIC insures deposits in all banks
• It was created in 1963 by Republic Act 3591
• Functions
• Insurance
• Risk Mitigation
• Liquidation
• The Board of Directors is primarily responsible for the governance of the corporation.