The College of Maasin

“Nisi Dominus Frustra”

Tunga-tunga, Maasin City

FM42 – BANKING AND FINANCIAL SYSTEM

Prepared by: MAUNECA LOU MELAGROSO
[email protected] 09651335057

MODULE 1

MONETARY SYSTEM AND FINANCIAL SYSTEM

Development of Monetary System

1. Barter system
Barter system was the first stage of monetary development. It is the direct exchange or
swapping of good for goods, services for services, goods for services or services for goods.

Society abandoned the barter system for the following reasons:

1. It was difficult to look for that person who has the things you need and who also wants
the things you are offering for exchanges.
2. There is no common denominator to measure the value of goods and services sought
for exchange.
3. Most of the goods traded have unequal values.
4. It is time consuming, cumbersome and very inconvenient for individuals to use the barter
system.
5. It lacks generalized purchasing power.
Purchasing power- the financial ability to buy products and services.
2. Money
Money is anything used by society as a medium of exchange, and is widely acceptable for
payment of goods and services without questioning the integrity of the person offering it. The
primary function of money is to facilitate the process of exchange.
Functions of Money
1. Medium of exchange: money enables goods and services to be transferred
from person to person. It is a way of exchange or a means of exchange.
2. Standard to measure the value of goods and services: money measures the
value of goods and services. It is used as a yardstick in the pricing of things.
The monetary unit of the country is used as a standard of value.
3. A store of value: Money can be kept for future use. Since money is a widely
acceptable, it enjoys a generalized purchasing power and can serve as a
store of value.
 Money Accelerates economic growth
Individuals who have surplus money are the bank savers or depositors. The borrowers
use the money of the savers to put up their business enterprises, like factories, agri-businesses,
department stores, hospitals and others.
The financial institutions mobilize the savings of individuals for investment.
When more people have incomes, it results to more expenditures. Such expenditures
further encourage more investments. Businessmen are pushed to put up more enterprises
whenever there is an increasing demand for goods and service. This simply means there are
more buyers. Eventually, such accelerated economic activities lead to economic growth.
Without money, this is not possible at all.

Financial System

A financial system consists of institutional units and markets that interact, typically in a complex
manner, for the purpose of mobilizing funds for investment and providing facilities, including
payment systems, for the financing of commercial activity.
The role of financial institutions within the system is primarily to intermediate between those that
provide funds and those that need funds, and typically involves transforming and managing risk.
Particularly for a deposit taker, this risk arises from its role in maturity transformation, where
liabilities are typically short term (for example, demand deposits), while its assets have a longer
maturity and are often illiquid (for example, loans).
Financial markets provide a forum within which financial claims can be traded under established
rules of conduct and can facilitate the management and transformation of risk. They also play
an important role in identifying market prices (“price discovery”).
How funds flow through the financial system
  Direct financing-where funds flow directly through financial markets ( the route at
the top of the diagram)
 Indirect financing-(Financial Intermediation), where funds flow indirectly through
financial intermediation market (the route at the bottom of the diagram).

Financial System Structure and Function

The financial system plays the key role in the economy by stimulating economic growth,
influencing performance of the actors, affecting economic welfare. This is achieved by financial
infrastructure, in which entities with funds allocate those funds to those who have potentially
more productive ways to invest those funds. A financial system makes it possible a more
efficient transfer of funds. As one party of the transaction may possess superior information than
the other party, it can lead to the information asymmetry problem and inefficient allocation of
financial resources. By overcoming the information asymmetry problem the financial system
facilitates balance between those with funds to invest and those needing funds.
According to the structural approach, the financial system of an economy consists of
three main components:
1) financial markets;
2) financial intermediaries (institutions);
3) financial regulators.
Each of the components plays a specific role in the economy.
According to the functional approach, financial markets facilitate the flow of funds in order to
finance investments by corporations, governments and individuals. Financial institutions are
the key players in the financial markets as they perform the function of intermediation and thus
determine the flow of funds. The financial regulators perform the role of monitoring and
regulating the participants in the financial system.
Financial markets studies, based on capital market theory, focus on the financial system, the
structure of interest rates, and the pricing of financial assets.
An asset is any resource that is expected to provide future benefits, and thus possesses
economic value. Assets are divided into two categories: tangible assets with physical properties
and intangible assets. An intangible asset represents a legal claim to some future economic
benefits. The value of an intangible asset bears no relation to the form, physical or otherwise, in
which the claims are recorded.
Financial assets, often called financial instruments, are intangible assets, which are
expected to provide future benefits in the form of a claim to future cash. Some financial
instruments are called securities and generally include stocks and bonds.
Any transaction related to financial instrument includes at least two parties:
1) the party that has agreed to make future cash payments and is called the issuer;
2) the party that owns the financial instrument, and therefore the right to receive the payments
made by the issuer, is called the investor.
Financial assets provide the following key economic functions.
 they allow the transfer of funds from those entities, who have surplus funds to invest to
those who need funds to invest in tangible assets;
 they redistribute the unavoidable risk related to cash generation among deficit and
surplus economic units.
The claims held by the final wealth holders generally differ from the liabilities issued by
those entities who demand those funds. They role is performed by the specific entities operating
in financial systems, called financial intermediaries. The latter ones transform the final liabilities
into different financial assets preferred by the public.

References:
 Money, Credit & Banking the basics 7th edition by Laman, R and Laman,
V
 Financial Institutions, Market, and Money 11 th Edition Kidwell. Blackwell.
Whidbee. Sias
 Microsoft Word - Ch visi En sabl.doc (bcci.bg)

ACTIVITIES AND EXCERCISES:

Email answers to [email protected] before February 1, 2021.

ACTIVITY 1: ESSAY (MONETARY SYSTEM)

Answer BRIEFLY :
1. What are the disadvantages of barter system and how these motivate the development
of the monetary system?
ACTIVITY 2: ESSAY (FINANCIAL SYSTEM)
Answer BRIEFLY:
1. What is the role and contribution of financial system in the economy?