Financial system in Sri Lanka

What is a Financial System ?

A financial system can be defined at the global, regional or firm-specific level and is a set of implemented procedures that track financial activities. On a regional scale, the financial system is the system that enables lenders and borrowers to exchange funds. A financial system is the system that covers financial transactions and the exchange of money between investors, lender and borrowers. A financial system can be defined at the global, regional or firm specific level. Financial systems are made of intricate and complex models that portray financial services, institutions and markets that link depositors with investors.

Financial systems are not only evident in bank financial institutions. Some institutions have market brokering, investment and risk pooling services. However, these institutions are non-bank financial institutions that are not regulated by a bank regulation firm or agency.

The components of a financial system

Financial institutions

Financial institutions provide financial services for members and clients. It is also termed as financial intermediaries because they act as middlemen between the savers and borrowers.

Banks - Banks are financial intermediaries that lend money to borrowers to generate revenue and accept deposits. They are typically regulated heavily, as they provide market stability and consumer protection. Banks include,

Commercial bank

Specialize bank

Non-bank financial institutions - Non-bank financial institutions facilitate financial services like investment, risk pooling, and market brokering. They generally do not have full banking licenses. Non-bank financial institutions include,

Finance and loan companies

Insurance companies

Mutual funds

Commodity traders

Financial markets

Financial markets are markets in which securities, commodities, and fungible items are traded at prices representing supply and demand. The term "market" typically means the institution of aggregate exchanges of possible buyers and sellers of such items.

Primary markets - The primary market (or initial market) generally refers to new issues of stocks, bonds, or other financial instruments. The primary market is divided into two segment, the money market and the capital market.

Secondary markets - The secondary market refers to transactions in financial instruments that were previously issued.

Financial instruments

Financial instruments are tradable financial assets of any kind. They include money, evidence of ownership interest in an entity, and contracts.

Cash instruments - A cash instrument's value is determined directly by markets. They may include securities, loans, and deposits.

Derivative instruments - A derivative instrument is a contract that derives its value from one or more underlying entities (including an asset, index, or interest rate).

Financial services

Financial services are offered by a large number of businesses that encompass the finance industry. These include credit unions, banks, credit card companies, insurance companies, stock brokerages, and investment funds.

What is a Financial Intermediary ?

A financial intermediary is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment banks, mutual funds and pension funds. Financial intermediaries offer a number of benefits to the average consumer, including safety, liquidity, and economies of scale involved in commercial banking, investment banking and asset management. Although in certain areas, such as investing, advances in technology threaten to eliminate the financial intermediary, disintermediation is much less of a threat in other areas of finance, including banking and insurance.

BREAKING DOWN Financial Intermediary

A non-bank financial intermediary does not accept deposits from the general public. The intermediary may provide factoring, leasing, insurance plans or other financial services. Many intermediaries take part in securities exchanges and utilize long-term plans for managing and growing their funds. The overall economic stability of a country may be shown through the activities of financial intermediaries and growth of the financial services industry.

Functions of Financial Intermediaries

Financial intermediaries move funds from parties with excess capital to parties needing funds. The process creates efficient markets and lowers the cost of conducting business. For example, a financial advisor connects with clients through purchasing insurance, stocks, bonds, real estate and other assets. Banks connect borrowers and lenders by providing capital from other financial institutions and from the Federal Reserve. Insurance companies collect premiums for policies and provide policy benefits. A pension fund collects funds on behalf of members and distributes payments to pensioners.

Benefits of Financial Intermediaries

Through a financial intermediary, savers can pool their funds, enabling them to make large investments, which in turn benefits the entity in which they are investing. At the same time, financial intermediaries pool risk by spreading funds across a diverse range of investments and loans. Loans benefit households and countries by enabling them to spend more money than they have at the current time.

Financial intermediaries also provide the benefit 
of reducing costs on several fronts. For instance, they have access to economies of scale to expertly evaluate the credit profile of potential borrowers and keep records and profiles cost-effectively. Last, they reduce the costs of the many financial transactions an individual investor would otherwise have to make if the financial intermediary did not exist.