Functions of Securities Market

The securities market allows people to do more with their savings than they would otherwise. It also allows people to do more with their ideas and talents than would otherwise be possible. The people’s savings are matched with the best ideas and talents in the economy. Stated formally, the securities market provides a linkage between the savings and the preferred investment across the entities, time and space. It mobilizes savings and channelises them through securities into preferred enterprises

The securities market enables all individuals, irrespective of their means, to share the increased wealth provided by competitive enterprises. The securities market allows individuals who can not carry an activity in its entirety within their resources to invest whatever is individually possible and preferred in that activity carried on by an enterprise. Conversely, individuals who can not begin an enterprise they like can attract enough investment form others to make a start and continue to progress and prosper. In either case, individuals who contribute to the investment share the fruits.

The securities market also provides a market place for purchase and sale of securities and thereby ensures transferability of securities, which is the basis for the joint stock enterprise system. The liquidity available to investors does not inconvenience the enterprises that originally issued the securities to raise funds. The existence of the securities market makes it possible to satisfy simultaneously the needs of the enterprises for capital and of investors for liquidity.

The liquidity the market confers and the yield promised or anticipated on security encourages people to make additional savings out of current income. In the absence of the securities market, the additional savings would have been consumed otherwise. Thus the provision of securities market results in net savings.

The securities market enables a person to allocate his savings among a number of investments. This helps him to diversify risks among many enterprises, which increases the likelihood of long term overall gains.

A well functioning securities market is conducive to sustained economic growth. There have a number of studies, starting from World Bank and IMF to various scholars, which have established robust relationship not only one way, but also the both ways, between the development in the securities market and the economic growth. An important study by Ross Levine and Sara Zervos (1996) finds that the stock market development is highly significant statistically in forecasting future growth of per capita GDP. Their regressions forecast that if Mexico or Brazil were to obtain stock markets as advanced as Malaysia, then they might obtain an additional per capita GDP growth per year of 1.6%. This happens, as market gets disciplined / developed/ efficient, it avoids the allocation of scarce savings to low yielding enterprises and forces the enterprises to focus on their performance which is being continuously evaluated through share prices in the market and which faces the threat of takeover. Thus securities market converts a given stock of investible resources to a larger flow of goods and services.

The securities market fosters economic growth to the extent that it-

1. augments the quantities of real savings and capital formation from any given level of national income,

2. increases net capital inflow from abroad

3. raises the productivity of investment by improving allocation of investible funds, and

4. reduces the cost of capital.

It is reasonable to expect savings and capital accumulation and formation to respond favourably to developments in securities market. The provision of even simple securities decouples individual acts of saving from those of investment over both time and space and thus allows savings to occur without the need for a concomitant act of investment. If economic units rely entirely on self-finance, investment is constrained in two ways: by the ability and willingness of any unit to save, and by its ability and willingness to invest. The unequal distribution of entrepreneurial talents and risk taking proclivities in any economy means that at one extreme there are some whose investment plans may be frustrated for want of enough savings, while at the other end, there are those who do not need to consume all their incomes but who are too inert to save or too cautious to invest the surplus productively. For the economy as a whole, productive investment may thus fall short of its

Potential level. In these circumstances, the securities market provides a bridge between ultimate savers and ultimate investors and creates the opportunity to put the savings of the cautious at the disposal of the enterprising, thus promising to raise the total level of investment and hence of growth. The indivisibility or lumpiness of many potentially profitable but large investments reinforces this argument. These are commonly beyond the financing capacity of any single economic unit but may be supported if the investor can gather and combine the savings of many. Moreover, the availability of yield bearing securities makes present consumption more expensive relative to future consumption and, therefore, people might be induced to consume less today. The composition of savings may also change with fewer saving being held in the form of idle money or unproductive durable assets, simply because more divisible and liquid assets are available.

The securities market facilitates the internationalisation of an economy by linking it with the rest of the world. This linkage assists through the inflow of capital in the form of portfolio investment. Moreover, a strong domestic stock market performance forms the basis for well performing domestic corporate to raise capital in the international market. This implies that the domestic economy is opened up to international competitive pressures, which help to raise efficiency. It is also very likely that existence of a domestic securities market will deter capital outflow by providing attractive investment opportunities within domestic economy. Any financial development that causes investment alternatives to be compared with one another produces allocational improvement over a system of segregated investment opportunities. The benefits of improved investment allocation is such that Mc Kinnon defines economic development as reduction of the great dispersion in social rate of return to existing and new investments under domestic entrepreneurial control. Instead of emphasising scarcity of capital, he focuses on the extra-ordinary distortions commonly found in the domestic securities markets of the developing countries. The distortions in the real sectors such as monopoly power, tariff protection, import quotas, credit rationing and so forth add salt to injury. In the face of great discrepancies in rate of return, the accumulation of capital does not contribute much to development. A developed securities market successfully monitors the efficiency with which the existing capital stock is deployed and thereby significantly increases the average return.

In as much as the securities market enlarges the financial sector, promoting additional and more sophisticated financing, it increases opportunities for specialisation, division of labour and reductions in costs in financial activities. The securities market and its institutions help the user in many ways to reduce the cost of capital. They provide a convenient market place to which investors and issuers of securities go and thereby avoid the need to search a suitable counterpart. The market provides standaridised products and thereby cuts the information costs associated with individual instruments. The market institutions specialise and operate on large scale which cuts costs through the use of tested procedures and routines.

There are also other developmental benefits associated with the existence of a securities market. First, the securities market provides a fast-rate breeding ground for the skills and judgement needed for entrepreneurship, risk bearing, portfolio selection and management. Second, an active securities market serves as an ‘engine’ of general financial development and may, in particular, accelerate the integration of informal financial systems with the institutional financial sector. Securities directly displace traditional assets such as gold and stocks of produce or, indirectly, may provide portfolio assets for unit trusts, pension funds and similar FIs that raise savings from the traditional sector. Third, the existence of securities market enhances the scope, and provides institutional mechanisms, for the operation of monetary and financial policy.

While the above indicate that the securities market promotes economic growth, it is not one way relation. The economic growth also promotes securities market