financial institution and eco dev

8/9/2019 Financial Institution and Eco Dev

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Financial Institutions & EconomicDevelopment

FI-I


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Financial Institution

FIs are business organizations that act asmobilizers and depositories of savings andas purveyors of credit and finance.Also provide various financial services to thecommunity.Distinct from real sector organizations.

Differences in various financial institutions-based on primary activity (functional),sectoral, geographic.


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C lassification of FIs

Banking and Non banking

Intermediaries and non intermediaries

Regulatory institutions* SEBI* RBI* IRDA


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Financial systems

Financial system is concerned about money ,credit and finance and comprises of :

1. Specialized and non- specialized FIs2. Organized and unorganized financial markets3. Financial instruments and services that facilitate

savings, transfer of funds, credit , investments.

4. Financial practices, interrelationships are alsopart of financial systems.


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C lassification of Financial Markets

Primary & secondary marketsMoney & capital markets

Organised & unorganised marketsOfficial & unofficial marketsFormal & informal markets

Domestic & foreign


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Financial instruments/services

Financial assetsFinancial securities

- ownership & debt- direct / indirect

Financial instrument differ from each other

in respect of their investment characteristics.


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C haracteristics of Financial

instrumentsLiquidityMarketability

ReversibilityTransferabilityTrx. C ostsRisk of defaultMaturity periodTax status


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Basic Role of Financial Institutions

FIs play a significant role in capital formationC apital formation critical and indispensable for economic development.

The process of capital formation involves:a) Savingsb) C reditc) Investments

The volume of capital formation depends onintensity & efficiency with which the above 3activities carried out.


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Role of FIs in Eco.Development

FIs play an important role in efficient allocation of funds from savings surplus

to savings deficit units through variousfinancial innovations and developmentsin technology

FIs act as a link between savers andinvestors.


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C apital Formation

The transfer of savings from households andgovernments to the business sector resulting inincreased output and economic development.The creation of productive assets that expand aneconomy's capacity to produce goods andservices. Private savings facilitates capitalformation by allowing resources to be diverted tocorporate investment rather than individualconsumption.


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Process of capital formation


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Role of FIs in C apital Formation

Divorce between savings & investmentsThree kinds of eco. units

- Savings surplus units- Economic units or savings deficit units- Neutral unitsFor capital formation savings of first groupmust be transferred to second group.FIs help in this transfer process


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Stages of Financial Development

The growth in financial innovations andcapital formation can be seen in followingthree situations

* Rudimentary finance

* Direct finance* Indirect finance


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Types of moneyPaper money C urrencyBank accounts C heques , money transfers

C redit

Financial assets/ instruments (securities)- Shares/debentures- MF- Foreign Exchange

- DerivativesPlastic money - C redit/ Debit cardsTelcom service providers - call credits


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Financial System & Economic

DevelopmentEffects of Fin. System on Savings & Investment1. C lassical Prior Voluntary Savings Theory2. C redit C reation Theory3. Inflationary Financing Theory

4. Financial Repression Theory5. Financial Liberalization Theory


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Financial Liberalization Theory

Developing countries suffer due to poor performance in respect of savings,investment and growth due to financialcontrol (Quota/license), regulation,repression etc.Fin repression results in lower volume of

investments, rationing of funds, politicalpressures, directed credit programs etc.


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Indicators of Financial repression

Distortion in financial pricing: interestrates, exchange rates etc.

Interest rate ceilings or fixing ratesadministratively.Directed credit programs.

Credit rationing

Inefficiencies in allocation of resources


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Distortions due to interest rateceilings

Bias towards current consumption.Induce saver to hold savings in non productive

real assets.Result in financing projects that are lowyielding and inefficient.

Borrowers choose more capital intensiveprojects.They make people rent seekers.


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Financial liberalization

Elimination of financial repression through:- deregulation- privatization- trade liberalization- C urrency convertibility

*current account*capital account


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Financial liberalization-results

Increase in savings, and investmentsIncrease in availability of funding for

projects through investments & creditExpansion in supply of foreign investmentsFree market interest rates

Increase in efficiency of investment.In short, Fin. Liberalization acceleratesfinancial & economic development


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Financial Development A fewconcepts

InnovationsDiversificationUniversal bankingDisintermediationBroad, wide, deep & shallow marketsPrivatization

Prudential regulationIntegrationGlobalization

financial institution and eco dev

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