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FINANCIAL SYSTEM Facilitate resource transfer and mobilizes savings to the productive sectors thereby contributing to the economic development Includes; Markets Institutions Instruments Markets: Mechanism designed to facilitate the exchange of  financial assets by bringing buyer and seller together Provides channels and pricing mechanism through which flow of savings are allocated to the investment Can be classified in to Money and Capital Markets Participants are financial institutions, agents, brokers, dealers, borrowers, savers and many others Institutions: 1.       Regulatory Institutions Regularly monitor markets and participants to ensure fairness, transparency and credibility in the market Also responsible for executing government policies Develop and implement various policies depending on the situation of the market Example; In Nepal: Central Bank (Nepal Rastra Bank)- ba

MARKET FAILURE AND NEED FOR GOVERNMENT INTERVENTION Market failure can be divided into two types; i)                     Which has impact on efficiency ii)                   Which has impact on stability Government intervention is necessary to promote efficiency and maintain stability 1.   Efficiency: ·          A situation in which the sum of all gains from lending, payments and trade in risk are as large as possible ·          Major conditions for efficiency are; o    Competitive pricing o    Minimum transaction cost o    Integration of market services Competitive pricing o    First condition for efficiency o    Pricing that covers the cost of all resources used to produce a good or service but no more Minimum transaction cost o    Transaction cost absorbs the resources that could be put to better use o    One way to attract more business and to increase profit is to find a way arranging transaction cost lower o    Search for lower cost and for h

STABILITY OF THE FINANCIAL SYSTEM Government solution for bank run and banking panics ·          Regulation and supervision Certain standard is given Supervision of compliance to those standards If not complied, enforcement actions are taken New standards can be set as per the situation ·          Lender of the last resort Private initiatives: Problem of liquidity, credibility and moral hazard Since government can create unlimited money, liquidity and credibility is not a problem for government Government create institutions which provide the banking system with the liquidity it needs in crises is the lender of last resorts Central bank as lender of last resort What should lender of the last resort do? Should lend only against good collateral (see book) Should accept all good as collateral Should charge penalty rate of interest on loans Policies should be made known to public ·          Discount window Borrowing from the central bank is