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Lenders and borrowers

The first element is lenders and borrowers. As seen in Figure 1, they can be categorized into the four groups or "sectors" of the economy:

Household sector (= individuals).

Corporate sector (= companies - private and government owned).

Government sector = all levels of government - local, provincial, central).

Foreign sector (= any foreign entity - corporate sector, financial intermediaries such as retirement funds).

The members of these sectors may be either lenders or borrowers or both at the same time. For example, a member of the household sector may have a mortgage bond (= borrower by the issue of a non-marketable debt instrument) and at the same time hold a balance on your accounts at the bank (= a lender; a holder of money).

Financial intermediaries

The second element is financial intermediaries. As seen in Figure 1, lending and borrowing takes place either directly between ultimate lenders and borrowers [e.g. when an individual buys a share (also called equity or stock) issued by a company], or indirectly via financial intermediaries. Financial intermediaries essentially solve the differences (or conflicts) that exist between ultimate lenders and borrowers in terms of their requirements: size, risk, return, term of loan, etc.

An example: your friend Johnny (a member of household sector) has LCC2 10 000 he would like to lend out (= invest) for 30 days at low risk. You (a member of household sector) would like to borrow LCC 20 000 for 365 days to buy a car. You don't mind who you borrow from, because you represent the risk, not the lender. Your and Johnny's requirements don't match at all; direct financing won't work. He places his LCC 10 000 on deposit with a prime bank for 30 days and you borrow LCC 20 000 from the bank for 365 days. You and Johnny are both in high spirits; the bank satisfied your different requirements.

Financial intermediaries exist not only because of the divergence of requirements of lenders and borrowers, but for the specialized services they provide, such as insurance policies (insurance companies), retirement fund products (retirement funds), investment products (securities unit trusts, exchange traded funds), overdraft and deposit facilities (banks), and so on. The banks also provide a payments system, the system we don't see but rely much on. The central bank provides an interbank settlement system (as we will see later).

financial intermediaries

Figure 2: financial intermediaries

The main financial intermediaries that exist in most countries and their relationships with one another are presented in Figure 2. A useful of classification of them is presented in Box 1. Note that the non-deposit intermediaries may also be seen as investment vehicles. Their products (= their liabilities), which can be called participation interests (PIs), are designed as investments for the household sector (and in some cases other financial intermediaries).

Financial instruments

The third element is financial instruments. They are also called securities; borrowers issue securities. They are therefore evidences of debt or shares. They also represent claims on the issuers / borrowers.

Ultimate lenders exchange money (deposits) for securities and ultimate borrowers exchange (issue new) securities for money. Financial intermediaries issue their own securities (e.g. deposits) and hold the securities of the ultimate borrowers (e.g. treasury bills). As you know, the banks have a special and unique role in this market for money in that they are able to create money (bank deposits) by making new loans (buying new securities).

Securities offer a return that is fixed (fixed-interest debt) or variable (variable-rate debt and share dividends). The capital amount of shares and debt is paid back after a period (bonds and preference shares) or not ever (perpetual bonds and shares). Securities are also either marketable of non-marketable. This is discussed in more detail in the next section.

Box 1: financial intermediaries


Central bank (CB)

Private sector banks NON-DEPOSIT INTERMEDIARIES (INVESTMENT VEHICLES) Contractual intermediaries (CIs)


Retirement funds (pension funds, provident funds, retirement annuities) Collective investment schemes (CISs)

Securities unit trusts (SUTs) Property unit trusts (PUTs) Exchange traded funds (ETFs) Alternative investments (AIs)

Hedge funds (HFs)


Development finance institutions (DFIs) Special purpose vehicles (SPVs) Finance companies Investment trusts / companies Micro lenders

The instruments of the financial system are showninFigure 3and outlined below.

financial intermediaries & instruments / securities

Figure 3: financial intermediaries & instruments / securities

There are two categories of financial instruments:

• Debt (and deposits).

• Shares.

The instruments of debt and shares and their issuers are as follows: The household sector issues:

• Non-marketable debt (NMD) securities

- Examples: overdraft loan from a bank; mortgage loan from a bank.

The corporate sector issues:

• Share securities (marketable = listed & non-marketable = non-listed)

- Ordinary shares (aka common shares).

- Preference shares (aka preferred shares).

• Debt securities

- Non-marketable debt (NMD).

- Marketable debt (MD)

- Examples: corporate bonds, commercial paper (CP), bankers' acceptances (BAs), promissory notes (PNs).

The government sector issues:

• Marketable debt (MD) securities

- Treasury bills (aka TBs and T-bills).

- Bonds (aka T-bonds).

The foreign sector issues (into the local markets):

• Foreign share securities (inward listings).

• Foreign debt securities (inward listings).

The deposit financial intermediaries (central and private sector banks) issue:

• Deposit securities

- Central bank

- Non-negotiable certificates of deposit (NNCDs).

- Notes and coins.

- Central bank securities3.

- Private sector banks

- Non-negotiable certificates of deposit (NNCDs).

- Negotiable certificates of deposit (NCDs).

- Loans (mainly from the central bank).

The quasi-financial intermediaries issue:

• Debt securities

- Non-marketable debt (NMD)

- Example: utilised overdraft facility.

- Marketable debt (MD)

- Examples: bonds, commercial paper (CP) The above may be summarized as in Table 2.

As we have indicated, it is rare that the individual invests in these financial instruments (the exceptions are bank deposits in the form of NNCDs and shares). Rather, they invest in these ultimate financial instruments via the investment vehicles, by buying their PIs.

Debt & deposits


Non-marketable debt & deposits

Marketable debt & deposits




Listed ordinary shares

preference shares


Household sector

OD & mortgage loans from banks





Corporate sector

OD & mortgage loans from banks

Corp bonds, CP, BAs, PNs




Government sector

OD loans from banks

Govt bonds, TBs




Foreign sector


Foreign bonds



(inward listing)


(inward listing)


Central bank


NCDs**, notes & coins




Private sector banks






Quasi-financial intermediaries

OD loans from banks

Corp bonds, CP




Investment vehicles

Participation interests (PIs)





OD = overdraft); CP = commercial paper; BAs = bankers' acceptances; PNs = promissory notes; Corp = corporate; NNCDs = non-negotiable certificates of deposit; NCDs = negotiable certificates of deposit.

* Non-listed preference shares do exist but are rare. ** Central bank (CB) securities, which are akin to NCDs.

Table 2: financial instruments / securities

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