Financial System: An Overview of Building Societies - Case Study Example

Running head: Financial system: An Overview of Building Societies Financial system: An Overview of Building Societies s Name] Financial system: According to the definition given by (GAO) the financial system is: An information system, comprised of one or more applications, that is used for any of the following: collecting, processing, maintaining, transmitting, and reporting data about financial events; supporting financial planning or budgeting activities; accumulating and reporting cost information; or supporting the preparation of financial statements. (GAO) Financial Markets: Financial markets facilitate the lending of funds from saving to those who wish to undertake investments. The various forms of IOUs are known collectively as financial instruments. Such instruments, which also are called securities, are claims that those who lend their savings have on the future incomes of borrowers who use those funds for investment. Financial instruments are paper documents. Yet just as a surgeon uses instruments as financial instruments to undertake crucial exchanges of financial resources. They also can use financial instruments to help reduce the risks of financial loss. There are two basic ways to categorise financial markets. One, which distinguishes between primary or secondary markets, separates types of financial markets depending upon whether or not they are markets for newly issued instruments. The other, which distinguishes between capital and money markets, defines financial markets on the basis of the instrument maturities. The maturity of an instrument is the time ranging from the date of issue until final principal and interest payments are due to the holders of the instruments. Maturities of less than a year are short-term maturities, while maturities in excess of ten years are long-term maturities. Maturities ranging from one to ten years are intermediate-term maturities. Institutions that serve as the middlemen in this process of financing are financial intermediaries. These intermediaries exist solely to take the funds of savers and redistribute those funds to the ultimate borrowers. When individual savers allocate some of their saving to a business by purchasing a corporate bond, they effectively make a direct loan to the business. That is, they assist in the direct finance of the capital investment that the business desires to undertake. But the process of financing such endeavours is not always so direct. Consider, for instance, what may happen if the server also purchases a long-term time deposit issue by a banking firm. The bank, turn, may use these funds, together with those of other deposit holders to buy corporate bonds issued by the same business. In this instance, the saver has indirectly financed business capital investment. The bank, in turn, has intermediated the financing of the investment. There are two types of finance Direct finance Indirect finance In the case of direct finance, a financial intermediary such as a bank plays no role. A saver lends directly to parties who undertake investment. Under indirect finance, however, some other institution channels the funds of savers to those who wish to make capital investments. This latter process of indirect finance, which is the most common way in which funds are channelled from saving to investment, is financial intermediation. There are two groups, which comprise market: 1) Involved: These are the people who are the market participants of economic theory. They have all the knowledge regarding financial assets portfolio. 2) Uninvolved: these are the people with limited knowledge. The usually don’t have information about the nature of financial claims and fair market value. The financial intermediaries help these people by providing services in shape of information. By investing on their behalf. This reduced the perceived cost of transaction due to the lack of information. Most of the household consumers partly participate in the market. (Allen & Santomero, 1998). Benefits of Financial intermediation: Financial intermediaries exist to save the potential holders of financial instruments from incurring costs. These institutions cannot eliminate the adverse selection and moral hazard problems that stem from asymmetric information. What they can do, however, is specialise in collecting information about the prospects of financial instruments and in monitoring the performance of those whom issue such instruments. For instance, intermediaries could specialise in checking up on the prospects of municipal bonds that cities issue for trash disposal and recycling programs. This would reduce the extent of potential adverse selection problems in the market for municipal bonds. They also could keep tabs on the performances of such programs in various cities. Cities that did not manage their programs well would have a difficult time issuing municipal bonds in the future because intermediaries would be less likely to purchase them. The potential for moral hazard problems thereby would be reduced. In secondary markets, brokers perform similar functions. They provide their clients with updated information that they are able to glean from their daily presence in these markets. This enables their clients to overcome somewhat the asymmetric information problems they otherwise would face. The decision making of financial market participants largely depends upon meaningful economic information. (Michael, 2004; Large, 2004) The strength of U.K financial system largely depends upon the external shocks the banks have to suffer. In the year 2005 the U.K banks financial strength ratings were comparatively high as compare to rest of other international banking institutions. The composition of the earnings of the banks kept reshaping. The income indicated a declining trend of retail borrowing, although offset by revenues from corporate banking than that from retail lending. Some banks in wholesale markets also gained dealing profits. It is future forecast, that the banks will earn nominal profits in coming year. Due to the unsecured lending exposure some of the banks would have slower income growth. The competition in the banking industry and the declining trend of retail rending can result in a slow income growth capitalisation. The capital ratios in major UK banks remained unchanged i.e. above regulatory minimum balance required. Passing the stress tests the banks had sufficient profits and reserves capital despite facing various economic and external, shocks. The IMF (FSAP) report stated that despite all the worst case scenario combined together the total cost for the banking sector is just 0.35 % total assets. (Bumn et al, 2005) Risk: In F Real Estate Dictionary Risk is defined as An assessment of the possibility that a given investment or loan will fail to bring a return and may result in a loss of the original investment or loan. (F Real Estate Dictionary) Return: According to Wikipedia Encyclopedia (2005): In finance the return on investment (ROI) or just return is a calculation used to determine whether a proposed investment is wise, and how well it will repay the investor. It is calculated as the ratio of the amount gained (taken as positive), or lost (taken as negative), relative to the basis. The analysis of the return on investment is either done by static or dynamic formal methods, which may be distinguished by the role of time in the model chosen. Dynamic models take account of the fact that a later date of payment may be valued inferior in a model with interest rates. In other words, static approaches can be regarded as sufficient, if the distribution of payments in each period may be assumed as equal to others. All basic ROI-Models are deterministic, for instance the well-known Total Cost of Ownership Model by the Gartner Group. Deterministic models assume the security of prediction. Abandoning this leads into the wide sphere of risk-aware-models that are inspired by the mathematics of insurances. (Wikipedia, 2005) Building Society: It is a mutual organisation. Retail customers are the main but not only finances of these organisations. They provided mortgage lending to common man for house purchase. Products offered by Building Societies: Taking out a mortgage is probably one of the most important financial decisions one’s ever make. Most of the building societies offer many different mortgage products available. They offer three different types of interest rates. Fixed rate mortgages are for customers who wish to budget their monthly repayments for a fixed period of time without exposure to changing interest rates. Discounted rate mortgages are designed for customers who are happy to be linked to a variable rate mortgage with a discount applied against our standard variable rate for a fixed period of time. Bank of England Base Rate Tracker mortgages track changes in the Bank of England Base Rate for a fixed period of time. This means rates can go up and down depending on when the Bank of England changes their Base Rate. Savings: These societies offer saving account packages like banks. Whether a customer is saving for a rainy day or investing for his familys future. The societies offer different accounts and savings products for customers. From high-interest notice accounts and tax-free savings to postal accounts. They also offer the accounts, which are designed to help customers make the most of their tax-free savings. The notice accounts offered by these societies allow the customer’s cash to earn a competitive rate of interest with a choice of notice periods for withdrawals. These societies also offer young’s saving accounts which encourage young people to get the savings habit early. Most of the young savers account offers a competitive rate of interest and easy access. The postal accounts allow the customers to manage their savings from home with the reassurance that the money is earning a competitive rate of interest. With the emerging e technology in every field of life these societies also offer e accounts which are usually managed through Internet. These accounts have economic transaction costs and are easily available virtually. Most of the societies also offer consultations for the customers regarding the profitable investment of their money so that the customers can earn the highest returns on their investments. This play part in the future financial security of the household customer. Improving the financial planning: These societies also provide consultation services to the customers since most of them are busy with their business or family lives to dedicate sufficient time to plan for their financial futures. Without adequate planning financial goals may be unrealistic, which can result in significant financial under-achievement. They often get teamed up with other legal companies in order to provide the customers with a comprehensive range of value for money insurance products to protect home, contents, and mortgage repayments. The kinds of Insurance provided by them are: Building insurance Contents insurance Mortgage payment protection insurance Mortgage term assurance Credit cards: Like all the commercial banks the building societies also offer the Credit card services which have easy terms and conditions and provide the customer with the facility of loan. These credit cards are also different according to the packages they provide such as The low rate Classic card, offering 0% pa for the first six months. Pensions: Pension plans are also provided that to the old consumers so that they can make their both ends meet easily. (Mrs. Mopples, 2005) In the last few decades the financial services is expanding. There has been an extending use and purchase of these services in European countries. A trend of increases at both supply and demand sides is evident. The customers are become more informed at their part and demand a variety of products in order to fulfill their needs. The demand for customer side has also given rise to the number of institutions providing these services. This has made the industry more competitive. In United Kingdom the demand for financial products has increased with the increase in net disposable income. The building society branch network was expanded at high pace in the 1980’s in the United Kingdom. But facing the recessions in the 1990’s the trend declined. Most of the societies rationalized their network in order to cut the cost. The new trend was to give importance to the quality rather than quantity. This in turn gave rise to the trend of targeting high profit customers in order to gain high profits by cross- selling products to these customers. (Birkin & Clarke, 1998) The main customers of the building societies are the common men. Most of the products of building societies as discussed above are designed while keeping in view the needs of household customers. These products are attractive for them because the way to use them is simple. References Allen, F. & Santomero A.M, (1998). The Theory of Financial Intermediation, Journal of Banking & Finance 21 (1998), 1461-1485. Mark Birkin, M. & Clarke, G., (1998). GIS, Geodemographics, and Spatial Modeling in the U.K. Financial Service Industry, Journal of Housing Research 9(1), 87-89 Bumn, P., Cunningham, A., & Drehmann M (2005). Stress testing as a tool for assessing systemic risks. Financial stability review, June, 116-26. F Real Estate Dictionary, retrieved as on December 29, 2005 from GAO, Glossary of IT Investment Terms: Definitions of Financial System on the Web, retrieved as on December 29, 2005 from Large A (2004), Financial instrument accounting. Bank of England financial stability review, December, 107-11. Michael, I., (2004). Accounting and financial stability, Bank of England financial stability review, June, 118-28. Mrs. Mopples, (2005). Nationwide - your mutual friend: A review by mrsmopples on Nationwide Building Society, September 2nd, retrieved as on December 28, 2005 from Wikipedia, (2005). Return on investment, the free encyclopedia, page was last modified 08:26, December 26, 2005 from Read More