Financial System and Institution

Financial Systems and Institutions

Stud Name: Stud ID: 270184LC USN: 0711866864223

Financial Systems and Institutions Stud Name: Liang CHEN Stud ID: 270184LC USN: 0711866864223

Introduction:

Financial intermediaries, financial innovation and financial regulatory are all important components in financial markets. Financial intermediaries take charge of transferring information between all the participants including all the news about financial innovation. But all the action are supervised by financial regulatory. This paper discusses these three parts and their roles in financial markets and their influence and their reaction to some financial activities.

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Financial Systems and Institutions Stud Name: Liang CHEN Stud ID: 270184LC USN: 0711866864223

PART 1.

\primary function of the financial system is to facilitate the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment.\of exchange; the transfer of resources from savers to investor -users of the resources (and the eventual repayment to the savers); the gathering o f savings for the purposes of pure time transformation (i.e., deferral/smoothing of consumption); and the reduction o f risk through insurance and diversification. The operation of a financial system involves real resource costs, such as labor, materials, and capital employed by financial intermediaries (e.g., banks, insurance companies, etc.) and by financial facilitators (e.g., stock brokers, market makers, financial advisors, etc.). Further, since multiple time periods are an inherent characteristic of finance, there are also uncertainties about future states of the world that generate risks. For risk -adverse individuals, these risks represent costs.

The possibility of new financial products/services/instruments that can better satisfy financial system participants’ demands is always present. Viewed in this context, a financial innovation represents something new that reduces costs, reduces risks, or provides an improved product/service/instrument that better satisfies participants’ demands.

Financial innovations can be grouped as new products (e.g., adjustable rate mortgages; exchange-traded index funds); new services (e.g., on-line securities trading; Internet banking); new \credit scoring); or new organizational forms (e.g., a new type of electronic exchange for trading securities; Internet-only banks). Of course, if a new intermediate product or service is created and used by financial services firms, then it may become part of a new financial production process.

There are close analogies with familiar forms of innovation in non-financial contexts. There we see new products (e.g., DVD players; self-stick postage stamps); new

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Financial Systems and Institutions Stud Name: Liang CHEN Stud ID: 270184LC USN: 0711866864223

services (e.g., Internet based retail shop ping); new production processes (e.g., improved processes for manufacturing computer chips) and new organizational forms (e.g., the \decentralized corporate structure). And innovations in producer goods are often essential for innovations in production processes.

Much of the research attention to innovation focuses on the new idea. But at least as important is the adoption and spread of an innovation -- its diffusion -- across an industry. Indeed, faster diffusion means a higher societal return on the underlying investments in the innovation.

Because of these, decline in activities of financial institutions is must. The simplest explanation is saving enormous labor, money and time, in other words, financial innovation means make more money in the least cost of money and time. Financial innovation makes the financial regulatory unified. Before, we need to set different regulatory rules for different products in different markets. Now, after financial innovation, we only need to set few but unified regulatory rules for different markets in different countries, which is more convenient and efficient for the whole world. Financial innovation can make monetary integration, euro is the best production. Monetary integration can greatly reduce the transfer coat among different banks in different countries. The major impulses to successful innovations over the past twenty years have come; I am saddened to have to say, from regulation and taxes. The list of tax and regulatory induced products would include zero coupon bonds, Eurodollar Eurobonds, various equity-linked structures used to monetize asset holdings without triggering immediate capital gains taxes, and trust preferred structures. If we think of taxes as a major “imperfection” added to the M&M world, then the search to maximize after-tax returns has arguably stimulated much innovation, and changes in tax law in turn stimulate even more innovation. For example, various equity-linked structures used by firms to monetize their holdings of stock permit these firms to delay paying capital gains taxes. These innovations decouple economic ownership or exposure from legal ownership (governance and tax implications.)

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Financial Systems and Institutions Stud Name: Liang CHEN Stud ID: 270184LC USN: 0711866864223

The first key challenge facing the banks is avoiding risk. Globalization of finance means we need to afford not only the risk from ourselves but also the risk all over the world. To improve liquidity is the best way to avoid risk. As in this financial crisis, high liquidity can ensure the normal business of banks and guarantee the stability. In order to reach this goal, banks need to reduce the loan and increase the reserve. The Fed’s response to 9/11 in U.S. has proved it.

Not only the liquidity risk, bank need to improve the technology system to avoid the banks on Internet bank system which has become the main financial trading platform. The basic underlying \technologies of finance are those of telecommunications and data processing, which permit the gathering of information, its transmission, and its analysis. Increasingly, these technologies allow financial market participants to measure and manage their risk exposures more efficiently and effectively. For example, with respect to lending, asymmetric information problems imply that lenders have difficulties determining who is a creditworthy borrower (adverse selection) and also have difficulties monitoring borrowers after a loan has been made (moral hazard). Accordingly, better (more advanced, faster, lower cost) physical technologies have permitted more innovations (e.g., credit and behavioral scoring) that allow lenders better to overcome those asymmetric information problems.

On the other hand, banks must provide more products to attract investors. Financial innovation lead finance to a new regime: foreign exchange, futures, forwards, and options. Banks need to seek the new sizes of this contracts and new markets, such as Asian countries. Banks need to expense their services to some new areas.

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