THE ROLE OF FINANCIAL

MARKETS AND FINANCIAL

INTERMEDIARIES
 LEARNING OBJECTIVES
1. define the money and determine how the money supply is
measured
2. develop a yield curve and contrast positive and negative yield
curves
3. differentiate the direct and indirect transfer of savings to users of
funds
4. enumerate the primary assets and liabilities of a commercial bank
5. describe several regulations that apply to the banking system
6. differentiate required and excess banks reserves
7. contrast the various money market instruments
 THE ROLE OF MONEY
Money – anything that is generally accepted in payment for
goods and services for the retirement of debt.

Money may also be used to transfer purchasing power to the

future.

Money acts as a store of value from one time period to

another.
 THE ROLE OF MONEY
Liquidity – ease of converting an asset into cash without
loss; the depth of a financial market.

The Bangko Sentral ng Pilipinas (BSP) is the only authorized

government entity to print money and is responsible for the
proper administration of the monetary banking credit
system of the republic to achieve monetary stability and
create conditions conducive to economic developments.
 • Money supply – total amount of
money in circulation.

M1 or Narrow Money
Measures of • Currency in circulation (or currency
the Supply of outside depository corporations)
and peso demand deposits.
Money
M2 or Broad Money
• M1 plus peso savings and time
deposits
 M3 or Broad Money Liabilities
• M2 plus peso deposit substitutes,
Measures of such as promissory notes and
commercial papers
the Supply of
Money M4
• M3 plus transferable and other
deposits in foreign currency.
 THE ROLE OF INTEREST RATES
• Interest – cost of credit; it is the price paid for the use of someone
else’s money

• Rate of interest – cost of credit is often expressed as a percentage.

• Generally, the longer the term of the debt and the riskier the debt
instrument, the higher will be the rate of interest.
 THE ROLE OF INTEREST RATES

•Basis Point
•Term used to refer to a fraction of a percentage point;
typically used in discussions on interest rates
•1 basis point = 0.01 percent
•100 basis points = 1.0 percent
The Term Structure of Interest Rates

•The relationship between interest rates and the length of

time to maturity for debt in a given risk class.

•Yield curve – illustrates the structure, which relates the yield

on debt instruments with different terms of maturity.
The Term Structure of Interest Rates

Three primary shapes of yield curve

•Normal = ST < LT
•Inverted = ST > LT
•Flat = ST = LT
Yield Curve
Inverted Yield Curve
Financial Markets and the
Transfer of Savings
 FINANCIAL MARKETS
Refer broadly to any marketplace where the trading of securities occurs,
including the stock market, bond market, forex market, and derivatives market,
among others.

Two important functions:

1. Facilitate the transfer of funds from saver to firms, governments, and
individuals who use the funds.
2. Facilitate the transfer of existing securities from sellers to buyers.
 FINANCIAL INTERMEDIARIES

An entity that acts as the middleman between two parties in a financial

transactions, such as commercial bank, investment banks, mutual funds and
pension funds.
 COMMERCIAL BANKS

•The most important depository institution in terms of size.

•Also a prime source of funds to consumers.

•Commercial banks tend to stress loans that must be paid off

quickly.
 COMMERCIAL BANKS
• Certificate of deposit (CD) – time deposit issued by a bank with a
specified interest rate and maturity.

• An LTNCD, or Long-Term Negotiable Certificate of Deposit - a bank

product offered to investors looking for a relatively safe investment,
but with higher interest rates than a regular savings account or
short-term time deposit.
 THRIFT INSTITUTIONS

•A place for savers, especially individuals with modest sums,

to deposit funds.

Two types of thrifts:

1. Mutual savings banks
2. Savings and loan associations (S&Ls)
 THRIFT INSTITUTIONS
Mutual savings banks
• owned by its depositors, but the bank itself is managed by a board of
trustees.
• Mutual savings banks must have sufficient liquidity to meet withdrawals
Savings and loan associations (S&Ls)
• Primarily as a source of mortgage loans and has evolved into a thrift
institutions that accepts deposits from anyone and makes a variety of loan.
• Tend to pay a rate of interest that is slightly higher than the rates paid by
commercial banks
REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS

•Reserves

•Deposit insurance
 REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS
Required reserves
•funds that banks must hold against deposit liabilities

•The minimum amount that all banks must maintain as a

reserve is determined by the Monetary Board
 REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS
Reserve requirements
•refer to the percentage of bank deposits and deposit
substitute liabilities that banks must set aside in deposits
with the BSP which they cannot lend out, or where available
through reserve-eligible government securities.
•Changes in reserve requirements have a significant effect on
money supply in the banking system, making them a
powerful means of liquidity management by the BSP.
 REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS

The term "deposit substitutes" is defined as an alternative

form of obtaining funds from the public, other than deposits,
through the issuance, endorsement, or acceptance of debt
instruments for the borrower's own account, for the purpose
of relending or purchasing of receivables and other
obligations.
 REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS

•Excess reserves – reserves held by a bank in excess of those

it must hold to meet its reserve requirements.

•Correspondent bank – a bank that provides services on

behalf of another, equal or unequal, financial institution. It
can facilitate wire transfers, conduct business transactions,
accept deposits, and gather documents on behalf of another
financial institution.
 REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS

•Secondary reserves – Short-term securities especially

Treasury bills, held by banks to increase their liquidity
 REGULATION OF COMMERCIAL BANKS AND
THRIFT INSTITUTIONS

• Deposit insurance - essentially the assured amount a bank depositor

gets in the case that the bank cannot fulfill its obligations. It is
mandatory by law and is designed to maintain financial stability.

• Philippine Deposit Insurance Corporation (PDIC) - pays deposit

insurance on all valid deposits up to Maximum Deposit Insurance
Coverage (MIDC) of P500,000 per depositor of a closed bank.
Conduct of Monetary Policy

• Monetary Policy – measures or actions taken by the central

bank to influence the general price level and the level of liquidity
in the economy. Monetary policy actions of the BSP are aimed
at influencing the timing, cost and availability of money and
credit, as well as other financial factors, for the main objective
of stabilizing the price level.
Conduct of Monetary Policy
• Expansionary Monetary Policy – monetary policy setting that intends
to increase the level of liquidity/money supply in the economy and
which could also result in a relatively higher inflation path for the
economy. Examples are the lowering of policy interest rates and the
reduction in reserve requirements. Expansionary monetary policy
tends to encourage economic activity as more funds are made
available for lending by banks. This, in turn, increases aggregate
demand which could eventually fuel inflation pressures in the
domestic economy.
Conduct of Monetary Policy
• Contractionary Monetary Policy - monetary policy setting that
intends to decrease the level of liquidity/money supply in the
economy and which could also result in a relatively lower inflation
path for the economy. Examples of this are increases in policy
interest rates and reserve requirements. Contractionary monetary
policy tends to limit economic activity as less funds are made
available for lending by banks. This, in turn, lowers aggregate demand
which could eventually temper inflation pressures in the domestic
economy.
 LIFE INSURANCE COMPANIES AND PENSION
PLANS

• Life insurance companies - also performs the role of a financial

intermediary because they receive the funds of savers, create a claim
on themselves, and lend the funds to borrowers.

• Pension plan - a retirement plan that requires an employer to make

contributions to a pool of funds set aside for a worker's future
benefit. The pool of funds is invested on the employee's behalf, and
the earnings on the investments generate income to the worker upon
retirement
LIFE INSURANCE COMPANIES AND PENSION
PLANS
• The Personal Equity Retirement Account (PERA) has been fully
implemented by law in 2016.
• PERA is a type of retirement investment plan that can only be availed
through banks, insurance companies, or any other administrator
accredited by the Bangko Sentral ng Pilipinas (BSP), the Insurance
Commission, and the Securities and Exchange Commission.
• PERA is a voluntary retirement contribution plan that gives you the
freedom to save and invest up to PhP100,000 annually. Also, the
returns are completely tax-free.
 MONEY MARKET MUTUAL FUNDS AND
MONEY MARKET INSTRUMENTS
• A money market mutual fund is a type of mutual fund that invests in
high-quality, short-term debt instruments, cash, and cash
equivalents.

MONEY MARKET INSTRUMENTS

• Issued by Bureau of Treasury (BTr)
• Sold to the public through Government Securities Eligible Dealers (GSED)
1) Treasury Bills (T-bills)
• Short-term securities <1 year tenor
• Three principal tenors: 91, 182, and 364 days
• Most actively traded zero-coupon debt instrument in the Philippine bond market
• Do not bear interest. Sold at a discount to face value
 MONEY MARKET MUTUAL FUNDS AND
MONEY MARKET INSTRUMENTS
2) Treasury Bonds/ Fixed Rate Treasury Notes (FXTN)
• Peso denominated
• Maturities >1 year
• Principal tenors: 3, 5, 7, 10, 20, and 25 years
• Interest bearing, semi-annual coupon payments
3) Retail Treasury Bonds (RTBs)
• Tenors ranging from 3 to 25 years, quarterly coupon
• For retail investors, minimum of PhP5,000 on the primary market
• Sold through GSEDs, selling agents (ie banks), BTr
 MONEY MARKET MUTUAL FUNDS AND
MONEY MARKET INSTRUMENTS
• Issued by Corporations
• Commercial paper – unsecured short-term promissory notes issued by the
most creditworthy corporations

• Repurchase agreements (repo) – sale of a short-term security in

which the seller agrees to buy back the security at a specified price

• Banker’s acceptance – short-term promissory note guaranteed by a

bank