Page 504 - Introduction to Business

478 PART 5 Finance

competitive financial firms. Too much government protection of commercial banks
led to problems. Banks gradually became unable to provide the quality and types of
financial services demanded by the public. Other financial service firms, such as
securities firms, grew in importance, and banks began to shrink in influence. In
recent years, financial systems around the world have been in the process of dereg-
ulation. Previous barriers to expanding into various kinds of financial services and
into other geographic areas are being removed. In the United States, Europe, and
Japan, recent deregulation has allowed banks, securities firms, and insurance com-
panies to join together into single, conglomerate financial services firms called
financial holding companies. In the United States, geographic deregulation now
allows banks to freely move across state lines, while Europe has adopted similar
changes allowing any financial service firm to move across national borders in the
25-member European Union countries. Due to deregulation, a wave of mergers and
other changes is causing the formation of mega-institutions that are truly global in
scale. These transcontinental financial institutions will offer many new finance
careers in the years ahead.
One of the most important regulators in financial systems are the central banks
of different countries. Central banks, such as the Federal Reserve (or Fed) in the
United States, not only regulate financial firms but can control the amount of
money in circulation, the levels of interest rates, and general economic conditions,
such as the growth of output and jobs in the nation. Can central bank activities
affect you? Let’s assume that you work for a small business that produces and sells
pizza. Your business finances the purchase of dough, meats, cheese, and sauce by
borrowing funds from a local bank. On the evening news, you hear that the Fed
increased the money supply and decreased the level of interest rates. What will be
the impact of this news on your pizza sales? Your bank financing? Your profitability
over the next year? Lately, the pizza business has been slower than normal. Will
times get better due to the Fed’s actions? Due to the birth of a child in your family,
you have been thinking of buying a new house. How will the Fed’s actions affect
your home purchase decision? Will the cost of the house be affected? Events within
our financial system have direct effects on our personal lives.

The Financial System

LEARNING OBJECTIVE 1
Define the components of financial systems and understand the benefits
of financial intermediation.

In this section we discuss the components of the financial system, including the
principal kinds of financial instruments, financial markets, and financial institu-
tions. We overview different possible financial system structures, government regu-
lation to promote safety and soundness and public confidence, and how financial
systems affect the economy. 1

Components of the Financial System
financial system The financial Financial systems are comprised of three basic components: financial instruments,
marketplace, including financial financial markets, and financial institutions.
instruments, financial markets, and
financial institutions
Financial Instruments. Financial instruments are bought and sold and,
therefore, priced in financial markets. Financial instruments can be classified as
debt, equity, or derivative securities. They can also be classified as money market
instruments or capital market instruments.

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