Financial Market

Financial markets: The term financial market refers to a conceptual mechanism rather than a physical
location or a specific type of organization or structure. It is usually defined as a system that includes
individuals and institutions. Instruments and procedures that bring together borrowers and savers no
matter the location. A financial market is a market in which people trade financial securities,
commodities and value at low transaction costs and at prices that reflect supply and demand. Securities
include stocks and bonds and commodities include precious metals or agricultural products.

Money markets versus capital markets: The markets for short-term financial instruments are termed
the money markets and the markets for long-term financial instruments are called the capital markets.
More specifically, the money markets include debt instruments that have maturities equal to one year
or less when originally issued and the capital markets include instruments with original maturities
greater than one year. By definition, money markets include only debt instruments because equity
instruments have no specific maturities, whereas capital markets include both equity instruments and
such long-term debt instruments as mortgages, corporate bonds and government bonds.

The primary function of the money markets is to provide liquidity to businesses, governments and
individuals so that they can meet their short-term needs for cash. Individuals, companies and
governments use the money markets to better align short-term cash flows. Thus, when cash surpluses
exist for short periods, short-term investments are desirable; when cash deficits exist for short periods,
short-term loans (debt instruments) are desirable.

The primary function of the capital markets is to provide us with the opportunity to transfer cash
surpluses or deficits to future years- that is, transfer income through time. For example, without the
availability of mortgages, most individuals could not afford to buy houses when they are young and just
starting their careers because they have little or no savings and their incomes are not sufficient to pay
for such houses. Similarly, corporations issue stocks and bonds to get funds to support such current
investment needs as expansion and investors who provide the funds receive promises that cash flows
generated by these firms will be distributed at some point in the future.

Debt markets versus equity markets: The debt markets are markets in which loans are traded and the
equity markets are markets in which stocks are traded. A debt instrument is a contract that specifies the
amounts, as well as the dates, a borrower must repay a lender. In contrast, equity represents ownership
in a corporation; it entitles the stockholder to share in future cash distributions generated from income
and from liquidation of the firm.

The debt markets permit individuals, companies and governments to consume future income in the
current period through such loans as mortgages and corporate bonds. These loans require repayment,
with interest, from income generated during the loan period. Conversely, the equity markets permit
corporations to raise funds by selling ownership interests, thereby transferring some risks associated
with businesses to individuals and other companies. Purchasers of equity receive the right to
distributions of cash flows made by the firm from income generated in the future. Unlike debt, however,
equity is not a specific contract that guarantees that cash distributions will be made or that the
investment will be repaid. Because debt typically has a maturity, it can be considered temporary
funding; equity is more permanent because it has no specific maturity.
Debt markets generally are described according to the characteristics of the debt that is traded. For
example, short-term debt instruments are traded in the money markets, long-term debt instruments,
such as corporate bonds and mortgages, are traded in the capital markets. Thus the segmentation of the
debt markets is based on the maturity of the instrument, the type of debt and the participant-
borrowers and investors.

Primary markets versus secondary markets: The Primary markets are markets in which new securities
are traded and the secondary markets are markets in which used securities are traded. Primary markets
are the markets in which corporations raise new capital. Secondary markets are markets in which
existing, previously issued securities are traded among investors. Secondary markets also exist for
mortgages, other types of loans and other financial assets. The corporation whose securities are traded
in the secondary market is not involved in the transaction and therefore does not receive any funds
from the transaction.

Financial institutions: Financial institutions serve as intermediaries by channeling the savings of

Financial intermediaries facilitate the transfer of funds from those who have funds to those who need
funds by manufacturing a variety of financial products that take the form of either loans or savings
instruments. The process by which financial intermediaries transform funds provided by savers into
funds used by borrowers is called financial intermediation.

The benefits associated with financial intermediaries are:

1. Economic well-being: Without financial intermediaries, savers would have to provide funds
directly to borrowers, which would be a difficult task for those who do not possess such
expertise; loans such as mortgages and automobile financing would be much more costly, so the
financial markets would be much less efficient. Financial intermediaries were created to fulfill
specific needs of both savers and borrowers and to reduce the inefficiencies.
2. Reduced cost: Without intermediaries, the net cost of borrowing would be greater and the net
return earned by savers would be less because individuals with funds to lend would have to seek
out appropriate borrowers themselves and vice versa. Intermediaries create combinations of
financial products that better match the funds provided by savers with the needs of borrowers
and they spread the costs associated with these activities over large numbers of transactions.
3. Risk diversification: The loan portfolios of intermediaries generally are well diversified because
they provide funds to a large number and variety of borrowers by offering many types of loans.
Just like investors who purchase varied financial securities, intermediaries spread their risk by
not putting all their financial eggs in one basket.
4. Fund pooling: Intermediaries can pool funds provided by individuals to offer loans or other
financial products with different denominations. An intermediary can offer a large loan to a
single borrower by combining the funds provided by many small savers.
5. Financial flexibility: The financial products created by intermediaries are quite varied with
respect to denominations, maturities and other characteristics; hence, attract many different
 types of savers and borrowers. Both savers and borrowers have greater choices or financial
flexibility than can be achieved with direct placements.
6. Related services: A system of specialized intermediaries offers more than just a network of
mechanisms to transfer funds from savers to borrowers. Many intermediaries provide financial
services in areas in which they achieve comparative advantages.

Types of financial intermediaries: Competition and government policy have created a rapidly changing
arena such that different types of institutions currently create financial products and perform services
that previously were reserved for others.

1. Commercial banks: Commercial banks are among the most important financial institutions in the
economy because they provide savers with a secure place to invest funds and they offer both
individuals and companies loans to finance investments, such as the purchase of a new home or the
expansion of a business. The traditional business model of a commercial bank is taking in and paying
interest on deposits and investing or lending those funds back out at higher interest rates. Banks in
Bangladesh are primarily of two types:
a. Scheduled banks: There are 61 scheduled banks in Bangladesh who operate under full
control and supervision of Bangladesh Bank which is empowered to do so through
Bangladesh Bank Order, 1972 and Bank Company Act, 1991. Scheduled Banks are classified
into following types:
i. State Owned Commercial Banks (SOCBs): There are 6 SOCBs which are fully or majorly
owned by the Government of Bangladesh.
ii. Specialized Banks (SDBs): 3 SDBs are now operating which were established for
specific objectives like agricultural or industrial development. These banks are also
fully or majorly owned by the Government of Bangladesh.
iii. Private Commercial Banks (PCBs): There are 43 PCBs which are majorly owned by
private entities. PCBs can be categorized into two groups:
 Conventional PCBs: 33 conventional PCBs are now operating in the industry.
They perform the banking functions in conventional fashion i.e., interest-based
operations.
 Islami Shariah based PCBs: There are 10 Islami Shariah based PCBs in
Bangladesh and they execute banking activities according to Islami Shariah
based principles i.e. Profit-Loss Sharing (PLS) mode.
 Foreign Commercial Banks (FCBs): 9 FCBs are operating in Bangladesh as the
branches of the banks which are incorporated in abroad.
b. Non-scheduled banks: The banks which are established for special and definite objective
and operate under any act but are not scheduled banks. These banks cannot perform all
functions of scheduled banks. There are now 5 non-scheduled banks in Bangladesh
which are: Ansar VDP Unnayan Bank, Karmashangosthan Bank, Grameen Bank, Jubilee
Bank, Palli Sanchay Bank.
2. Investment banks: Investment banks are institutions that assist companies in raising capital, advise
firms on major transactions such as mergers or financial restructurings and engage in trading and
market making activities.
3. Non-Bank Financial Institutions: NBFIs are those types of financial institutions which are regulated
under Financial Institution Act, 1993 and controlled by Bangladesh Bank. Now, 35 FIs are operating
 in Bangladesh. Out of the total, 2 is fully government owned, 1 is the subsidiary of a SOCB, 19 were
initiated by private domestic initiative and 13 were initiated by joint venture initiative. Major
sources of funds of FIs are Term Deposit, Credit Facility from Banks and other FIs, Call Money as well
as Bond and Securitization. The major difference between banks and FIs are as follows:
i. FIs cannot issue cheques, pay-orders or demand drafts.
ii. FIs cannot receive demand deposits,
iii. FIs cannot be involved in foreign exchange financing,
iv. FIs can conduct their business operations with diversified financing modes like
syndicated financing, bridge financing, lease financing, securitization instruments,
private placement of equity etc.
4. Mutual funds: Mutual funds are organizations that accept money from savers and then use these
funds to buy stocks, long-term bonds or short-term debt instruments issued by businesses or
government units. These organizations pool funds and thus reduce risks by diversification. They also
achieve economies of scale in analyzing securities, managing portfolios and buying and selling
securities. Different funds are designed to meet the objectives of different types of savers. Hence,
there are bond funds for those who prefer safety, stock funds for savers who are willing to accept
significant risks in the hope of higher returns and money market funds that are used as interest-
bearing checking accounts.
5. Insurance companies: Insurance companies take savings in the form of annual premiums; invest
these funds in stocks, bonds, real estate and mortgages and make payments to the beneficiaries of
the insured parties. Insurance companies also offer a variety of tax-deferred savings plans designed
to provide benefits to participants when they retire.
6. Brokerage firms: Brokerage firms are financial institutions that facilitate the buying and selling of
financial securities between a buyer and a seller.

Financial system of Bangladesh: The financial system of Bangladesh is comprised of three broad
fragmented sectors. The sectors have been categorized in accordance with their degree of regulation.

1. Formal sector: The formal sector includes all regulated institutions like Banks, Non-Bank
Financial Institutions (FIs), Insurance Companies, Capital Market Intermediaries like Brokerage
Houses, Merchant Banks etc.; Micro Finance Institutions (MFIs).
2. Semi-Formal Sector: The semi-formal sector includes those institutions which are regulated
otherwise but do not fall under the jurisdiction of Central Bank, Insurance Authority, Securities
and Exchange Commission or any other enacted financial regulator. This sector is mainly
represented by Specialized Financial Institutions like House Building Finance Corporation (HBFC),
Palli Karma Sahayak Foundation (PKSF), Samabay Bank, Grameen Bank etc., NGOs and discrete
government programs.
3. Informal sector: The informal sector includes private intermediaries which are completely
unregulated.

Stock market: Stock market can be a very sophisticated marketplace, where stocks and shares are the
traded commodity. At the same time, it is central to the creation and development of a strong and
competitive economy. It is a key to structural transformations in any economy; from traditional, rigid,
insecure bank-based to a more flexible, more secure economy that is immune to shocks, fluctuations
and lack of investors’ confidence.