Financial System and Institution.docx

Financial System and Institution.docx

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FinancialSystemandInstitution

FinancialSystemsandInstitutions

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Introduction:

Financialintermediaries,financialinnovationandfinancialregulatoryareallimportantcomponentsinfinancialmarkets.Financialintermediariestakechargeoftransferringinformationbetweenalltheparticipantsincludingallthenewsaboutfinancialinnovation.Butalltheactionaresupervisedbyfinancialregulatory.Thispaperdiscussesthesethreepartsandtheirrolesinfinancialmarketsandtheirinfluenceandtheirreactiontosomefinancialactivities.

PART1.

"Theprimaryfunctionofthefinancialsystemistofacilitatetheallocationanddeploymentofeconomicresources,bothspatiallyandacrosstime,inanuncertainenvironment."Thisfunction,inturn,encompassesapaymentssystemwithamediumofexchange;thetransferofresourcesfromsaverstoinvestor-usersoftheresources（andtheeventualrepaymenttothesavers）;thegatheringofsavingsforthepurposesofpuretimetransformation（i.e.,deferral/smoothingofconsumption）;andthereductionofriskthroughinsuranceanddiversification.Theoperationofafinancialsysteminvolvesrealresourcecosts,suchaslabor,materials,andcapitalemployedbyfinancialintermediaries（e.g.,banks,insurancecompanies,etc.）andbyfinancialfacilitators（e.g.,stockbrokers,marketmakers,financialadvisors,etc.）.Further,sincemultipletimeperiodsareaninherentcharacteristicoffinance,therearealsouncertaintiesaboutfuturestatesoftheworldthatgeneraterisks.Forrisk-adverseindividuals,theserisksrepresentcosts.

Thepossibilityofnewfinancialproducts/services/instrumentsthatcanbettersatisfyfinancialsystemparticipants’demandsisalwayspresent.Viewedinthiscontext,afinancialinnovationrepresentssomethingnewthatreducescosts,reducesrisks,orprovidesanimprovedproduct/service/instrumentthatbettersatisfiesparticipants’demands.

Financialinnovationscanbegroupedasnewproducts（e.g.,adjustableratemortgages;exchange-tradedindexfunds）;newservices（e.g.,on-linesecuritiestrading;Internetbanking）;new"production"processes（e.g.,electronicrecord-keepingforsecurities;creditscoring）;orneworganizationalforms（e.g.,anewtypeofelectronicexchangefortradingsecurities;Internet-onlybanks）.Ofcourse,ifanewintermediateproductorserviceiscreatedandusedbyfinancialservicesfirms,thenitmaybecomepartofanewfinancialproductionprocess.

Therearecloseanalogieswithfamiliarformsofinnovationinnon-financialcontexts.Thereweseenewproducts（e.g.,DVDplayers;self-stickpostagestamps）;newservices（e.g.,Internetbasedretailshopping）;newproductionprocesses（e.g.,improvedprocessesformanufacturingcomputerchips）andneworganizationalforms（e.g.,the"M-form"decentralizedcorporatestructure）.Andinnovationsinproducergoodsareoftenessentialforinnovationsinproductionprocesses.

Muchoftheresearchattentiontoinnovationfocusesonthenewidea.Butatleastasimportantistheadoptionandspreadofaninnovation--itsdiffusion--acrossanindustry.Indeed,fasterdiffusionmeansahighersocietalreturnontheunderlyinginvestmentsintheinnovation.

Becauseofthese,declineinactivitiesoffinancialinstitutionsismust.Thesimplestexplanationissavingenormouslabor,moneyandtime,inotherwords,financialinnovationmeansmakemoremoneyintheleastcostofmoneyandtime.Financialinnovationmakesthefinancialregulatoryunified.Before,weneedtosetdifferentregulatoryrulesfordifferentproductsindifferentmarkets.Now,afterfinancialinnovation,weonlyneedtosetfewbutunifiedregulatoryrulesfordifferentmarketsindifferentcountries,whichismoreconvenientandefficientforthewholeworld.

Financialinnovationcanmakemonetaryintegration,euroisthebestproduction.Monetaryintegrationcangreatlyreducethetransfercoatamongdifferentbanksindifferentcountries.Themajorimpulsestosuccessfulinnovationsoverthepasttwentyyearshavecome;Iamsaddenedtohavetosay,fromregulationandtaxes.Thelistoftaxandregulatoryinducedproductswouldincludezerocouponbonds,EurodollarEurobonds,variousequity-linkedstructuresusedtomonetizeassetholdingswithouttriggeringimmediatecapitalgainstaxes,andtrustpreferredstructures.Ifwethinkoftaxesasamajor“imperfection”addedtotheM&Mworld,thenthesearchtomaximizeafter-taxreturnshasarguablystimulatedmuchinnovation,andchangesintaxlawinturnstimulateevenmoreinnovation.Forexample,variousequity-linkedstructuresusedbyfirmstomonetizetheirholdingsofstockpermitthesefirmstodelaypayingcapitalgainstaxes.Theseinnovationsdecoupleeconomicownershiporexposurefromlegalownership（governanceandtaximplica