27 Aug An Overview of the Financial Services Industry
The world is becoming increasingly integrated and interdependent, as trade and investment flows are global in nature. It is, therefore, important to understand the core role that the financial services industry performs within a globalised economy; which are they key markets within the financial industry; and also identify which are the players that have a role to play in the functioning of the financial services Furthermore, particular emphasis must be place on the increasingly important role of technological advances and how this impact financial markets.
A ‘Financial Market’ refers to a marketplace in which financial assets (including shares, debentures, bonds, derivatives, currencies, and others) are generated and exchanged,. Within a globalised world the financial sector has a crucial role in bringing together individuals that have finance/capital needs with those that have available finance/capital and are willing to lend it i.e. exchange of interests at a mutually agreed price and within a predefined repayment period.
The services provided by the financial sector can be broken down into three core functions:
- The investment chain – Through the investment chain, savers and borrowers are brought together. Savers provide financing to businesses, while businesses that wish to grow offer opportunities for savers to take part in their growth and the resulting potential returns.
- Risk – The financial services sector allows risks to be managed effectively and efficiently through the use of insurance and sophisticated derivatives. These tools help businesses and households cope with global uncertainties and everyday contingencies.
- Payment systems – Payment and banking services operated by the financial services sector provide the practical mechanisms by which money is managed, transmitted and received quickly and reliably. It is an essential requirement for both commercial activities and participation in international trade and investment to take place
Overall, the financial markets provide the buyers and sellers with a place to meet to exchange assets at a price dictated by demand and supply. Different markets exist within the financial industry and the key ones are reviewed below:
Equity markets are the best-known financial markets. They facilitate the trading of shares in quoted companies. According to statistics from the World Federation of Exchanges (WFE), the total value of shares quoted on the world’s stock exchanges added up to more than 78 trillion US dollars at the end of 2018 (note that not all stock exchanges provide data to the World Federation of Exchanges so actual figures may well be higher).
Rivals to traditional stock exchanges have also arisen with the development of technology and communication networks known as multilateral trading facilities (MTFs). MTFs are systems that bring together multiple parties that are interested in buying and selling financial instruments including shares, bonds and derivatives. These systems are also known as crossing networks or matching engines that are operated by an investment firm or another market operator.
Investors in this market buy and sell fixed claims or debt instruments, such as debentures or bonds. Investors are becoming lenders of corporations and governments, who are the leading issuers of debt securities. Bond trading does not take place in a centralised and physical location, where the participants can meet.
The most common method of investing in debt instruments is by buying bonds. The issue of bonds takes place by corporations or by the government to raise capital for their existing and/or upcoming operations, and bonds usually have a fixed interest rate.
At this marketplace, investors can transact monetary assets which mature within a year. The money market belongs to the broader financial market and accumulates numerous smaller sub-markets such as the bill market, acceptance market, call money market and others. The money markets do not have a physical location and investors transact financial assets and securities which mature within a year. The transactions are performed over electronic and virtual networks like fax, internet, or phone. Deals on the money market are not in money/cash but through other financial instruments such as trade bills, government papers, promissory notes, and others.
Some of the popular money market instruments include Treasury Bills, Banker’s Acceptance, Certificate of Deposits, Repurchase Agreements, and Commercial Papers.
Capital markets are venues where savings and investments are channelled between the suppliers who have capital and those who are in need of capital. The entities that have capital include retail and institutional investors while those who seek capital are businesses, governments, and people.
Capital markets are composed of primary and secondary markets. The most common capital markets are the stock market and the bond market.
Cash or Spot Market
It is the marketplace where transactions settlement between buyers and sellers takes place in real-time.
Forward or Futures Market
At this market, the execution of all the transaction takes place in the future at the maturity date. The involved counterparties decide the price of the financial instrument at present, and they execute it in the future.
Exchange-Traded Markets allow investors to trade at an organised and centralised location, both derivatives and their underlying assets, which are available only in markets such as NYSE and NASDAQ.
Over-the-Counter Market (O.T.C.)
Over-The-Counter Markets allow the market participants to formulate their products and trade them directly with the investors under customised procedures and at a decentralised location, i.e., not a physical location. Investors have a wide variety of financial instruments to select from, but the level of financial instruments’ information is shallow compared to any other form of markets
Insurance markets specialise in the management of personaI risk, corporate risk and the protection of life events. Globally, the US, Japan and the UK are the largest insurance markets; they account for around 50 per cent of worldwide premium income. The insurance market is led by a number of major players that dominate insurance activity. These include household names such as American International Group (AIG), AXA and Zurich Insurance.
The number of individuals and legal entities operating in the financial services sector is wide and varied. Each may carry out a specialised function, and an understanding of the key roles is important in order to better comprehend how the sector is organised and how participants interact.
Although each function is considered to be offered by a separate organisation, the nature of financial conglomerates means that some of the largest global firms may have divisions with each division carrying out one of the functions reviewed below. Analytically the following functions are considered to be the most prominent ones:
Investment banks provide advice and arrange finance for companies wishing to float on the stock market to raise funds by issuing more shares or bonds or undertaking mergers and acquisitions. They also provide services to institutional firms, especially pension funds and asset managers, who may want to invest in stocks and debt.
Custodians are banks specialise in safe custody services, managing portfolios of shares and bonds on behalf of others. Examples of custodian banks include fund managers, pension funds, and insurance companies.
Retail and Commercial banks are the same thing. Their name simply differs from country to country. They are the financial institutions that provide services, such as taking deposits from retail customers and lending them funds, as well as providing payment and money transfer services. Historically, these banks have tended to run across a network of high-street branches but are switching gradually to telephone and internet-based services. Larger retail banks now sell other financial products as well as general banking services, such as savings, pensions, and insurance. Banks providing multiple functions like these are known as ‘financial conglomerates.’
Most countries do have savings institutions that started by specialising in providing retail customers savings products but nowadays they aim to have a wide range of services, similar to those offered by retail banks.
Peer-to-Peer (P2P) and Crowdfunding
A more recent development in the banking sector has been the emergence of competitors to the traditional role of banks in the form of peer-to-peer (P2P) lending or crowdfunding. In the traditional banking model, banks take in deposits on which they pay interest and then lend out at a higher rate; the spread between the two is where they earn their profit. P2P lending cuts out the banks so that borrowers often receive slightly lower rates, while savers get far improved headline rates, with the P2P firms themselves profiting via a fee.
The insurance industry supplies options for the standard areas, such as life cover, comprehensive insurance cover and more. Protection planning is a crucial area of financial advice, and the insurance industry supplies a variety of products for various potential scenarios to satisfy these needs. Insurance firms are charging premiums in exchange for the coverage. Insurance companies invest the premium income in stocks and debt, thereby making the insurance industry a significant participant in both stock and bond markets. Insurance firms must also keep a substantial amount of cash to be able to cover any claims that might occur on the various insurance plans and if required, will liquidate investment holdings.
Fund managers, who are also known as fund managers, portfolio managers or wealth managers, run investment portfolios for others. They invest money held by institutions as well as wealthier individuals, such as pension funds and insurance companies. Investment managers buy and sell stocks, bonds, and other assets intending to raise the value of their clients’ portfolios. Institutional fund managers work for institutions, such as saving capital for the pension fund of a company or the fund of an insurance firm or managing mutual fund investments. Another area of Asset management includes the running of so-called hedge funds.
Stockbrokers and Wealth Managers
Stockbrokers conduct on behalf of their clients’ stock market transactions. The clients can be financial institutions, fund managers or private investors. Stockbrokers may recommend investments where shares, funds, or bonds can be acquired, or they may provide execution-only services when the broker executes a trade on the order of a client without giving advice.
Sovereign Wealth Funds (SWFs)
A sovereign wealth fund (SWF) is a state-owned investment fund which holds financial assets such as equities, bonds, real estate, or other financial instruments. SWFs are Government-owned special purpose investment funds or arrangements.
Tied agents are natural or legal persons who actunder the full and unconditional responsibility of only one Investment Firm and on its behalf it promotes its single interests via numerous services.
Technological Advances and Other Developments
Technology and the demand for greener solutions are changing the way that the financial services industry operates.
Financial technology, known as FinTech, is impacting the conservative banking and wealth management industry with a focus onthe development of new digital services and platforms. People across all generations are increasingly becoming digitally proficient and they desire constant access to sophisticated tools and services, with clients of financial services firms being no different.
Technological developments in communications are also changing the face of the industry. Today, we communicate using the latest apps or buy products online based on the artificial intelligence (AI) recommendations of digital providers. Customers are demanding the same range of digital capabilities that they have become used to for other products and services.
Green finance and sustainable finance have also become prominent topics in the financial services sector. Sustainable finance refers to the process of taking due account of environmental and social considerations in investment decision-making, leading to increased investments in longer term and sustainable activities. Climate finance is an emerging form of green finance available for projects in developing countries which helps reduce emissions or adapt to climate change.
Importance of Financial Services Industry
The financial services Industry is the primary driver of a nation’s economy. It provides the free-flow of capital and liquidity in the marketplace. When the sector is strong, the economy grows, and companies in this industry are better able to manage risk.
The strength of the financial services sector is also important to the prosperity of a country’s population. When the sector and economy are strong, consumers generally earn more. This boosts their confidence and purchasing power. When they need access to credit for large purchases, they turn to the financial services sector to borrow.