MiNİstry of education of the respublic of azerbaijan university iNDİVİdual work

MİNİSTRY OF EDUCATİON OF THE RESPUBLİC OF AZERBAİJAN
AZERBAİJAN UNİVERSİTY


İNDİVİDUAL WORK

Faculty: Finance

Group: 189403
Course: 5
Student’s name: Aytaj Alakbarli
Subject: Financial market
Teacher’s name: Anar Yusubov
Topic: Financial market institutions
Baku-2022
September 2021 marked 10 years since the global financial crisis and much has been written about the crisis, inter alia the reasons for it, who was likely to blame, the role of regulators and central banks and the interconnectedness of global financial systems. Following the crisis, the global financial community considered numerous measures to make the financial systems safer and to mitigate against the likelihood of a similar event occurring. Importantly, whilst the monetary loss incurred as a result of the global financial crisis can be calculated, the loss of confidence in, and the reputational damage to the participants in the financial system and the regulators remains incalculable. Global leaders instructed regulators to consider measures to improve the safety of the financial system and the accountability of market participants. This resulted in an overhaul of financial legislation in various parts of the world, including for banking, financial markets and financial market infrastructures. Furthermore, renewed attention was given to conduct and governance arrangements within financial markets and institutions. Linked to this, authorities started to question incentive structures and the behaviour that these incentives encouraged. As a member of the G20, which spearheaded the reform effort, South Africa adopted global best practices aimed at building a safer and more efficient financial system. Although the South African market is relatively small compared to major markets, its financial system (including the financial markets) has the reputation of being a sophisticated and highly liquid emerging market. Policymakers and regulators have been working tirelessly to ensure that the South African financial system meets global standards. National Treasury issued a policy document in 2011 titled A safer financial sector to serve South Africa better. This document set out a framework for a comprehensive and complete system for regulating the South African financial sector.
The ‘Twin Peaks’ approach to regulation included the establishment of two dedicated regulatory authorities, namely the Prudential Authority (PA) and the Financial Sector Conduct Authority (FSCA). These two regulatory authorities came into operation on 1 April 2018. The South African Reserve Bank (SARB), which is ultimately responsible for financial stability, will work closely with the two authorities to create a safer financial system. Following various reports of misconduct in the global foreign exchange markets, the SARB and the Financial Services Board (as from 1 April 2018 the FSCA) published the Foreign Exchange Review in 2015. This report considered the conduct and governance arrangements of South African authorised dealers in the local foreign exchange market. Whilst the report did not reveal any conduct- related issues that required the regulators’ immediate attention, it suggested that South Africa would benefit from a formal review of the domestic wholesale fixed-income, currency and commodities (FICC) markets. In February 2017, the then Minister of Finance announced that a review of the domestic FICC markets would be conducted under the auspices of National Treasury, the SARB and the FSCA. As a consequence, the Financial Markets Review Committee (FMRC) was appointed to undertake the Financial Markets Review (FMR), assisted by a FMR Secretariat. The scope of the FMR and the process followed in performing the FMR are detailed in the FMR report, which was drafted and published for comment in 2018 and finalised in 2019. The FMR report contains 42 recommendations concerning governance, market conduct and structure, and innovation in financial markets, as well as proposed legislative reforms. A broad range of policy alternatives has been suggested, and many of the recommendations highlight areas which require modernisation. The governance review has highlighted the fact that institutions representing over 90% of turnover in the FICC markets in South Africa are well governed and maintain high standards of market conduct.
Similarly, the majority of transactions on the licensed exchanges are well governed and benefit from robust surveillance systems. One of the recommendations in the FMR report is that consideration be given to the formation of a Financial Markets Standards Group (FMSG). Ideally, this group would be funded and managed by the private sector, with the buy-side and sell-side institutions being equally represented. The FMSG would comprise senior managers and practitioners of the sponsoring members. One of the most important aspects of the FMSG would be regular attestation by its members of compliance with the required standards and norms. The FMRC will hand over the FMR report to the Financial Markets Implementation Committee (FMIC), an interagency committee comprising senior officials from National Treasury, the SARB, the PA and the FSCA. The FMIC will consider the recommendations and make specific policy choices, and, where required, develop the appropriate legislation and/or regulatory instruments. The FMRC will then be dissolved, as it will have fulfilled its mandate. The FMRC Co-Chairs would like to take this opportunity to thank the members of the FMRC, the various associations, as well as all the other participants that contributed to the FMR report. A special word of thanks is extended to the FMR Secretariat under the leadership of former Senior Deputy Governor of the SARB, Mr James Cross. We look forward to continued engagement, the successful implementation of the recommendations, and a more effective, fair and stable financial system.
Different from other textbooks, Financial Markets and Institutions: A European Perspective has a wide coverage dealing with the various elements of the European financial system supported by recent data and examples. This wide coverage implies that we treat not only the functioning of financial markets where trading takes place but also the working of supporting infrastructures (clearing and settlement) where trades are executed.
Turning to financial institutions, we cover the full range of financial intermediaries, from institutional investors to banks and insurance companies. Based on new data, we document the gradual shift of financial intermediation from banks towards institutional investors, such as pension funds, mutual funds, and hedge funds. In this process of re-intermediation, the assets of institutional investors have quadrupled over the last 25 years. As to policy making, we cover the full range of monetary policy, financial regulation and supervision, financial stability, and competition. We deal with the challenges of European financial integration for monetary, financial supervision and financial stability policies. Competition and state aid is a new topic for a finance textbook. The existing textbooks in the field of financial markets and institutions generally describe the relevant theories and subsequently relate these theories to the general characteristics of financial markets. An excellent example of a more in-depth textbook is The Economics of Financial Markets by Roy E. Bailey. The broad coverage of our book is comparable to the widely used textbook Financial Markets and Institutions by Frederic S. Mishkin and Stanley G. Eakins. Whereas our book focuses on the EU (with international comparisons to the United States and China), Mishkin and Eakins analyse the US financial system. The early European textbooks (e.g. The Economics of Money, Banking and Finance - A European Text, by Peter Howells and Keith Bain) typically contain chapters on the UK, French, and German banking systems, but do not provide an overview of European banking. More advanced textbooks that do discuss the specifics of the European financial system mostly do this in the context of monetary policy making. Finally, the excellent Handbook of European Financial Markets and Institutions, edited by Xavier Freixas, Philipp Hartmann, and Colin Mayer, has a broad coverage of the European financial system, but deals with topics on a stand-alone basis in separate chapters and is not constructed as an integrated textbook.
Nevertheless, this handbook contains very useful material for further study of particular aspects of the European financial system. Financial Markets and Institutions: A European Perspective is an accessible textbook for both undergraduate and graduate students of Finance, Economics, and Business Administration. Each chapter first gives an overview and identifies learning objectives. Throughout the book we use boxes in which certain issues are explained in more detail, by referring to theory or practical examples. Furthermore, we make abundant use of graphs and tables to give students a comprehensive overview of the European financial system. At the end of each chapter we provide suggestions for further reading. Cambridge University Press provides a supporting website for this book. This website contains exercises (and their solutions) for each chapter.
The European Union (EU) consists of 27 Member States as of 2020 after Brexit (the new EU 27). Before the accession of the New Member States in 2004, 2007 and 2013, the EU consisted of 15 Member States, which are usually indicated by EU-15. The 10 New Member States in 2004 are indicated by NMS-10, the total of 12 New Member States in 2004 and 2007 are indicated by NMS-12 and the total of 13 New Member States in 2004, 2007 and 2013 are indicated by NMS-13. EU-28 refers to the EU-15 and NMS-13 before Brexit.
Having a well-functioning financial system in place that directs funds to their most productive uses is a crucial prerequisite for economic development. The financial system consists of the financial infrastructure and all financial intermediaries and financial markets, and their relationships with respect to the flow of funds to and from households, governments, business firms, and foreigners. The main task of the financial system is to channel funds from those with a surplus to sectors that have a shortage of funds.
In doing so, the financial sector performs two main functions:
(1) reducing information and transaction costs and
(2) facilitating the trading, diversification, and management of risk.
This chapter discusses both of these functions at length. The importance of financial markets and financial intermediaries differs across Member States of the European Union. An important question is how these differences affect macroeconomic outcomes. Atomistic markets face a free-rider problem: when an investor acquires information about an investment project and behaves accordingly, he reveals this information to all investors, thereby dissuading other investors from devoting resources to acquiring information. Financial intermediaries, particularly banks, may be better able to deal with this problem than financial markets. This chapter discusses these and other pros and cons of market-based and bankbased systems. A specific element of this debate is the role of corporate governance, i.e. the set of mechanisms that arrange the relationship between stakeholders of a firm, notably equity holders, and the management of the firm. Investors (the outsiders) cannot perfectly monitor managers acting on their behalf, since managers (the insiders) have superior information about the performance of the company. Therefore mechanisms are needed to prevent company insiders from using the firm’s profits for their own benefit rather than transferring them to outside investors. This chapter outlines the various mechanisms in place.
Before the financial crisis, the traditional banking model, in which issuing banks hold loans until they are repaid, was increasingly replaced by the ‘originate and distribute’ model, in which banks pool loans (like mortgages) and then tranch and sell them via securitisation.
Therefore this chapter discusses the recent growth of non-bank financial intermediaries. Finally, the chapter describes the ‘law and finance’ view, according to which legal system differences are key to explaining international variations in financial structure. According to this approach, distinguishing countries by the efficiency of their national legal systems in supporting financial transactions is more useful than categorising them based on whether they have bank-based or market-based financial systems.
After you have studied this chapter, you should be able to:
• explain the main functions of a financial system,
• differentiate between the roles of financial markets and financial intermediaries,
• explain why financial development may stimulate economic growth, and why this relationship may be non-linear,
• explain why government regulation and supervision of the financial system is needed,
• describe the advantages and disadvantages of bank-based and market-based financial systems,
• explain the various corporate governance mechanisms,
• explain the ‘law and finance’ view.
This section explains why financial development affects economic welfare. To understand the importance of financial development, the essentials of a country’s financial system will first be outlined. The financial system encompasses the financial infrastructure and all financial intermediaries and financial markets, and their relationships with respect to the flow of funds to and from households, governments, business firms, and foreigners. \
Financial infrastructure is the set of institutions that enables the effective operation of financial intermediaries and financial markets, including payment systems, credit information bureaus, and collateral registries.
Figure 1.1 Functioning of the financial system

The main task of the financial system is to channel funds from sectors that have a surplus to those with a shortage of funds. Figure 1.1 explains the working of the financial system. Sectors that have saved and are lending funds are on the left, and those that must borrow to finance their spending are on the right. The bottom of the figure illustrates the process of direct finance, when one sector borrows funds from another sector via a financial market – a market in which participants issue and trade securities. The top of the figure depicts an indirect finance transaction, in which a financial intermediary obtains funds from savers and uses these savings to issue loans to a sector in need of finance. Financial intermediaries are (coalitions of) agents that provide financial services, such as banks, insurance companies, finance companies, mutual funds, and pension funds (Levine, 1997).

In most countries, indirect finance is the main route for moving funds from lenders to borrowers. These countries have a bank-based system, while those that rely more on financial markets have a market-based system.
The financial system transforms household savings into funds that are available for investment by firms. However, the importance of financial markets and financial intermediaries varies across EU Member States, as will be explained in detail below. The types of assets held by households also differ among European countries. Yet EU countries’ financial systems share one common feature – the importance of internal finance: most investments by firms in industrial countries are financed through retained earnings, regardless of the relative importance of financial markets and intermediaries (Allen and Gale, 2000). The structure of the world’s financial markets and institutions has experienced revolutionary changes over the last 30 years. Some financial markets have become obsolete, while new ones have emerged. Similarly, some financial institutions have gone bankrupt, while new entrants have emerged. However, the functions of the financial system have been more stable than the markets and institutions used to accomplish these functions (Merton, 1995). This chapter discusses the functions of the financial system in detail. Later chapters will discuss the changes in Europe’s financial markets and financial institutions over the last generation.
Major disruptions sometimes occur in the financial system that are characterised by sharp declines in asset prices and the failure of financial intermediaries. Capitalist economies have experienced such financial crises for hundreds of years. Often, these crises are followed by severe economic downturns. Chapter 2 will discuss financial crises, focusing on the banking and debt crises that have hit the euro area since 2008.
Having a well-functioning financial system in place that directs funds to their most productive uses is a crucial prerequisite for economic development. If sectors with surplus funds cannot channel their money to sectors with good investment opportunities, many productive investments will never take place. Indeed, cross-country, case-study, industry- and firm-level analyses suggest that the functioning of financial systems is vitally linked to economic growth. Countries with larger banks and more active stock markets have higher growth rates, even after controlling for many other factors underlying economic growth (Levine, 2005; Popov, 2017). However, others have questioned the importance of finance for economic growth. For instance, Lucas (1988: 6) argues: “I believe that the importance of financial matters is very badly over-stressed…”. Furthermore, several recent studies conclude that the relationship between financial and economic development may be non-linear. For instance, Arcand et al. (2015) report that at intermediate levels of financial depth, there is a positive relationship between the size of the financial system and economic growth, but at high levels of financial depth, more finance is associated with less growth.
In fact, the marginal effect of financial depth on output growth becomes negative when credit to the private sector reaches 80–100 per cent of GDP. This reflects the fact that higher levels of financing increase the likelihood of financial crises (see Chapter 2), which may depress economic growth. In addition, a large financial sector may lead to a misallocation of resources, as the financial sector may attract talent from more productive sectors of the economy, which may be inefficient from society’s point of view. Finally, some types of finance, like mortgage credit, are considerably less conducive to sustainable economic development than other types, such as enterprise credit.

References
1. Allen, F. and D. Gale (2020), Comparing Financial Systems, MIT Press, Cambridge (MA).
2. Adrian, T. and H. S. Shin (2021), The Changing Nature of Financial Intermediation and the Financial Crisis of Federal Reserve Bank of New York Staff Reports 439.
3. Beck, T., A. Demirgüç-Kunt and R. Levine (2010) Law, Endowment and Finance, Journal of Financial Economics, 70(2), 137–181.