ekta zatakia
Ekta Zatakia
INTRODUCTION ON FINANCIAL MARKET
Financial markets are the centres that provide facilities for buying and selling of financial claims and services. It is an institution that facilitates the exchange of financial instruments such as deposits, loans, corporate stocks and government bonds. It is a market wherein financial instruments are traded. In other words, the place where people and institutions wanting to borrow money are bought together with those having surplus funds is known as “financial market.” These markets contribute to the development of the entrepreneurial class by making available necessary financial resources. This kind of market also allows the lenders to earn interest or dividend on their surplus investible funds. Hence, it provides liquidity and the funds can be used for productive purpose. In this market, also financial transactions may take place either at a specific location like stock exchange or through mechanism of telephone, telex and other electronic media. However, one of the most important requisites for the accelerated development of an economy is the existence of a dynamic financial market. The participants in the financial market are financial institutions, brokers, dealers, borrowers and investors.
Financial Market attains the equilibrium position when the supply and demand are equal to each other. They are said to be perfect when large number of investors and savers operate in the market. The supply of funds depends upon aggregate savings and credit creation by the banking system. The need for funds depends upon the demands for investment, consumer durables, etc. the function of financial system is to establish a bridge between savers and investors. The ultimate goal of the financial system is to accelerate the rate of economic development.
STRUCTURE OF FINANCIAL MARKET IN NEW YORK
THE MONEY MARKET
The money market is the financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded. Money market securities are usually more widely traded than long-term securities and so tend to be more liquid. Money markets are integral to the financial infrastructure of industrial countries and the money markets of New York City (U.S) are among the largest financial markets in the world. These markets, which serve as channels for the execution and transmission of monetary policy and as trading venues for the shortest-term instruments, anchor the entire term structure of interest rates. Money markets are central to the allocation of capital, the efficient distribution of liquidity among financial institutions, and the hedging of short-term risks. The markets also play an important role in the credit evaluation process and in the large-value payments systems where trades are settled.
THE CAPITAL MARKET
The capital market is the market in which long-term debt (generally those with original maturity of one year or greater) and equity instruments are traded. Capital market securities, such as stocks and long-term bonds, are often held by financial intermediaries such as insurance companies and pension funds, which have little uncertainty about the amount of funds they will have available in the future. Capital market in New York City (U.S) works closely with the Bank’s Trading Desk on market monitoring, policy implementation, and Treasury financing issues, and advises senior Bank management on market developments and the information content of financial market prices. Recent work includes analyses of dealer positioning and leverage and their relationship to market behavior, assessments of liquidity in fixed-income markets, and studies of inflationary expectations embedded in financial market prices.
THE PRIMARY MARKET
Primary market is a market where new issues of treasury are sold at auction. The Federal Reserve Bank of New York organizes the auctions. The amount, maturity, and denomination mix of each new issue are announced at least a week in advance, so the market can absorb the new issue smoothly. The treasury sells an average of $10 billion to 12$ billion of new issues each week. About one-half represents refinancing of old debt: the money raised is used to pay off old issues that mature. The rest goes to finance current deficit. There are weekly auctions of bills and regular, mostly quarterly, auctions of notes and bonds.
HOW PRIMARY MARKET WORKS:
A person who buys a part of new issue must submit a sealed bid to any one of the Federal Reserve Banks (most are submitted to New York Fed). There are 2 types of bids: Competitive bids specify a price; non-competitive bids do not specify price. The non-competitive bidders are usually less sophisticated small investors. Competitive bidders are either dealers, who expect to resell the securities at a profit, or institutional investors, who believe they can get the securities more cheaply by bidding themselves than by buying from a dealer. Any bid for more than $5 million of securities must be competitive. No single competitive bidder may purchase more than 35% of a given issue.
THE SECONDARY MARKET
While the primary market for government seem large, the secondary market dwarfs it. I 1992, the volume of transactions reported by major dealers averaged about $100 billion a day. If we add smaller dealers, who do not report their transactions, and transactions overseas, total trading volume is much higher. The secondary market for government securities is very liquid: bid-ask spreads are small, the market is deep, routinely accommodating traders in the billion of dollars with nary a ripple.
HOW THE SECONDARY MARKET IS ORGANIZED:
The secondary market is a decentralized, over-the-counter dealer market. Information is carried on computer terminals, but actual trading takes place on the telephone. The market operates 24 hours a day, worldwide. Although it has no single physical location, it is entered in the New York City. The principal participants are dealers, brokers and clearing banks.
THE DEBT MARKET
A firm or an individual can obtain funds in a financial market in two ways. The most common method is to issue a debt instrument. A contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals (interest and the principal payments) until a specific date (the maturity date), when a final payment is made. The maturity of a debt instrument is the number of years (term) until the instrument’s expiration date. A debt instrument is short-term if its maturity is less than a year and long-term if its maturity is ten years or longer. Debt instrument with a maturity between one and ten years are said to be intermediate-term.
THE EQUITY MARKET
The second method of raising funds is by issuing equities, such as common stock, which are claim to share in the net income (income after expenses and taxes) and the assets of a business.
The main disadvantage of owing a corporation’s equities rather than its debt is that an equity holder is a residual claimant; that is, the corporation must pay all its debt holders before it pays its equity holders. The advantage of holding equities is that equity holder’s benefit directly from any increases in the corporations’ profitability or asset value because equities confer ownership rights on the equity holders.
The total value of equities in US has typically fluctuated between $4 and $20 trillion since the early 1990s, depending on the prices of shares. Although the average person is more aware of the stock market than any other financial market, the size of the debt market is often larger than the size of the equities market: the value of debt instrument was $41 trillion at the end of 2005, while the value of equities was $18 trillion at the end of 2005.
The stock market is also an important factor in business investment decisions, because the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. A higher price for a firm’s shares means that it can raise a larger amount of funds, which can be used to buy production facilities and equipment.
THE FOREIGN EXCHANGE MARKET
For the funds to be transferred from one country to another, they have to be converted from the currency in the country of origin (say dollars) into the currency of the country they are going to (say euros). The foreign exchange market is where this conversion takes place, so it is instrumental in moving funds between countries, it is also important because it is where the foreign exchange rate, the price of one country’s currency in terms of another is determined.
The exchange rate and the fluctuations in prices in the market for the U.S dollar from 1970 to 2005 were substantial: the dollars value weakened considerably from 1971 to 1973, rose slightly until 1976, and then reached a low point in the 1978-1980 period. From 1980 to early 1985, the dollar’s value appreciated and then declined again reaching another low in 1995. The dollar appreciated from 1995 to 2000, only to depreciates thereafter.
PARTICIPANTS IN THE MARKET
DEALERS
Dealers make the market: the quotes bid and ask prices at which they are willing to buy and sell the securities. To backup their quoted prices, they must take a position in securities. If some one wants to buy the, dealers must have the securities available to sell; of some one wants to sell, they must be buy and to add the securities to their inventory. There are 2 types of dealers: primary and secondary.
Primary Dealers: Dealers large enough and sound enough to be ‘recognized’ by the Fed, as potential trading partners are known as primary dealers. Fed does an enormous amount of trading in U.S. securities in order to carry out its monetary policy. Primary dealers enjoy a considerable prestige from their status. Many large institutional investors will trade only with a primary dealer.
There are many important informational benefits to being a primary dealer. He can have immediate information on what the Fed is up to. They are connected via brokers, to other primary dealers. This helps to know what other major players in the market are doing. All this information can help him inn getting an edge in predicting interest rate changes. Being a primary dealer has its costs. To be recognized as a primary dealer a dealer must demonstrate to the Fed that it has capital, expertise, and the capacity to be a reliable trading partner. Primary dealers trade with one another on what is called as inside market. Inside market in which primary dealers trade among themselves. It is a market where you can buy what you need. The customers of primary dealers include secondary dealers, corporations, financial institutions, and individuals.
Secondary Dealers: In addition to the primary dealers, there are also some 300 smaller, secondary dealers. Secondary dealers do not deal directly with the Fed, and they are much less closely monitored than primary dealers. Secondary dealers buy securities from the primary dealers and sell them to the public. Almost any one can set up as a secondary dealer.
BROKERS
Unlike dealers, Brokers never take a position in securities. Their rule is nearly to bring together buyers and sellers. Brokers are particularly important in the inside market. Brokers provide centralization. The more centralized the market, the more efficient it is. With, say, twenty different brokers, there would be little centralization. Dealers could do almost as well trading with one another directly. Reducing the number of brokers to five would be a bring improvement. Of course, the greater efficiency would result from having a single broker. Then, all the information could be displayed on a single screen. There are, in fact, only six or seven brokers of government securities, with four – RMJ, FBI, CANTOR FITZGERALD, AND GARBAN – accounting for most of the business.
CLEARING AND SETTLEMENTS
U.S. government securities are traded under three conventions – same day, next day (“regular way”), and forward settlement. All same day transactions are steeled directly between the counter parties. Other trades may be settled either directly or through Government Securities Clearing Corporation (GSCC), a clearinghouse
INSTRUMENTS IN FINANCIAL MARKETS
Money Market Instruments
The money market has undergone significant changes in past 35 years, with new financial instruments being introduced and the amount outstanding of other instruments increasing at far more rapid pace than the level of economic activity.
Money Market Instruments
Amount Outstanding ($ Billions, end of year)
Type of Instrument 1980 1990 2000 2005
U.S. Treasury Bills 216 527 647 923
Negotiable (CDs) 317 543 1053 1742
Commercial Paper 122 557 1619 1544
Banker's Acceptance 42 52 8 4
Repurchase Agreements 57 144 366 518
Federal Funds 18 61 60 83
Eurodollars 55 92 195 438
Source: Federal Reserve Flow of Funds Accounts; Federal Reserve Bulletin; Economic Report of the President.
U.S. Treasury Bills
U.S. Treasury bills (T-bills) are short term debt instruments of the U.S. government with typical maturities of 3 to 12 months. They pay a set amount at maturity and have no explicit interest payments. In reality, they pay interest by initially selling at a discount – that is, at a price lower than the amount paid at a maturity. For instance, in April 2004 you might pay $9,770 to buy a one-year T-bill that can be redeemed for $10,000 in April 2005; thus, the bill effectively pays $230 in interest ($10,000 - $9,770 = $ 230). The yield on such a bill is 2.35 percent or $230/$9,770 [(interest amount)/(purchase price)].
U.S. Treasury bills are the most liquid of all the money market instruments because they have an active secondary market and relatively short-term to maturity. They also are the safest of all money market instruments because there is no possibility that the government will fail to pay back the amount owned when the security matures.
Negotiable Certificates of Deposit (CDs)
A certificate of deposit (CD) is a debt instrument sold by a depository institution that pay annual interest payments equal to a fixed percentage of the original purchase price. In addition, at maturity the original purchase price is also paid back. Most CDs have a maturity of 1 to 12 months. CDs are more liquid and more attractive to investors. Negotiable CDs have a minimum denomination of $100,000 but in practice, the minimum denomination to trade in secondary market is $2,000,000.
Commercial Paper
Commercial paper is a short-term debt instrument issued by corporation such as General Motors, AT&T, and other less well-known domestic and foreign enterprise. The Commercial paper has undergone tremendous growth since 1970, when there was $33 billion outstanding, to over $1.6 trillion outstanding at the end of 2005. Indeed, commercial paper has been one of the fastest growing money market instruments.
Bankers’ Acceptance
Bankers’ acceptances are money market instruments created in the course of financing the international trade. Banks were first authorized to issue bankers’ acceptances to finance the international and domestic trade of their customers by the Federal Reserve Act in 1913. A bankers’ acceptance is a bank draft (a guarantee of payment similar to a check) issued by a firm and payable on some future date. For a fee, the bank on which the draft is drawn stamps as “accepted”, thereby guaranteeing that the draft will be paid even in the event of default by the firm. If the firm fails to deposit the funds into its account to cover the draft by the future due date, the bank’s guarantee means that the bank is obligated to pay the draft. The bank’s creditworthiness is substituted for that of the firm issuing the acceptance, making the draft more likely to accept when it is used to purchase goods abroad. The foreign exporter knows that even if the company purchasing the goods goes bankrupt, the bank draft will still be paid off. Bankers’ acceptances that trade in secondary market are similar to T-bills in that they are short-term and sell at a discount.
Repurchase Agreements
Repurchase Agreements are short-term agreements in which the seller sells a government security to a buyer and simultaneously agrees to buy the government security back on a later date at a higher price. In effect, the seller has borrowed funds for a short term, and the buyer ostensibly has made a secured loan for which the government security serves as collateral. If the seller (borrower) fails to pay back the loan, the buyer (lender) keeps the government security.
Federal (Fed) Funds
Federal (Fed) funds are typically overnight loans between depository institutions of their deposits at the Fed. This is effectively the market for excess reserves. A depository institution might borrow in the federal funds market if it finds that its reserve assets do not meet the amount required by law. It can borrow reserve deposits from another depository institution that has excess reserve deposits and chooses to lend them to earn interest. The reserve deposit balances are transferred between the borrowing and lending institutions using the Fed’s wire transfer system.
Eurodollars
Eurodollars are dollar-denominated deposits held in banks outside the United States. For example, if an American makes a deposit denominated in U.S. dollars in a bank in England or some other foreign country, that is a Eurodollar deposit. Eurodollar deposits are not subject to domestic regulations and are not covered by deposit insurance. The Eurodollar market stated in the 1950s when Soviet Bloc governments put dollar-denominated deposits into London banks.
Capital market Instruments
The capital market is extremely important because it raises the funds needed by net borrowers to carry out their spending and investment plans. A smoothly functioning capital market influence how fast the economy grows.
Capital Market Instruments
Amount Outstanding ($ Billions, end of year)
Type of Instrument 1980 1990 2000 2005
Stocks 1601 4146 17627 17853
Mortgages 1106 2886 5463 9436
Corporate Bonds 366 1008 2230 2983
U.S. Govt. Securities 407 1653 2184 2803
U.S. Govt. Agency Securities 193 435 1616 2696
State & Local Govt. Bonds 310 870 1192 1807
Source: Federal Reserve Flow of Funds Accounts; Federal Reserve Bulletin.
Stocks
Stocks are equity claims representing ownership of the net income and assets of a corporation. The income that stock holder receive for their ownership is called dividends. Preferred stock pays a fixed dividend, and in the event of bankruptcy of the corporation, the owners of preferred stock are entitled to be paid first after the corporation’s other creditors. Common stock pays a variable dividend, depending on the profits that are left over after preferred stock holders have been paid and retained earnings set aside. The largest secondary market for outstanding shares of stock is the New York Stock Exchange.
Mortgages
Mortgages are loans to purchase single – or multiple-family residential housing, land, or other real structures, with the structure or land serving as collateral for the loans. In the event the borrower fails to make the schedule payments, the lender can repossess the property. Mortgages are usually made for up to 30 years, and the repayment of the principal is spread out over the life of the loan. Some mortgages charge a fixed interest rate reminds the same over the life of the loan; other charges a variable interest rate that is adjusted periodically to reflect changing market conditions. Saving and loans associations and mutual savings banks are the primary lenders in the residential mortgage market, although commercial banks are now also active lenders in this market.
The federal government has played an important role in the mortgage market by creating two government–sponsored enterprises that sell bonds and use the proceeds to purchase mortgages.
Corporate Bonds
Corporate bonds are long-term bonds issued by corporations usually (although not always) with excellent credit ratings. Maturities range from 2 to 30 years. The owner receives an interest payment twice a year and the principal at maturity. Because the outstanding amount of bonds for any given corporation is small, corporate bonds are not nearly as liquid as other securities such as U.S. government bonds. However, an active secondary market has been created by dealers who are willing to buy and sell corporate bonds. The principal buyers of corporate bonds are life insurance companies, pension funds, households, commercial banks, and foreign investors.
U.S. Government Securities
U.S. government securities are long-term debt instruments with maturities of 2 to up to 30 years issued by the U.S. Treasury to finance deficits of the federal government. Notes have an original maturity of 2 to 10 years; bonds have an original maturity between 10 and 30 years. An active secondary market exists, although it is not as active as the secondary market for T-bills. Despite this, because of the ease with which they are traded, government securities are still the most liquid security traded in the capital market. The principal holders of government securities are the Federal Reserve, financial intermediaries, securities dealers, households, and foreign investors.
U.S. Government Agency Securities
U.S. government agency securities are long-term bond issued by various government agencies including those that support commercial, residential, and agriculture real estate lending and student loans. The federal government guarantees some of these securities, and some are not, even though all of the agencies are federally sponsored. Active secondary market exists for most agency securities. Those that are guaranteed by the federal government function much like U.S. government and tend to be held by the same parties that hold government securities.
State and Local Government Bonds (Municipals)
State and local government bonds (municipals) are long-term instruments issued by the state and local government to finance expenditure on schools, roads, college dorms, and the like. They carry some risk that the issuer will not be able to make scheduled interest or principal payments. Payments are generally secured in one of two ways. Revenue bonds are used to finance specific projects, and the proceeds of those projects are used to payoff the bondholders. General obligation bonds are backed by the full faith and credit of the issuer; taxes can be raised to pay the interest and principal on general obligation bonds. Households in high tax brackets are the largest holders of state and local governments bonds.
FUNCTION OF FINANCIAL MARKETS
Financial markets perform the essential economic function of channeling funds from households, firms and governments that have saved surplus funds by spending less then their income to those that have a shortage of funds because they wish to spend more then their income. This function is shown in following figure. Those who have saved and are lending funds, the lender-savers, are at the left, and those who must borrow funds to finance their finance their spending, the borrower-spenders, are at the right. The principal lender-savers are households, but business enterprise and the government, as well as foreigners and their government, sometimes also find themselves with excess funds and so lend them out. The most important borrower-spenders are business and the government (particularly the federal government), but households and foreigners also borrow to finance their purchases of cars, furniture and houses. The arrow shows that funds flow from lender-severs to borrower-spenders via two routes.
Flows of Funds through the Financial System
In direct finance, borrowers borrow funds directly from lenders in financial markets by selling them securities (financial instruments), which are claims on borrower’s future income or assets. Securities are assets for the person who buys them but liabilities who sells them.
For example; if General Motors needs to borrow funds to pay for a new factory to manufacture electric cars, it might borrow the funds from savers by selling them bonds, debt securities the promise to make periodically for a specific period of time.
The existence of financial market is beneficial even if someone borrows for a purpose other than increasing production in a business.
For example; you are recently married, have a job, and want to buy a house. You earn a good salary, but because you have just started to work, you have not much saved much. Over the time, you would have no problem saving enough to buy the house of your dreams, but by then you would be too old to get full enjoyment from it. Without financial markets, you are stuck; you cannot buy the house and must continue to live in tiny apartment.
If a financial market were set up so that people who had build up savings could lend you funds to buy the house, you would be more than happy to pay them some interest so that you could own a house while you are still young enough to enjoy it. Then, over the time, you would pay back your loan. If this loan could occur, you would be better off, as would the persons who made you the loan. They would now earn some interest, whereas they would not if the financial market did not exit.
So we can see that financial markets have such an important function in the economy. They allow funds to move from people who lack productive investment opportunities to people who have such opportunities. Financial markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy.
Well-functioning financial markets also directly improve the well-being of consumers by allowing them to purchase better. They provide funds to young people to buy what they need and can eventually afford without forcing them to wait until they have saved up the entire purchase price. Financial markets that are operating efficiently improve the economic welfare of everyone n the society.
REGULATION OF FINANCIAL SYSTEM
The financial system is among the most heavily regulated sectors of the American economy. The government regulates financial markets for two main reasons, to increase the information available to investors and to ensure the soundness of the financial system.
Principal Regulatory of the U.S Financial System
Regulatory Agency Subject of Regulation Nature of Regulations.
Securities and Exchange Commission(SEC) Organized exchanges and financial markets. Requires disclosure of information, restricts insider trading.
Commodities Futures Trading Commission. (CFTC) Futures market exchanges. Regulates procedures for trading in future markets.
Office of the Comptroller of the currency Federally chartered commercial banks. Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold.
National Credit Union Administration(NCUA) Federally chartered credit unions Charters and examines the books of federally chartered credit unions and imposes restrictions on assets they can hold.
State banking and insurance commissions State –chartered depository institutions. Charter and examine the books of state-chartered banks and insurance companies, impose restrictions on assets they can hold, and impose restrictions on branching.
Federal Deposit Insurance Corporation (FDIC) Commercial banks, mutual saving banks, savings and loan associations. Provides insurance of up to $100,000 for each depositor at a bank, examines the books of insured banks and imposes restrictions on assets they can hold.
Federal Reserve System All depository institutions Examines the books of commercial banks that are member of the system, sets reserve requirements for all banks.
Office of Thrift Supervision Savings and loan associations Examines the books of savings and loan associations, imposes restrictions on assets they can hold.
Increasing Information Available to Investors:
Asymmetric information in financial markets means that investors may be subject to adverse selection and moral hazard problems that may affect the efficient operation of financial markets. Risky firms or outright crooks may sell the security to unwary or unknown investors. Once an investor has bought a security, thereby lending money to a firm, the borrower may have incentives to engage in risky activities or to commit outright fraud. The presence of this moral hazard problem may keep the investors away from the financial markets. Government regulation can reduce adverse selection and moral hazard problem in financial markets and increase their efficiency by increasing the amount of information available to investors.
Ensuring the Soundness of Financial Intermediaries:
Asymmetric information can lead to the widespread collapse of financial intermediaries, referred to as financial panic. Because providers of funds to financial intermediaries may not be able to assess whether the institutions holding their funds are sound, if they have doubts about the overall health of financial intermediaries, they may want to pull their funds out of both sound and unsound institutions. The possible outcome is financial panic that produces large losses for the public and causes serious damage to the economy. To protect the public and the economy from the financial panics, the government has implemented 6 types of regulations:
1. Restrictions on Entry: State banking and insurance commissions, as well as the Office of the Comptroller of the Currency have created right regulations governing who is allowed to set up the financial intermediary. Individuals or groups who want to establish a financial intermediary, such as bank or an insurance company, must obtain a charter from the state or the federal government. Only if they are upstanding citizens with impeccable credentials and a large amount of initial funds will they be given a charter.
2. Disclosure: There are stringent reporting requirements for financial intermediaries. Their bookkeeping must follow certain principles, their books are subject to periodic inspection and they must make certain information available to the public.
3. Restrictions on Assets and Activities: There are restrictions on what financial intermediaries are allowed to do and what assets they can hold. To ensure whether your funds will remain safe or not and whether the financial intermediary will be able to meet its obligations, you must restrict the financial intermediary from engaging in certain risky operations as per legislation passed in 1933(repealed in 1999). Another way to restrict or control the financial intermediary is to restrict it from holding certain risky assets or to restrict it from holding a greater quantity of risky assets which is prudent.
4. Deposit Insurance: The government can insure people’s deposits so that they do not suffer from financial loss if the financial intermediary holding deposits would fail. Federal Deposit Insurance Corporation (FDIC) who is the most important government agency insures each depositor at a commercial bank or mutual savings bank up to a loss of $ 100,000 per account. The FDIC was created in 1934 after the massive bank failures of 1930-1933, in which the savings of many depositors at commercial banks were wiped out. Another government agency known as Savings Association Insurance Fund (part of the FDIC) provides deposit insurance for savings and loan associations and the National Credit Union Share Insurance Fund (NCUSIF) does the same for credit unions.
5. Limits on Competition: Politicians have often declared that competition among financial intermediaries promotes failures that will harm the public. Although it was known that the competition is extremely weak, it did not stop the state and federal governments from imposing restrictions on the opening of additional branches.
6. Restrictions on Interest Rates: Competition has also been inhibited by regulations that impose restrictions on interest rates which can be paid on deposits. For decades after 1933, banks were prohibited from paying interest on checking accounts but in the year 1986, Federal Reserve System had the power under Regulation Q to set maximum interest rates that banks could pay on savings deposits. These regulations were instituted because of the widespread belief.
FINANCIAL REGULATION ABROAD
The financial regulation of countries like Japan, Canada and the nations of Western Europe are similar to the financial regulation in the United States. The provision of information is improved by requiring corporations issuing securities to report details about assets and liabilities, earnings, sales of stock and by prohibiting insider trading. The soundness of intermediaries is ensured by licensing, periodic inspection of financial intermediaries books and the provision of deposit insurance.
The major differences between financial regulation in the United States and abroad relates to bank regulation. In the past, the United States was the only industrialized country to subject banks to restrict on branching, which limited bank’s size and also restricted them to certain geographic regions. (These restrictions were abolished by legislation in 1994.) U.S banks were also restricted from holding in the range of assets. Banks abroad, frequently hold shares in commercial firms, in Japan and Germany.
COMPARISON OF NEW YORK & INDIAN FINANCIAL MARKET
PARTICULARS NEW YORK FINANCIAL MARKET INDIAN FINANCIAL MARKET
1.Nature of Growth 2.Control over the market 3.Weapons used to control market4.Competition among institutions 5.System of banking6.Number of central banks7.Operation of foreign funds. Organized & well developed.The Federal Reserve Banks control the financial market through statutory power.The Federal Banks use more direct weapons of credit controls as variation of cash reserve ratios, etc.In this market various institutions function independently & compete for the funds in the market. But the competition is healthy.In U.S.A. unit banking is prevailing, since there are numerous banks of small size.In U.S.A. there are 12 Federal Reserve Banks for different regions. With Federal reserve system at the apex levelMore attraction of foreign funds Fast catching up but matured market since 1992.RBI and SEBI have control over the market & regulates liquidity through DHFI, OMO etc.CRR, Repo transactions, Moral suasion OMO of Treasury Bills, etc. Healthy competition is gaining ground. RBI determines the players in the market-large number of lenders including financial institutions mutual funds, big corporate. In India branch banking is popular even then many private sector banks are small in sizeIn India there is only RBI for the entire central banking operations.Underdeveloped due to restrictions over foreign exchange transactions. Capital account convertibility is required to attract foreign funds
CONCLUSION
The financial market in New York (U.S.) is a well-developed and systematized market. The highly developed nature of the financial market in New York and the wide range of choices for borrowing and lending have facilitated massive expansion of outstanding debt which can be seen as a sign of economic and financial vigor but sometimes it can also be worrisome. There is lot of transparency in the market. The market works in modernized way using new technologies to make it more efficient. The financial market here is international in scope since the U.S. dollar is the main international currency. Most of the transactions are done in U.S. dollars only, also banks for many nations bid for deposits and make loans through out the world. The development of financial market has allowed large creditworthy commercial entities to avoid traditional intermediaries and go for direct borrowing and direct placement. The Federal Reserve Bank through its collective efforts, along with the developments in the information technology and risk management techniques is contributing to achieve market stability.
Financial markets are the centres that provide facilities for buying and selling of financial claims and services. It is an institution that facilitates the exchange of financial instruments such as deposits, loans, corporate stocks and government bonds. It is a market wherein financial instruments are traded. In other words, the place where people and institutions wanting to borrow money are bought together with those having surplus funds is known as “financial market.” These markets contribute to the development of the entrepreneurial class by making available necessary financial resources. This kind of market also allows the lenders to earn interest or dividend on their surplus investible funds. Hence, it provides liquidity and the funds can be used for productive purpose. In this market, also financial transactions may take place either at a specific location like stock exchange or through mechanism of telephone, telex and other electronic media. However, one of the most important requisites for the accelerated development of an economy is the existence of a dynamic financial market. The participants in the financial market are financial institutions, brokers, dealers, borrowers and investors.
Financial Market attains the equilibrium position when the supply and demand are equal to each other. They are said to be perfect when large number of investors and savers operate in the market. The supply of funds depends upon aggregate savings and credit creation by the banking system. The need for funds depends upon the demands for investment, consumer durables, etc. the function of financial system is to establish a bridge between savers and investors. The ultimate goal of the financial system is to accelerate the rate of economic development.
STRUCTURE OF FINANCIAL MARKET IN NEW YORK
THE MONEY MARKET
The money market is the financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded. Money market securities are usually more widely traded than long-term securities and so tend to be more liquid. Money markets are integral to the financial infrastructure of industrial countries and the money markets of New York City (U.S) are among the largest financial markets in the world. These markets, which serve as channels for the execution and transmission of monetary policy and as trading venues for the shortest-term instruments, anchor the entire term structure of interest rates. Money markets are central to the allocation of capital, the efficient distribution of liquidity among financial institutions, and the hedging of short-term risks. The markets also play an important role in the credit evaluation process and in the large-value payments systems where trades are settled.
THE CAPITAL MARKET
The capital market is the market in which long-term debt (generally those with original maturity of one year or greater) and equity instruments are traded. Capital market securities, such as stocks and long-term bonds, are often held by financial intermediaries such as insurance companies and pension funds, which have little uncertainty about the amount of funds they will have available in the future. Capital market in New York City (U.S) works closely with the Bank’s Trading Desk on market monitoring, policy implementation, and Treasury financing issues, and advises senior Bank management on market developments and the information content of financial market prices. Recent work includes analyses of dealer positioning and leverage and their relationship to market behavior, assessments of liquidity in fixed-income markets, and studies of inflationary expectations embedded in financial market prices.
THE PRIMARY MARKET
Primary market is a market where new issues of treasury are sold at auction. The Federal Reserve Bank of New York organizes the auctions. The amount, maturity, and denomination mix of each new issue are announced at least a week in advance, so the market can absorb the new issue smoothly. The treasury sells an average of $10 billion to 12$ billion of new issues each week. About one-half represents refinancing of old debt: the money raised is used to pay off old issues that mature. The rest goes to finance current deficit. There are weekly auctions of bills and regular, mostly quarterly, auctions of notes and bonds.
HOW PRIMARY MARKET WORKS:
A person who buys a part of new issue must submit a sealed bid to any one of the Federal Reserve Banks (most are submitted to New York Fed). There are 2 types of bids: Competitive bids specify a price; non-competitive bids do not specify price. The non-competitive bidders are usually less sophisticated small investors. Competitive bidders are either dealers, who expect to resell the securities at a profit, or institutional investors, who believe they can get the securities more cheaply by bidding themselves than by buying from a dealer. Any bid for more than $5 million of securities must be competitive. No single competitive bidder may purchase more than 35% of a given issue.
THE SECONDARY MARKET
While the primary market for government seem large, the secondary market dwarfs it. I 1992, the volume of transactions reported by major dealers averaged about $100 billion a day. If we add smaller dealers, who do not report their transactions, and transactions overseas, total trading volume is much higher. The secondary market for government securities is very liquid: bid-ask spreads are small, the market is deep, routinely accommodating traders in the billion of dollars with nary a ripple.
HOW THE SECONDARY MARKET IS ORGANIZED:
The secondary market is a decentralized, over-the-counter dealer market. Information is carried on computer terminals, but actual trading takes place on the telephone. The market operates 24 hours a day, worldwide. Although it has no single physical location, it is entered in the New York City. The principal participants are dealers, brokers and clearing banks.
THE DEBT MARKET
A firm or an individual can obtain funds in a financial market in two ways. The most common method is to issue a debt instrument. A contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals (interest and the principal payments) until a specific date (the maturity date), when a final payment is made. The maturity of a debt instrument is the number of years (term) until the instrument’s expiration date. A debt instrument is short-term if its maturity is less than a year and long-term if its maturity is ten years or longer. Debt instrument with a maturity between one and ten years are said to be intermediate-term.
THE EQUITY MARKET
The second method of raising funds is by issuing equities, such as common stock, which are claim to share in the net income (income after expenses and taxes) and the assets of a business.
The main disadvantage of owing a corporation’s equities rather than its debt is that an equity holder is a residual claimant; that is, the corporation must pay all its debt holders before it pays its equity holders. The advantage of holding equities is that equity holder’s benefit directly from any increases in the corporations’ profitability or asset value because equities confer ownership rights on the equity holders.
The total value of equities in US has typically fluctuated between $4 and $20 trillion since the early 1990s, depending on the prices of shares. Although the average person is more aware of the stock market than any other financial market, the size of the debt market is often larger than the size of the equities market: the value of debt instrument was $41 trillion at the end of 2005, while the value of equities was $18 trillion at the end of 2005.
The stock market is also an important factor in business investment decisions, because the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. A higher price for a firm’s shares means that it can raise a larger amount of funds, which can be used to buy production facilities and equipment.
THE FOREIGN EXCHANGE MARKET
For the funds to be transferred from one country to another, they have to be converted from the currency in the country of origin (say dollars) into the currency of the country they are going to (say euros). The foreign exchange market is where this conversion takes place, so it is instrumental in moving funds between countries, it is also important because it is where the foreign exchange rate, the price of one country’s currency in terms of another is determined.
The exchange rate and the fluctuations in prices in the market for the U.S dollar from 1970 to 2005 were substantial: the dollars value weakened considerably from 1971 to 1973, rose slightly until 1976, and then reached a low point in the 1978-1980 period. From 1980 to early 1985, the dollar’s value appreciated and then declined again reaching another low in 1995. The dollar appreciated from 1995 to 2000, only to depreciates thereafter.
PARTICIPANTS IN THE MARKET
DEALERS
Dealers make the market: the quotes bid and ask prices at which they are willing to buy and sell the securities. To backup their quoted prices, they must take a position in securities. If some one wants to buy the, dealers must have the securities available to sell; of some one wants to sell, they must be buy and to add the securities to their inventory. There are 2 types of dealers: primary and secondary.
Primary Dealers: Dealers large enough and sound enough to be ‘recognized’ by the Fed, as potential trading partners are known as primary dealers. Fed does an enormous amount of trading in U.S. securities in order to carry out its monetary policy. Primary dealers enjoy a considerable prestige from their status. Many large institutional investors will trade only with a primary dealer.
There are many important informational benefits to being a primary dealer. He can have immediate information on what the Fed is up to. They are connected via brokers, to other primary dealers. This helps to know what other major players in the market are doing. All this information can help him inn getting an edge in predicting interest rate changes. Being a primary dealer has its costs. To be recognized as a primary dealer a dealer must demonstrate to the Fed that it has capital, expertise, and the capacity to be a reliable trading partner. Primary dealers trade with one another on what is called as inside market. Inside market in which primary dealers trade among themselves. It is a market where you can buy what you need. The customers of primary dealers include secondary dealers, corporations, financial institutions, and individuals.
Secondary Dealers: In addition to the primary dealers, there are also some 300 smaller, secondary dealers. Secondary dealers do not deal directly with the Fed, and they are much less closely monitored than primary dealers. Secondary dealers buy securities from the primary dealers and sell them to the public. Almost any one can set up as a secondary dealer.
BROKERS
Unlike dealers, Brokers never take a position in securities. Their rule is nearly to bring together buyers and sellers. Brokers are particularly important in the inside market. Brokers provide centralization. The more centralized the market, the more efficient it is. With, say, twenty different brokers, there would be little centralization. Dealers could do almost as well trading with one another directly. Reducing the number of brokers to five would be a bring improvement. Of course, the greater efficiency would result from having a single broker. Then, all the information could be displayed on a single screen. There are, in fact, only six or seven brokers of government securities, with four – RMJ, FBI, CANTOR FITZGERALD, AND GARBAN – accounting for most of the business.
CLEARING AND SETTLEMENTS
U.S. government securities are traded under three conventions – same day, next day (“regular way”), and forward settlement. All same day transactions are steeled directly between the counter parties. Other trades may be settled either directly or through Government Securities Clearing Corporation (GSCC), a clearinghouse
INSTRUMENTS IN FINANCIAL MARKETS
Money Market Instruments
The money market has undergone significant changes in past 35 years, with new financial instruments being introduced and the amount outstanding of other instruments increasing at far more rapid pace than the level of economic activity.
Money Market Instruments
Amount Outstanding ($ Billions, end of year)
Type of Instrument 1980 1990 2000 2005
U.S. Treasury Bills 216 527 647 923
Negotiable (CDs) 317 543 1053 1742
Commercial Paper 122 557 1619 1544
Banker's Acceptance 42 52 8 4
Repurchase Agreements 57 144 366 518
Federal Funds 18 61 60 83
Eurodollars 55 92 195 438
Source: Federal Reserve Flow of Funds Accounts; Federal Reserve Bulletin; Economic Report of the President.
U.S. Treasury Bills
U.S. Treasury bills (T-bills) are short term debt instruments of the U.S. government with typical maturities of 3 to 12 months. They pay a set amount at maturity and have no explicit interest payments. In reality, they pay interest by initially selling at a discount – that is, at a price lower than the amount paid at a maturity. For instance, in April 2004 you might pay $9,770 to buy a one-year T-bill that can be redeemed for $10,000 in April 2005; thus, the bill effectively pays $230 in interest ($10,000 - $9,770 = $ 230). The yield on such a bill is 2.35 percent or $230/$9,770 [(interest amount)/(purchase price)].
U.S. Treasury bills are the most liquid of all the money market instruments because they have an active secondary market and relatively short-term to maturity. They also are the safest of all money market instruments because there is no possibility that the government will fail to pay back the amount owned when the security matures.
Negotiable Certificates of Deposit (CDs)
A certificate of deposit (CD) is a debt instrument sold by a depository institution that pay annual interest payments equal to a fixed percentage of the original purchase price. In addition, at maturity the original purchase price is also paid back. Most CDs have a maturity of 1 to 12 months. CDs are more liquid and more attractive to investors. Negotiable CDs have a minimum denomination of $100,000 but in practice, the minimum denomination to trade in secondary market is $2,000,000.
Commercial Paper
Commercial paper is a short-term debt instrument issued by corporation such as General Motors, AT&T, and other less well-known domestic and foreign enterprise. The Commercial paper has undergone tremendous growth since 1970, when there was $33 billion outstanding, to over $1.6 trillion outstanding at the end of 2005. Indeed, commercial paper has been one of the fastest growing money market instruments.
Bankers’ Acceptance
Bankers’ acceptances are money market instruments created in the course of financing the international trade. Banks were first authorized to issue bankers’ acceptances to finance the international and domestic trade of their customers by the Federal Reserve Act in 1913. A bankers’ acceptance is a bank draft (a guarantee of payment similar to a check) issued by a firm and payable on some future date. For a fee, the bank on which the draft is drawn stamps as “accepted”, thereby guaranteeing that the draft will be paid even in the event of default by the firm. If the firm fails to deposit the funds into its account to cover the draft by the future due date, the bank’s guarantee means that the bank is obligated to pay the draft. The bank’s creditworthiness is substituted for that of the firm issuing the acceptance, making the draft more likely to accept when it is used to purchase goods abroad. The foreign exporter knows that even if the company purchasing the goods goes bankrupt, the bank draft will still be paid off. Bankers’ acceptances that trade in secondary market are similar to T-bills in that they are short-term and sell at a discount.
Repurchase Agreements
Repurchase Agreements are short-term agreements in which the seller sells a government security to a buyer and simultaneously agrees to buy the government security back on a later date at a higher price. In effect, the seller has borrowed funds for a short term, and the buyer ostensibly has made a secured loan for which the government security serves as collateral. If the seller (borrower) fails to pay back the loan, the buyer (lender) keeps the government security.
Federal (Fed) Funds
Federal (Fed) funds are typically overnight loans between depository institutions of their deposits at the Fed. This is effectively the market for excess reserves. A depository institution might borrow in the federal funds market if it finds that its reserve assets do not meet the amount required by law. It can borrow reserve deposits from another depository institution that has excess reserve deposits and chooses to lend them to earn interest. The reserve deposit balances are transferred between the borrowing and lending institutions using the Fed’s wire transfer system.
Eurodollars
Eurodollars are dollar-denominated deposits held in banks outside the United States. For example, if an American makes a deposit denominated in U.S. dollars in a bank in England or some other foreign country, that is a Eurodollar deposit. Eurodollar deposits are not subject to domestic regulations and are not covered by deposit insurance. The Eurodollar market stated in the 1950s when Soviet Bloc governments put dollar-denominated deposits into London banks.
Capital market Instruments
The capital market is extremely important because it raises the funds needed by net borrowers to carry out their spending and investment plans. A smoothly functioning capital market influence how fast the economy grows.
Capital Market Instruments
Amount Outstanding ($ Billions, end of year)
Type of Instrument 1980 1990 2000 2005
Stocks 1601 4146 17627 17853
Mortgages 1106 2886 5463 9436
Corporate Bonds 366 1008 2230 2983
U.S. Govt. Securities 407 1653 2184 2803
U.S. Govt. Agency Securities 193 435 1616 2696
State & Local Govt. Bonds 310 870 1192 1807
Source: Federal Reserve Flow of Funds Accounts; Federal Reserve Bulletin.
Stocks
Stocks are equity claims representing ownership of the net income and assets of a corporation. The income that stock holder receive for their ownership is called dividends. Preferred stock pays a fixed dividend, and in the event of bankruptcy of the corporation, the owners of preferred stock are entitled to be paid first after the corporation’s other creditors. Common stock pays a variable dividend, depending on the profits that are left over after preferred stock holders have been paid and retained earnings set aside. The largest secondary market for outstanding shares of stock is the New York Stock Exchange.
Mortgages
Mortgages are loans to purchase single – or multiple-family residential housing, land, or other real structures, with the structure or land serving as collateral for the loans. In the event the borrower fails to make the schedule payments, the lender can repossess the property. Mortgages are usually made for up to 30 years, and the repayment of the principal is spread out over the life of the loan. Some mortgages charge a fixed interest rate reminds the same over the life of the loan; other charges a variable interest rate that is adjusted periodically to reflect changing market conditions. Saving and loans associations and mutual savings banks are the primary lenders in the residential mortgage market, although commercial banks are now also active lenders in this market.
The federal government has played an important role in the mortgage market by creating two government–sponsored enterprises that sell bonds and use the proceeds to purchase mortgages.
Corporate Bonds
Corporate bonds are long-term bonds issued by corporations usually (although not always) with excellent credit ratings. Maturities range from 2 to 30 years. The owner receives an interest payment twice a year and the principal at maturity. Because the outstanding amount of bonds for any given corporation is small, corporate bonds are not nearly as liquid as other securities such as U.S. government bonds. However, an active secondary market has been created by dealers who are willing to buy and sell corporate bonds. The principal buyers of corporate bonds are life insurance companies, pension funds, households, commercial banks, and foreign investors.
U.S. Government Securities
U.S. government securities are long-term debt instruments with maturities of 2 to up to 30 years issued by the U.S. Treasury to finance deficits of the federal government. Notes have an original maturity of 2 to 10 years; bonds have an original maturity between 10 and 30 years. An active secondary market exists, although it is not as active as the secondary market for T-bills. Despite this, because of the ease with which they are traded, government securities are still the most liquid security traded in the capital market. The principal holders of government securities are the Federal Reserve, financial intermediaries, securities dealers, households, and foreign investors.
U.S. Government Agency Securities
U.S. government agency securities are long-term bond issued by various government agencies including those that support commercial, residential, and agriculture real estate lending and student loans. The federal government guarantees some of these securities, and some are not, even though all of the agencies are federally sponsored. Active secondary market exists for most agency securities. Those that are guaranteed by the federal government function much like U.S. government and tend to be held by the same parties that hold government securities.
State and Local Government Bonds (Municipals)
State and local government bonds (municipals) are long-term instruments issued by the state and local government to finance expenditure on schools, roads, college dorms, and the like. They carry some risk that the issuer will not be able to make scheduled interest or principal payments. Payments are generally secured in one of two ways. Revenue bonds are used to finance specific projects, and the proceeds of those projects are used to payoff the bondholders. General obligation bonds are backed by the full faith and credit of the issuer; taxes can be raised to pay the interest and principal on general obligation bonds. Households in high tax brackets are the largest holders of state and local governments bonds.
FUNCTION OF FINANCIAL MARKETS
Financial markets perform the essential economic function of channeling funds from households, firms and governments that have saved surplus funds by spending less then their income to those that have a shortage of funds because they wish to spend more then their income. This function is shown in following figure. Those who have saved and are lending funds, the lender-savers, are at the left, and those who must borrow funds to finance their finance their spending, the borrower-spenders, are at the right. The principal lender-savers are households, but business enterprise and the government, as well as foreigners and their government, sometimes also find themselves with excess funds and so lend them out. The most important borrower-spenders are business and the government (particularly the federal government), but households and foreigners also borrow to finance their purchases of cars, furniture and houses. The arrow shows that funds flow from lender-severs to borrower-spenders via two routes.
Flows of Funds through the Financial System
In direct finance, borrowers borrow funds directly from lenders in financial markets by selling them securities (financial instruments), which are claims on borrower’s future income or assets. Securities are assets for the person who buys them but liabilities who sells them.
For example; if General Motors needs to borrow funds to pay for a new factory to manufacture electric cars, it might borrow the funds from savers by selling them bonds, debt securities the promise to make periodically for a specific period of time.
The existence of financial market is beneficial even if someone borrows for a purpose other than increasing production in a business.
For example; you are recently married, have a job, and want to buy a house. You earn a good salary, but because you have just started to work, you have not much saved much. Over the time, you would have no problem saving enough to buy the house of your dreams, but by then you would be too old to get full enjoyment from it. Without financial markets, you are stuck; you cannot buy the house and must continue to live in tiny apartment.
If a financial market were set up so that people who had build up savings could lend you funds to buy the house, you would be more than happy to pay them some interest so that you could own a house while you are still young enough to enjoy it. Then, over the time, you would pay back your loan. If this loan could occur, you would be better off, as would the persons who made you the loan. They would now earn some interest, whereas they would not if the financial market did not exit.
So we can see that financial markets have such an important function in the economy. They allow funds to move from people who lack productive investment opportunities to people who have such opportunities. Financial markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy.
Well-functioning financial markets also directly improve the well-being of consumers by allowing them to purchase better. They provide funds to young people to buy what they need and can eventually afford without forcing them to wait until they have saved up the entire purchase price. Financial markets that are operating efficiently improve the economic welfare of everyone n the society.
REGULATION OF FINANCIAL SYSTEM
The financial system is among the most heavily regulated sectors of the American economy. The government regulates financial markets for two main reasons, to increase the information available to investors and to ensure the soundness of the financial system.
Principal Regulatory of the U.S Financial System
Regulatory Agency Subject of Regulation Nature of Regulations.
Securities and Exchange Commission(SEC) Organized exchanges and financial markets. Requires disclosure of information, restricts insider trading.
Commodities Futures Trading Commission. (CFTC) Futures market exchanges. Regulates procedures for trading in future markets.
Office of the Comptroller of the currency Federally chartered commercial banks. Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold.
National Credit Union Administration(NCUA) Federally chartered credit unions Charters and examines the books of federally chartered credit unions and imposes restrictions on assets they can hold.
State banking and insurance commissions State –chartered depository institutions. Charter and examine the books of state-chartered banks and insurance companies, impose restrictions on assets they can hold, and impose restrictions on branching.
Federal Deposit Insurance Corporation (FDIC) Commercial banks, mutual saving banks, savings and loan associations. Provides insurance of up to $100,000 for each depositor at a bank, examines the books of insured banks and imposes restrictions on assets they can hold.
Federal Reserve System All depository institutions Examines the books of commercial banks that are member of the system, sets reserve requirements for all banks.
Office of Thrift Supervision Savings and loan associations Examines the books of savings and loan associations, imposes restrictions on assets they can hold.
Increasing Information Available to Investors:
Asymmetric information in financial markets means that investors may be subject to adverse selection and moral hazard problems that may affect the efficient operation of financial markets. Risky firms or outright crooks may sell the security to unwary or unknown investors. Once an investor has bought a security, thereby lending money to a firm, the borrower may have incentives to engage in risky activities or to commit outright fraud. The presence of this moral hazard problem may keep the investors away from the financial markets. Government regulation can reduce adverse selection and moral hazard problem in financial markets and increase their efficiency by increasing the amount of information available to investors.
Ensuring the Soundness of Financial Intermediaries:
Asymmetric information can lead to the widespread collapse of financial intermediaries, referred to as financial panic. Because providers of funds to financial intermediaries may not be able to assess whether the institutions holding their funds are sound, if they have doubts about the overall health of financial intermediaries, they may want to pull their funds out of both sound and unsound institutions. The possible outcome is financial panic that produces large losses for the public and causes serious damage to the economy. To protect the public and the economy from the financial panics, the government has implemented 6 types of regulations:
1. Restrictions on Entry: State banking and insurance commissions, as well as the Office of the Comptroller of the Currency have created right regulations governing who is allowed to set up the financial intermediary. Individuals or groups who want to establish a financial intermediary, such as bank or an insurance company, must obtain a charter from the state or the federal government. Only if they are upstanding citizens with impeccable credentials and a large amount of initial funds will they be given a charter.
2. Disclosure: There are stringent reporting requirements for financial intermediaries. Their bookkeeping must follow certain principles, their books are subject to periodic inspection and they must make certain information available to the public.
3. Restrictions on Assets and Activities: There are restrictions on what financial intermediaries are allowed to do and what assets they can hold. To ensure whether your funds will remain safe or not and whether the financial intermediary will be able to meet its obligations, you must restrict the financial intermediary from engaging in certain risky operations as per legislation passed in 1933(repealed in 1999). Another way to restrict or control the financial intermediary is to restrict it from holding certain risky assets or to restrict it from holding a greater quantity of risky assets which is prudent.
4. Deposit Insurance: The government can insure people’s deposits so that they do not suffer from financial loss if the financial intermediary holding deposits would fail. Federal Deposit Insurance Corporation (FDIC) who is the most important government agency insures each depositor at a commercial bank or mutual savings bank up to a loss of $ 100,000 per account. The FDIC was created in 1934 after the massive bank failures of 1930-1933, in which the savings of many depositors at commercial banks were wiped out. Another government agency known as Savings Association Insurance Fund (part of the FDIC) provides deposit insurance for savings and loan associations and the National Credit Union Share Insurance Fund (NCUSIF) does the same for credit unions.
5. Limits on Competition: Politicians have often declared that competition among financial intermediaries promotes failures that will harm the public. Although it was known that the competition is extremely weak, it did not stop the state and federal governments from imposing restrictions on the opening of additional branches.
6. Restrictions on Interest Rates: Competition has also been inhibited by regulations that impose restrictions on interest rates which can be paid on deposits. For decades after 1933, banks were prohibited from paying interest on checking accounts but in the year 1986, Federal Reserve System had the power under Regulation Q to set maximum interest rates that banks could pay on savings deposits. These regulations were instituted because of the widespread belief.
FINANCIAL REGULATION ABROAD
The financial regulation of countries like Japan, Canada and the nations of Western Europe are similar to the financial regulation in the United States. The provision of information is improved by requiring corporations issuing securities to report details about assets and liabilities, earnings, sales of stock and by prohibiting insider trading. The soundness of intermediaries is ensured by licensing, periodic inspection of financial intermediaries books and the provision of deposit insurance.
The major differences between financial regulation in the United States and abroad relates to bank regulation. In the past, the United States was the only industrialized country to subject banks to restrict on branching, which limited bank’s size and also restricted them to certain geographic regions. (These restrictions were abolished by legislation in 1994.) U.S banks were also restricted from holding in the range of assets. Banks abroad, frequently hold shares in commercial firms, in Japan and Germany.
COMPARISON OF NEW YORK & INDIAN FINANCIAL MARKET
PARTICULARS NEW YORK FINANCIAL MARKET INDIAN FINANCIAL MARKET
1.Nature of Growth 2.Control over the market 3.Weapons used to control market4.Competition among institutions 5.System of banking6.Number of central banks7.Operation of foreign funds. Organized & well developed.The Federal Reserve Banks control the financial market through statutory power.The Federal Banks use more direct weapons of credit controls as variation of cash reserve ratios, etc.In this market various institutions function independently & compete for the funds in the market. But the competition is healthy.In U.S.A. unit banking is prevailing, since there are numerous banks of small size.In U.S.A. there are 12 Federal Reserve Banks for different regions. With Federal reserve system at the apex levelMore attraction of foreign funds Fast catching up but matured market since 1992.RBI and SEBI have control over the market & regulates liquidity through DHFI, OMO etc.CRR, Repo transactions, Moral suasion OMO of Treasury Bills, etc. Healthy competition is gaining ground. RBI determines the players in the market-large number of lenders including financial institutions mutual funds, big corporate. In India branch banking is popular even then many private sector banks are small in sizeIn India there is only RBI for the entire central banking operations.Underdeveloped due to restrictions over foreign exchange transactions. Capital account convertibility is required to attract foreign funds
CONCLUSION
The financial market in New York (U.S.) is a well-developed and systematized market. The highly developed nature of the financial market in New York and the wide range of choices for borrowing and lending have facilitated massive expansion of outstanding debt which can be seen as a sign of economic and financial vigor but sometimes it can also be worrisome. There is lot of transparency in the market. The market works in modernized way using new technologies to make it more efficient. The financial market here is international in scope since the U.S. dollar is the main international currency. Most of the transactions are done in U.S. dollars only, also banks for many nations bid for deposits and make loans through out the world. The development of financial market has allowed large creditworthy commercial entities to avoid traditional intermediaries and go for direct borrowing and direct placement. The Federal Reserve Bank through its collective efforts, along with the developments in the information technology and risk management techniques is contributing to achieve market stability.