Overview of Financial Markets and Institutions

 

💡 Curious About How Financial Markets Actually Work?

Have you ever wondered what happens when you deposit money in a bank or buy something on credit? It's not just a private transaction - it's part of a vast financial system that connects people, banks, businesses, and even countries. 🌍

 

Let's take a closer look at how the financial system actually works, how money flows, and the role markets and institutions play behind the scenes.

 

    What Exactly Is A Financial System?

A financial system consists of a set of financial institutions, financial instruments, and financial markets that interact to facilitate the flow of funds through the financial system. The central bank oversees and sometimes plays a direct role in the financial system.

Money moves from those who have it to those who need it, through financial markets, with the central bank in charge.

·       Finance Markets

Money is exchanged, invested, and grown in financial markets, which link investors with opportunities and savers with borrowers.

 

Direct vs Indirect Finance: Two Ways Money Moves                       

Direct Finance:

In this system, borrowers are given money directly by savers (investors) usually by selling bonds or shares.

✔ Advantages:	✖ Disadvantages:
No intermediary = lower cost                 Greater choice for finance                 Access to international markets	Requires legal and professional advice                   Hazardous without good matching      Needs good reputation or ratings

 

Indirect / Intermediated Finance:

Intermediated finance consists of banks and financial institutions stepping in between the borrowers and the savers to render a series of services to be able to handle money effectively. 

1.      Asset Transformation

➤ Banks offer numerous loans and deposits to be able to serve the borrowers' as well as the savers' requirements.

 

2.      Maturity Transformation

➤ Banks make short-term savers receive interest while still lending the borrowers long-term.

 

3.      Credit Risk Diversification

➤ Savers do not lend directly, and hence their risk is minimized. The bank takes the risk and uses its knowledge to reduce it.

 

4.      Liquidity Provision

➤ Banks give money when needed, but still gaining a return in the long term.

 

5.      Economies of Scale / Cost of Distribution

➤ Banks employ extensive networks (e.g., ATMs and branches) and technology to reduce the cost of services for all.

 

·       Types of Financial Markets

 

Not all financial markets are alike — each plays a distinct role in the manner in which money moves, accumulates and changes hands. Here’s a quick overview:

 

                     💼 Market                              💡Type What It Does

  
Primary Market                          Where new securities (like government bonds or stock) are                                                             issued for the very first time. Investors buy directly from the                                                           issuer.          

Secondary Market                       Where previously issued securities are bought and sold.                                                                    Think: Colombo Stock Exchange.

Money Market                                  Involves short-term borrowing and lending, usually under one                                                          year. Minimal risk, fast returns.

Capital Market                                  Involves long-term investing, i.e., bonds and stocks. This                                                    is where firms raise some serious funds

🔍 Real-World Example (Sri Lanka):

The Employees' Provident Fund (EPF) regularly buys government securities in the primary market. In some cases, however, transactions have not been made available to all participants — pointing to a lack of transparency. This shows how crucial regulation and equitable access are to financial markets.

·        Financial Infrastructure Tools

Financial infrastructure refers to the essential systems and frameworks that allow a financial system to function effectively, safely, and efficiently. These tools make sure that money moves smoothly between individuals, banks, businesses, and even across borders. In Sri Lanka, two key infrastructure systems support this process: RTGS and LankaSecure.

The Real Time Gross Settlement (RTGS) system is used for high-value transactions and processes each payment immediately and individually. It is used by banks, the Central Bank of Sri Lanka (CBSL), primary dealers, and the Colombo Stock Exchange (CSE) to handle government securities, ATM clearing, and interbank payments.

For big sums of money, RTGS essentially functions as a quick and safe expressway.

Meanwhile, government and central bank securities are issued and settled electronically (scripless) through the LankaSecure system. It works on a Delivery versus Payment (DvP) basis, which means that a trade only occurs when the seller has the securities and the buyer has the money. As a division of LankaSecure, the SSDS serves as these securities' official custodian and title registry. This guarantees that each transaction is thoroughly documented and safeguarded by law.

By keeping Sri Lanka's financial system digital, safe, and effective, these infrastructure tools contribute to the preservation of transparency and confidence in each transaction.

Written By,

Ridmee Amarathunga