Financial Markets and Financial Institutions

Introduction: Economic System

With the lapse of time, relationships between people were becoming more and more complicated due to the fact that the number of ways to store and manage natural resources and the resources that involved the application of human labor was growing. Nowadays, there is a wide range of tools allowing people to distribute resources and meet the needs of as many members of society as possible.

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There is no doubt that the current economic system in the world includes a lot of elements that serve as essential tools providing people in different countries with the opportunity to manage resources in an effective manner and ensure the appropriate quality of life in the country. Within the context of the world economy, economic relationships between different countries remain extremely important, and various financial institutions are established in order to regulate these relationships and make all the countries act in accordance with the accepted rules.

Nevertheless, it cannot be stated that particular financial institutions and financial markets helping different countries to exchange resources on beneficial terms make the same contribution to the financial development of various countries. Instead, defining the role of financial markets and institutions in modern economics, it is necessary to understand that all countries can be divided into two large groups based on the degree of their economic development. The goal of the present paper is to review the information on financial markets and financial institutions, define their types and the functions they fulfil and understand the role that they play in the current economy. Summarizing the information concerning financial markets and institutions, it is possible to better understand the links between different parts of the economic system.

Types of Economies and Financial Institutions

Due to a great number of reasons related to natural resource stocks, production technologies, and population, different countries in the modern world do not hold the same positions when it comes to economic development. In fact, there are many methods that can be used in order to classify countries based on their degrees of economic development. To define the type of economy, specialists in many countries in the world take into account a few basic economic indicators such as per capita gross domestic product, the level of development of social institutions operating in a country, and feasibility of various production branches1. In general, the majority of experts single out countries with developed and developing economies; nevertheless, there are certain countries that do not fully conform to the definitions of both groups. The latter are supposed to be countries with economies in transition because, as it is clear from their financial performance, they have a chance to enter the group of developed countries.

In reference to countries with developed economies, it is necessary to say that they produce more than seventy percent of global GDP due to effective infrastructures allowing employees in different spheres to strike the right balance between large production volumes and high quality of products. Apart from that, the overall contribution of such countries to the development of the humanity is enormous because countries with developed economies do not only produce material benefits; apart from that, they possess large human capital assets that can be listed among the factors encouraging rapid economic growth and technological advancement.

There are many factors that make countries belonging to two major groups so different; for instance, people in developing countries usually report low quality of life and low incomes. More than that, developing countries usually depend upon the help of those countries belonging to the first group – such help can be manifested in financing or providing goods on special terms. The topic of financial markets and financial institutions remains important in connection with countries with developed economies as these elements are the main tools allowing these countries to boost their fortune and gain a competitive advantage over other countries from the group. Establishing financial institutions and encouraging the development of financial markets, countries with developed economies fulfil a range of tasks helping them to strengthen their positions in the world.

There are a lot of different financial institutions that are established to perform essential functions and improve the economic situation in developing and developed countries. As for the latter, specialists usually single out a few groups of institutions. First, financial institutions are represented by specialized banks, for instance, commercial banks and real estate banks2. Apart from that, there are investment institutions such as special funds, stock exchanges, and equity investment companies. Also, there are non-bank financial institutions such as loan societies, mutual loan associations, and insurance carriers.

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The Role of Financial Institutions

A financial institution is a broad term that is used in order to describe a range of institutions whose activity is strictly interconnected with providing clients with financial services. The role of financial institutions is difficult to overestimate as they are supposed to be the primary tools supporting the rapid development of a country. In fact, it can be stated that the degree of sophistication of the system of financial institutions remains one of the most important dissimilarities that exist between developing and developed countries.

Financial institutions operating in countries with developed economies are established in order to manage financial resources in an effective manner and bring substantial profits that can be spent on improving the performance of a country in many spheres. Speaking about financial institutions in prosperous and successful countries, we usually mean agencies and organs that specialize in providing services related to investment activities, credit provision, money transference, borrowing, and apply a wide range of tools in order to improve the efficiency of services delivered3. More importantly, financial institutions are created for the purpose of successful mediation attempts allowing to establish fruitful contacts between recipients of loans and savers.

In general, it can be said that the proper work of a sophisticated system of financial institutions remains the basic premise for the further economic growth of a country. Speaking about the role of such institutions in the modern economy, it is necessary to state that the existence of financial institutions facilitates carrying out a few important tasks that define financial success. To start with, the activity of financial institutions helps to improve financial liquidity that is the ability to sell assets without the necessity to cut down the prices, whereas deficient liquidity involves financial loss due to decreasing prices.

More than that, it needs to be mentioned that financial institutions play the primary role when it comes to intermediation. Due to their mediation activities, financial institutions establish the links between recipients of loans and savers and fulfil a lot of important functions related to assets. Financial institutions are supposed to deal with the issue of the use of accumulated financial resources. The latter remains an important problem as it is necessary to decide on measures helping to gain substantial incomes that have to be divided between savers and financial institutions. Therefore, the process of mediation remains extremely important for the economic development of a country as it encourages the effective use of financial resources that brings substantial profits.

In fact, there are a few reasons why the establishment of financial institutions acting as intermediaries is advantageous for economic progress. First, savers who use services provided by financial operations specialists have an opportunity to entrust financial resource management to professionals and, therefore, set aside more time to fulfil their primary duties and make contributions to further economic development of their countries4. Apart from that, financial mediation helps to facilitate the cash cycle and allows those savers who lack special knowledge related to financial operations to use their resources in an effective manner. More importantly, financial services provided by special institutions encourage economic growth as money received from savers can be involved in different projects and bring increasing profits.

There is no doubt that the activity of financial institutions is closely interconnected with constant changes that happen to assets. Therefore, another important function that is fulfilled with the help of financial institutions is transformation. Speaking about financial transformation, which is usually called the maturity transformation, it needs to be said that such a process involves transforming the properties of financial assets and financial responsibilities. Thus, due to the activity of financial institutions, it becomes possible to turn short-term assets into long-term ones. Considering the fact that long-term assets can be regarded as ones securing stability, different financial institutions apply various tools to transform financial resources. For instance, securitization has become one of the most popular ways to accomplish the discussed task5.

The given term is used to denote the mechanism that involves the withdrawal of money from bank accounts and transferring it to certain companies or authorized delegates chosen by representatives of financial institutions who are granted a remission of taxation. Also, the process involves the creation of asset-based commercial papers or receiving consortium loans. Discussing the important role that the activity of financial institutions plays in economic development, it is necessary to state that securitization has already become one of the most significant ways to raise funding in certain countries, including the United States that has used it in order to mitigate the consequences of the financial crisis.

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Another task that financial institutions in countries with developed infrastructures are supposed to fulfil is closely interconnected with the fact that operations with financial resources are always accompanied by numerous risks. In fact, it is clear that there is a need for the mechanism allowing to estrange the risks or at least mitigate them. Therefore, one of the most important reasons to establish financial institutions is the transfer of risks. In reference to the latter, it needs to be said that financial institutions possess a wide range of tools allowing to decrease the risks for savers putting up their capital. Within the economic system, risk transfer is very important as those parties that provide financial resources can devote more time to their primary duties encouraging the economic development of their countries.

As for the particular benefits of risk transfer, there are two goals that can be accomplished with its help. First, risk transfer can be indissolubly related to the need for risk regulation. If a financial institution is supposed to regulate financial risks, it means that it has to deal with the particular process that may cause potential risks; consequently, if unwanted factors interfere with the process, the institution is expected to mitigate their influence and cover concomitant losses6. Also, if the institution is to financial risks, it is expected to help the transmitting party to cover the losses if they occur.

There are a great number of financial institutions that allow their clients to pay attention to their primary duties instead of worrying about the security of financial resources that they possess. Therefore, another important function accomplished by various financial institutions is the protection of property and profit accumulation.

Taking into account the fact that economic systems of different countries are not separated, and collaboration in many fields usually brings numerous benefits, it is necessary to give special consideration to such function of various financial institutions as the organization of financial operations with foreign currencies. In fact, when it comes to modern economic system, it is necessary to understand that there is a wide range of companies that have already entered foreign markets or try to accomplish this task. Thus, it is obvious that the majority of companies that attract a lot of attention to their products or services and, therefore, boost economic development in the areas where they operate are supposed to deal with foreign exchange transactions on a regular basis.

In general, there are a number of reasons why different companies need assistance when it comes to exchange operations. To begin with, the presence of foreign business partners can be regarded as an important chance for companies in those countries facing certain economic problems. Due to collaboration with financial institutions, companies and self-employed entrepreneurs are provided with an opportunity to establish joint ventures with foreign partners or purchase production equipment that cannot be found in the territory of their countries. As it can be seen, foreign exchange operations have an important impact on economic positions of different countries (especially those that are still developing). Such operations are usually performed by financial institutions, and this fact also highlights their importance for the modern economy.

More than that, financial institutions help to change organizational structure of different organization turning them into publicly held companies. In case of problems related to provision of finance, such operation performed with the help of financial institutions remains indispensable and helps business owners to attract investors and encourage development of economies in their countries.

Financial Markets

Financial markets have an important impact on today’s economy due to the fact that they act as tools providing sellers and buyers with the opportunity to exchange material benefits they possess on favorable terms. Nowadays, there is a complex system of financial markets and each of the latter is supposed to encourage economic development. Speaking about financial markets, it is necessary to put an increased focus on their types. To begin with, all financial markets that operate within current economic system can be divided into two large groups. The first group includes those markets that provide opportunities for trading in securities and exchange of goods of different types. More than that, there is the second group of financial markets; its primary dissimilarity from the previous group is connected with the fact that it is more specialized. In other words, such markets are related to distribution of specific types of paper holdings or goods.

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In reference to the particular types of financial markets, it can be said that, according to different classifications, there are at least six types of financial markets in modern economic system. To begin with, it is necessary to pay attention to such type of financial market as stock or securities markets; their infrastructures include a wide range of financial institutions such as banks, stock exchanges, non-bank institutions and many others. Due to the existence of securities market, it becomes possible to establish the appropriate system regulating the use of different financial resources. Apart from that, it is important to mention such type of financial markets as a commodities market.

As for the latter, it provides a great number of opportunities related to the exchange of different goods such as alimentary products, metals of value, and many others. Obviously, the importance of such market cannot be overstated as distribution of material resources still remains one of the key factors securing survival of the humanity. What is more, the position of current economic system is closely interconnected with the activity of the futures markets. The latter allow people from different countries to perform operations related to financial futures contracts that outline terms of doing business defined by the parties.

When it comes to the importance of such market, it is necessary to say that the use of financial futures contracts provides numerous benefits to business owners; for instance, it helps to improve the efficiency of capital, enhance liquidity, and ensure transparency of trade practices. Indeed, the use of tools provided by futures markets helps to execute contracts within shorter periods of time, simplify sales strategy planning, and ensure security of material resources. Continuing on the topic of financial markets, it is important to define the role of foreign currency market specializing in performing currency transactions.

This market makes a significant contribution to global economic development as it provides a range of essential tools that are used to solve numerous problems related to international collaboration. Modern foreign currency market presents a sophisticated system used by people all over the world – it is known that its exchange transactions volume exceeds the one of any other market. Also, it is necessary to single out such type as real property market that unites numerous transactors conducting operations related to slow assets.

Conclusion

To sum it up, modern economy is a system including a great number of branches. When it comes to the particular elements of the system, it is important to pay attention to financial institutions and financial markets that are aimed at fulfilling a wide range of tasks. Markets and institutions can be regarded as important tools encouraging economic advancement in both developed and developing countries. In fact, the use of these tools helps to ensure security of slow assets and financial credit documents, improve the liquidity of assets, mitigate or eliminate financial risks, provide intermediary services, and perform foreign exchange transactions that simplify processes surrounding international collaboration. Therefore, it is obvious that it is impossible to overestimate the role of financial institutions and financial markets in modern economy.

Works Cited

Da Gbadji, Luc Armel G., et al. “International Analysis of Venture Capital Programs of Large Corporations and Financial Institutions.” Entrepreneurship Theory and Practice, vol. 39, no. 5, 2015, pp. 1213-1245.

Gennaioli, Nicola, et al. “Sovereign Default, Domestic Banks, and Financial Institutions.” The Journal of Finance, vol. 69, no. 2, 2014, pp. 819-866.

Gileadi, Ido, et al. “Industrialization in Financial Services: A New Wave of Opportunities.” Journal of Financial Transformation, vol. 37, 2013, pp. 29-38.

Greenbaum, Stuart I., et al. Contemporary Financial Intermediation. Academic Press, 2015.

Kidwell, David S., et al. Financial Institutions, Markets, and Money. John Wiley & Sons, 2016.

Mirakhor, Abbas, et al. “Is the Regime of Risk Transfer Sustainable? Impossible Contract and Inequality.” Research in International Business and Finance, vol. 41, 2017, pp. 16-19.

Footnotes

  1. Kidwell et al., 2016
  2. Gennaioli et al., 2014
  3. Da Gbadji et al., 2015
  4. Greenbaum et al., 2015
  5. Gileadi et al., 2013
  6. Mirakhor et al., 2017
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