What is the Financial Sector ?
WHAT IS THE FINANCIAL SECTOR?
The Financial Sector is part of the economy, it is made of several organizations (ex. financial institutions). Those businesses provide intermediary services to transfer and allocate financial capital to firms in an economy among others. The sector is made of various financial institutions such as investment companies, banks, insurance firms & real estate companies. Good access to finance is important for countries, financial products enable firms to make investments.
What does the Financial Sector refer to? The financial sector is part of the economy alongside other industries. In economics, industries are made of firms that operate in a similar business sphere such as the chemical industry, electronic industry (with products such as cellphones & quantum computers) etc. All those firms take loans from the financial sector, this is what can be found in the figure below a circular flow of income with the financial sector.
In this paper, the financial sector will be defined in the first part (I), in the second part different financial institutions will be listed (II) & in the third part enterprises' funding (capital) will be briefly discussed (III) & finally, in the fourth part, it will be about how firms can be efficient with the financial sector? (IV).
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Figure 1: The Circular Flow of Income with the Financial Sector
I- The Financial Sector
For an economy to grow & be stable, it needs to have a good financial sector, financial companies (banks) in the financial sector provide loans to businesses in order for them to expand. The financial sector generates a high portion of its revenue from loans and mortgages and functions better in a low-interest-rate environment. The sector is made up of various industries: banking industry, insurance companies, real estate brokers, investment houses, mortgage lenders, and consumer finance companies in which operate financial institutions. Technological development is an important factor in increasing the growth rate of an economy at the macro level and profits and market shares for firms at the micro level, new technology such as robotics, the internet of things, big data, artificial intelligence, 3d printer, quantum computer, technologies found in smart farming, greenhouses, 5G & 6G, e-commerce etc are important for productivity, through the financial sector with financial institutions such as fintech & bank, new & existing firms can access financing and make investment in those new technologies such as robotics, which will result in a transition to the industry 5.0 this is shown in the figure below - Figure 2: The Financial Sector, Business Process Outsourcing, Consulting, Smart City, New Technologies & Industry 5.0.
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Figure 2: The Financial Sector, Business Process Outsourcing, Consulting, Smart City, New Technologies & Industry 5.0
II- Firms within the Financial Sector
The financial sector is a section within an economy made up of firms and institutions that provide financial services. A list of firms is found below:
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-Retail banks: Retail banks accept cash deposits from savers (customers) and pay interest to them on this cash (savings). Those banks will generate revenue by lending out the deposits to borrowers with an interest rate (the amount charged on top of the principal by a lender to a borrower). Those banks use a messaging network to quickly, accurately, send, and receive data (money transfer instructions). Financial organizations have unique codes, bank identifier code, or BIC.
-Commercial Banks: Commercial Banks are financial institutions that accept deposits from individuals and offer loans, checking account services & financial products such as certificates of deposit (CDs).
- Digital Bank: A digital bank (fintech) is a bank that operates online & provides its customers the same services that were previously available only from banks. Digital banks enable customers to open an account on their phone in minutes, whenever, and wherever they want.
- Investment Banks: Investment banks are financial institutions (fi) that raise capital for enterprises & governments. They are involved in raising capital, corporate M&A (merger & acquisition) & securities trade for such organizations. They raise capital debt or equity (via an IPO – Initial Public Offering for example) in the primary market to finance capital expenditure. When the securities are sold, the investment bank makes a secondary market for the securities as brokers & dealers.
- Venture Capital: VC enterprises provide new firms with financing at the early stages of development. The venture capital enterprise will take an ownership stake usually less than 50%. The goal of this enterprise is to increase the value of the startup, then exit the investment with a profit through an IPO (initial public offering) or selling their stake. Venture capital funds begin with a capital-raising period where the enterprise seeks out investors for new funds those funds are then used to invest in startups. The 4 types of players in the venture capital industry are entrepreneurs, investors, investment banks & venture capital firms. Stages of VC financing are Pre-Seed/Accelerator-stage Capital, Seed-stage Capital, Early-stage Capital & finally Later-stage Capital.
- Investment Managers: Investment managers are enterprises that make investment decisions about portfolios of securities on behalf of their customers under the investment objectives and parameters of the customer. They include hedge funds, mutual funds & exchange-traded fund (EFT). Exchange-traded funds managers primarily serve retail investors with pre-packaged investment vehicles (offering), their business model is charging a fee on the assets under management.
- Exchanges: This is where trading of financial assets takes place, a stock exchange provides the technology & the infrastructure to enable the public trade of financial products such as shares, stocks, bonds, debentures, futures, and options. Some stock exchanges are automated. Stocks must be listed on an exchange to be traded, firms use the stock exchange to finance themselves.
- Insuretech: Insurtechs have now emerged in the insurance space.
- Insurance Providers: Insurance (including insuretech) providers encompass another large portion of the financial sector. They provide products against unforeseen financial losses arising from events like accidents and disasters with a business model which is: collection of a premium paid at regular intervals, they serve both individuals and institutions.
- Payment Processors: Payment processors are intermediaries that facilitate the exchange of funds between parties (organizations & individuals). They network with various organizations and ensure a transfer of funds between those parties. Some daily electronic transactions are processed by payment processors. While using a debit or credit card the payment processor transmits the data to the user’s bank & channels the money from the user’s bank account to the vendor’s bank account. The payment processor's business model involves charging a fee on every transaction.
- Factoring firm which is a company that purchases another company’s invoices. It offers products for firm cash flow issues due to slow-paying customers (B2B) & others. The finance company (factor) business model is as follows: the factor pays part of the account receivable (the value of an invoice) immediately to a firm at a discount for commission and fees it is also known as accounts receivable financing. Another arrangement is when a lender uses the account receivable (collateral) for a loan. Fintechs have entered various areas in the financial industry, one of these areas is the factoring business.
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III- Firm Financing
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As mentioned above the financial sector allocate financial capital to firms in an economy, to finance itself a firm may either use debt financing or equity financing or a mix of both. An enterprise obtains debt financing through a bank, or crowdfunding (crowdfunding loan), they can also source debt by issuing debt (bond) to the public through an exchange, in this case the borrower (firm) issues debt securities, such as corporate bonds. Firms that have bank loans in their source of financing, will purchase loans & make the payments, this process enables them to have a high level of financing through the years, and be ready to purchase new loans & do investments (conversion process) at any moment (arrival of new technologies: industrial revolution (conversion process) or quantum computer etc). Investments enables a firm to make revenue, the revenue from the conversion process (investment) will exceed the loan amount, part of this revenue is used to make the payment for the loan. An enterprise can also use another approach (equity financing) selling shares through the primary market, subsequent sales of the stock will then take place in the secondary market. The firm (private company) offers securities to the investors to raise capital and then subsequently becomes listed on the stock exchange, the firm will be then called a public company. Such arrangements provides capital to enterprises which they can use to fund and expand their business. A good exchange is considered important for economy, as it gives a firm the ability to quickly access capital from the public.
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To conclude, the financial sector through its organizations (example banks) enables companies to access funds & grow, which is important for the economy. There will be the need for more financial innovation (products & processes) in the future.
