the financial systemby ashikur rahaman ...university of dhaka

Shah AlamLecturer

Department of Accounting & Information SystemsUniversity of Dhaka

Financial SystemThe financial system is the system that allows the

transfer of money between savers and borrowers. It comprises a set of complex and closely interconnected financial institutions, markets, instruments, services, practices and transactions.

Thus, a financial system is a set of organized institutional set-up through which surplus units transfer their funds to deficit units.

Structure of Financial System

1. Financial InstitutionsFinancial institutions are intermediaries that channel the

savings of individuals, businesses, and governments into loans or investments. Financial institutions can be sub-categorized into banks and non-bank financial institutions:

Banks:Central BankState-Owned Commercial BanksPrivate Commercial BanksForeign Commercial BanksSpecialized Banks

1. Financial InstitutionsNon-Bank Financial Institutions (NBFIs):

Financing CompaniesInsurance CompaniesSecurity FirmsInvestment BanksMutual FundsPension Funds

1. Financial InstitutionsInvestment banks are institutions that assist companies in

raising capital, advise firms on major transactions such as mergers or financial restructurings, and engage in trading and market making activities.

Mutual funds are professionally managed investment schemes that collect funds from small investors and invest in stocks, bonds, short term money market instruments, and other securities.

A pension fund is a fund established by an employer to facilitate and organize the investment of employees' retirement funds contributed by the employer and employees.

2. Financial MarketsFinancial markets are forums in which suppliers of

funds and demanders of funds can transact business directly. Financial markets can be sub-categorized into the following:

Money MarketCapital Market

Primary MarketSecondary Market

2. Financial MarketsMoney Market vs. Capital Market:• The key distinguishing feature between the money

market and the capital market is the maturity period of the securities traded in them.

• The money market is concerned with the borrowing and lending of short term funds, whereas the capital market is a market that enables suppliers and demanders of long-term funds to make transactions.

2. Financial MarketsPrimary Market vs. Secondary Market:• The primary market is the financial market in which

securities are initially issued; the only market in which the issuer is directly involved in the transaction.

• Secondary market is the financial market in which previously issued securities are traded among investors. Secondary market is influenced by demand and supply theory, and heavily affected by market forces.

3. Financial InstrumentsFinancial instruments can be thought of as easily

tradeable packages of capital, each having its own unique characteristics and structure. Based on financial markets, financial instruments can be sub-categorized into money market instruments and capital market instruments.

Money Market Instruments:Treasury BillsCommercial PapersCertificate of DepositsBill of ExchangeBankers’ Acceptance

3. Financial InstrumentsCapital Market Instruments:

StocksCommon StocksPreferred Stocks

Debt SecuritiesSecuredUnsecured

Derivative Securities

3. Financial InstrumentsA treasury bill (T-bill) is a short-term maturity

promissory note issued by a national government as a primary instrument for regulating money supply and raising funds via open market operations. Issued through the country's central bank, T-bills commonly pay no explicit interest but are sold at a discount, their yield being the difference between the purchase price and the par-value.

A commercial paper is an unsecured short-term promissory note issued by a corporation to raise short-term cash, often to finance working capital requirements.

3. Financial InstrumentsA certificate of deposit is a savings certificate entitling

the bearer to receive interest. It is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand.

A banker’s acceptance is a short-term debt instrument issued by a firm that is guaranteed by a commercial bank. Banker's acceptances are considered to be relatively safe investments, since the bank and the borrower are liable for the amount that is due when the instrument matures.

3. Financial InstrumentsA stock is a type of security that signifies ownership in a

corporation and represents a claim on part of the corporation's assets and earnings.

There are two main types of stock: common and preferred. Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. It is a special form of ownership that has features of both a bond and common stock.

3. Financial InstrumentsA debt security is any debt instrument that can be bought or

sold between two parties and has basic terms defined, such as notional amount, interest rate and maturity/renewal date.

Secured loans are those loans that are protected by an asset or collateral of some sort. Examples of secured debt include mortgages, which are secured by houses, and auto loans, which are secured by cars.

An unsecured loan is a loan not backed by an underlying asset. Unsecured debt includes credit card debt, medical bills, utility bills and any other type of loan or credit that was extended without a collateral requirement.

3. Financial InstrumentsA derivative security is a security whose price is

dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes.

Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative purposes.

Regulatory AuthoritiesIn Bangladesh, there are separate regulatory bodies for

regulation of money market and capital market. They are as follows:

Bangladesh BankBangladesh Securities and Exchange Commission

Dhaka Stock ExchangeChittagong Stock Exchange

Regulatory AuthoritiesBangladesh Bank (BB), the central bank and apex

regulatory body for the country's monetary and financial system, was established in Dhaka as a body corporate vide the Bangladesh Bank Order, 1972 (P.O. No. 127 of 1972) with effect from 16th December, 1971. At present it has ten offices located at Motijheel, Sadarghat, Chittagong, Khulna, Bogra, Rajshahi, Sylhet, Barisal, Rangpur and Mymensingh in Bangladesh; total manpower stood at 4951 (officials 3961, subordinate staff 990) as on November 30, 2012.

BB performs all the core functions of a typical monetary and financial sector regulator, and a number of other non core functions. The major functional areas include: Formulation and implementation of monetary and credit policies. Regulation and supervision of banks and non-bank financial institutions,

promotion and development of domestic financial markets. Management of the country's international reserves. Issuance of currency notes.Regulation and supervision of the payment system.Acting as banker to the government.Money Laundering Prevention. Collection and furnishing of credit information. Implementation of the Foreign exchange regulation Act.Managing a Deposit Insurance Scheme.

Regulatory Authorities

Regulatory AuthoritiesThe Bangladesh Securities and Exchange

Commission (BSEC) was established on 8th June, 1993 as the regulator of the country’s capital market through enactment of the Securities and Exchange Commission Act 1993.  Through an amendment of the Securities and Exchange Commission Act, 1993, on December 10, 2012, its name has been changed as Bangladesh Securities and Exchange Commission from previous Securities and Exchange Commission.

The main functions of BSEC are: Regulating the business of the Stock Exchanges or any other securities market. Registering and regulating the business of stock-brokers, sub-brokers, share transfer

agents, merchant bankers and managers of issues, trustee of trust deeds, registrar of an issue, underwriters, portfolio managers, investment advisers and other intermediaries.

Registering, monitoring and regulating of collective investment schemes. Monitoring and regulating all authorized self regulatory organizations. Prohibiting fraudulent and unfair trade practices relating to securities. Promoting investors’ education and providing training for intermediaries. Prohibiting insider trading in securities. Regulating the substantial acquisition of shares and take-over of companies. Undertaking investigation and inspection, inquiries and audit of any issuer or dealer

of securities, the Stock Exchanges and   intermediaries and any self regulatory organization.

Conducting research and publishing information.

Regulatory Authorities

The Dhaka Stock Exchange (DSE) is registered as a Public Limited Company and its activities are regulated by its Articles of Association rules & regulations and by-laws along with the Securities and Exchange Ordinance - 1969, Companies Act - 1994 & Bangladesh Securities & Exchange Commission Act - 1993.

Regulatory Authorities

The major functions of DSE are: Listing of Companies (As per Listing Regulations). Providing the screen based automated trading of listed Securities. Settlement of trading (As per Settlement of Transaction Regulations). Gifting of share / granting approval to the transaction/transfer of share

outside the trading system of the exchange (As per Listing Regulations 42). Market Administration & Control. Market Surveillance. Publication of Monthly Review. Monitoring the activities of listed companies (As per Listing Regulations). Investors grievance Cell (Disposal of complaint bye laws 1997). Investors Protection Fund (As per investor protection fund Regulations

1999). Announcement of Price sensitive or other information about listed

companies through online.

Regulatory Authorities

The Chittagong Stock Exchange (CSE) began its journey in 10th October of 1995 from Chittagong City through the cry-out trading system with the promise to create a state-of-the art bourse in the country. CSE was formally opened by then Honorable Prime Minister of Bangladesh on November 4, 1995.

Objectives of CSE are to: Increase business turnoverModernize trading systemEnsure effective relationship managementAchieve high level of confidence & professionalism Engage in product and market diversificationContribute to capital market policy developmentEnsure exchange related quality services

Regulatory Authorities