The Role of Financial Institutions and Markets

Technology, globalization, competition, and deregulation all have contributed to the regeneration of worldwide fiscal securities industrys and the creation of an effectual, internationally linked foodstuff. However, these emergences have created say-so problems (Brigham 1995 111). As the worldwide pecuniary crisis, which started in the early summer of 2007 in America and string out globally, still shapes the headlines of newspapers and the political agenda of developed countries. These new-fangled economic developments drew back societies attention to the importance of the world parsimony and fiscal securities industrys. A fiscal mart is con placementred as a market in which financial assets .. can be grease ones palmsd or sold (Madura 2012 3).Here, any kind of marketplace, where buyers and sellers participate in the heap of financial assets such as equities, bonds, currencies and derivatives, is meant. Mostly financial markets have transpargonnt pricing, basic regula tions on trading, cost and fees, and market forces that determine prices of securities that atomic number 18 traded. There are three applic able classifications of financial markets in the context of the financial crisis capital versus corking markets, pristine versus secondary markets, and organized versus over-the counter markets (Madura 2012). The money versus capital market distinguishes in conglomerate points The money market is sole(prenominal) short- term oriented, a maturity date of less than one year, and the trading objects are referred to as money market securities, which are debt securities.These have a high degree of liquidness and wherefore offer a low return however, they are less equivocal (Madura 2012 5). In contrast, capital markets promote the sale of long-term securities, called capital market securities, which are around often bonds, mortgages and stocks. These are often bought with the intention of pay the purchase of capital assets such as buildin gs, equipment, or machinery. Capital market is composed of primary markets and secondary markets In the primary market only the trade of newly issues securities occurs, whereas in the secondary market previously issued so existing securities are traded (Madura 2012). The organized versus over-the counter markets differentiate in the localization of function f operationor.Whereas the organized markets represent true visible marketplaces, where member meet to trade and securities are listed like the New York Stock Exchange, the over-the-counter markets are a wired ne cardinalrk of dealer, which do not need a rudimentary and physical location to trade, because it is a direct trade between the two participants (Madura 2012). Telecommunication and Internet allowed dutyes to trade all over the world in every financial market. However, this global interconnection of financial markets also has its side effects as the fall of the LehmannBrothers and following economic developments have shown.In 2008 and 2009 there has been a worldwide crisis in the international financial markets, which has blow over to an complete high minute of credit defaults and amortizations on speculative assets of banks and financial institutions. The financial crisis has been triggered by the lending practice, the insufficient collateralisation of mortgages and securitization of credits in the documentary estate of the realm market in the United States of America. The speculation on rising real estate prices bursted and chancey bonds lost their value dramatically.The financial crisis developed to a liquidity crisis, because the credit lending of banks, which are equipped with liquidity, to banks, which need bullion and exchange equivalents in form of credits, stopped despite the fact that the most important national banks reduced the discount rate under 1 %. due to lack of trust between the banks, the interbank credit lending decreased dramatically, so that the liquidity crisis turned to a bank crisis. Henceforth, this crisis covered the goods market, in result unemployment rates change magnitude, international trade decreased and the recession settled. repayable to the dimensions the economic slump took it is considered as the new world economic crisis (bpb 2013).2. monetary Institutions monetary Institutions are firms that provide access to the financial markets, both to savers, who concupiscence to purchase financial instruments directly, and to borrowers, who want to issue them (Cecchetti/ Schoenholtz 2010). In fact, financial institutions also referred to as financial intermediaries are like most other businesses the primary business is to generate profit by minimizing the costs and maximizing the revenues. Additionally, financial intermediaries objective and sell financial products and services in accordance to customers demand at a reasonable profit level (Pilbeam 2010 46). A financial intercessor interacts with savers or lenders and borrowe rs simultaneously thereby it produces a set of services, which facilitate the displacement of its liabilities into assets such as loans, which is referred to as intermediation (Madura 2012 12).2.1 Types of pecuniary InstitutionsGenerally, there are three classifications of financial institutions monument institutions, contractual saving institutions, and investment institutions. Firstly, depository institutions such as commercial banks and savings banks don and manage hard currency deposits as well as make loans (Pilbeam 2010 46). Further more(prenominal), deposit-taking institutions strive to make a profit in the panache of spread income between the cost of the deposits that they accept and other sources of shoping, and the return that they receive on their investment portfolio in the way of loans, equity stakes and other investments (Pilbeam 2010 46).Depository institutions underlie default risks, regulatory risks as well as liquidity risks (Pilbeam 2010 46). Secondly, cont ractual savings Institutions attain monetary resource under long-term contractual arrangements and invest them largely in the capital market especially in long-term equity and debt instruments such as life insurances, private pension funds, and funded social pension insurance systems. Due to the agreements requirement of regular payments from for example policyholder and pension fund participant, contractual savings institutions have relatively stable inflows of funds.The stable cash flows both inflows and outflows are relatively stable as well as predictable, so that liquidity is not a predominant factor in the asset management of these institutions (Impavido/ Musalem 2000 3-5). Thirdly, investment institutions are commonly known as investment companies, corporations, or trusts. An investment company issues securities and is predominantly engaged in the business of investing in securities.Hereby, it aggregates funds of a large number of investors into a specific investment in co mpliance with the objectives of the investors. Individuals invest in diversified, professionally managed portfolios of securities, whereby they have access to a wider range of securities and a guaranteed spread of risk than without the investing company as intermediator (Pilbeam 2010 53-54).2. 2 subroutine of Financial Institutions in the Financial MarketAs previously described in quote to the financial crisis, financial markets are imperfect participants in the market do not have full access to information (Madura 2012 10). For example, an investor is not able to verify the creditworthiness of potential borrowers and there is a lack of expertise to treasure this creditworthiness. Here financial institutionsfunction is to resolve the limitations caused by market imperfections.Therefore, financial institutions are involved in the information processing (Madura 2012). Thereby, they investigate the financial conditions of the potential customers to figure out which have the best in vestment opportunities (Cecchetti/ Schoenholtz 2010). Consequently, financial intermediaries are saving information costs as well as dealings costs, because financial institutions assist in the transfer of funds from scanty to deficit units in the economy (Pilbeam 2010 63). For example, there are many lenders/ inordinateness units, who all strive to lend various low value money market securities for different periods of while, or there few borrowers/ deficit units, who wish to borrow capital market securities for a fixed period of time here financial institutions are useful as an intermediary.Lenders do not have to search the markets for suitable borrowers and vice versa. Financial institutions borrow various amounts of money from surplus units, reform these into an amount suitable for the final deficit unit, and transform them into a maturity suitable for the final borrower. Thereby financial institutions serve the special needs of the deficit units and surplus units (Madura 2012 10-11). Overall, flexibility is living for all participants, because lenders can change the terms and conditions of lending to the intermediary without the intermediary or final borrower being at disadvantage.While financial institution act as intermediary, they bear the risk and in result, the risk is reduced. By diversification meaning offering various bundles of financial assets, financial intermediaries spread the risk and thereby, transform risky assets to less risky ones (Madura 2012 10-11). In fact, individual investors are capable of diversification, however, they may not do it as cost efficient as financial institutions and therefore, they have a crucial role in financial markets.In conclusion, financial institutions ensure that the costs and risk are humiliate than if the surplus and deficit agents dealt directly with each other, and thereby ensure that there is greater flow than in the absence of financial intermediaries (Pilbeam 2010 63). Pilbeam means with grea ter flow that intermediaries increase investment as well as economic growth (Cecchetti/ Schoenholtz 2010).2.3 Role of Financial Institutions in the Financial CrisisFinancial crises mainly spare themselves at the level of financial institutions especially, the role of banking institutions in the occurrence and infection of financial crises is a deciding one for the recent financial crisis (Andries 2009 151). Financial Institution such as banks can facilitate the financial crises done their activities in the financial markets. Their activities can influence the interest rates, the uncertainty on the market and the price of assets (Andries 2009 152).The worldwide financial crisis of 2008 was subject to several developments of banks practices Financial innovations and risky speculations such as in subprime mortgages and collateralized debt obligations have been practiced, loans have been grow and the prices of assets increased without economic basis and unexpectedly decreased, so th e orientation changed towards liquidity (Andries 2009 149). Overall, banking institutions have overdone diversification and practiced financial innovations meaning coordinate finance, which were new complex products, whose risk could not be assessed by the judge agencies (Fratianni/ Marchionne 2009 8-9).While the crisis there has been uncertainty among market participants and default risk increased, so that borrowers increased the interest rates to all borrowers (Fratianni/ Marchionne 2009 13). Simultaneously, banks reacted by selling assets to reduce leverage, backcloth in motion a vicious circle of asset riddance and price declines across a vast range of assets. Financial integrating and made possible for the crisis to spread virtually worldwide(Fratianni/ Marchionne 2009 21).3. ConclusionIn conclusion, financial institutions possess a vibrant role in the financial markets and accelerate the development of financial crises, because of their activities. Furthermore, financial institutions act as an intermediary, thereby they decrease transaction costs and risk, and simultaneously increase efficiency through information processing. However, overly economic growth financial institutions encourage side effects particularly the banking institutions practices are responsible for the development of the recent financial crisis. Their striving for more profit with practices under the theme of no risk, no reward lead to the downturn ofthe worldwide economy. In the future, governments and international institutions meet certain requirements and tack together regulations, in order that such practices and activities are restrained.