What is financial system?

Financial system is the system that facilitates the movement of funds between depositors, investors and demanders. Financial systems may operate at the global level, national level and firm level. Financial systems are made up of complex, closely interconnected services, markets and institutions.

The financial system plays a major role in any economy as per the progress. This is indicated by the financial structure, in which more investment (surplus units) is given to those who have more investment avenues and funds which are used more productively (deficit units). Surplus units can be of personal, business or government type, which have large amounts of unspent money for some time, as well as they are willing to use this fund.

Deficit units on the other hand are those individuals, businesses or governments who have plans to spend more than their income and are interested in getting the money out.

Importance of Financial System:

  • Providing Funds Liquidity: The financial system provides liquidity to the entire economy and for this the action of collecting funds and providing them to the users is done.
  • Savings diffusion: Savings are converted into investments by the financial system and excess money is passed from its holders to the needy parties.
  • Providing funds: The right projects are selected by the financial system so that the funds can be channeled to the right performing locations.
  • System of payment for goods and services: It is done through various securities and electronic payment system is used in it.
  • Risk Management: This system helps in spreading the savings by properly distributing the funds.
  • Knowing, accurate and timely reporting of information and detail: Transparency is essential for right decision making and this is provided by the financial system itself.

Functions of the Financial System:

The role of a financial system is important in the economy of any country. For the economy to run smoothly, it is necessary to have a proper financial system:

Providing Liquidity to Funds:

Its main function is to keep the funds for the purpose in the form of money and keep them as real assets for the economy. It is necessary for the production of goods and services. Liquidity is provided by the financial system to the entire economy so that they can perform their functions. As mentioned earlier, this is done through the process of receiving and disbursing the funds to the users.

For example, money is provided by banks, insurance companies, etc. to large industries for their expansion or infrastructural development. Similarly, new types of assistance are issued by the broking institution to the company, which helps them to issue veritable securities.

Savings Spread:

The important work done by the financial system is to bring the spread of savings to small savers and big savers. It is through this financial system that savings are converted into investments. This system thus bridges the gap between those who have more money and those who want more money. One after another, institutions keep their funds in the bank.

They get money by saving, investment etc. and this is followed by the money deposited by the customers after which this money is given in the form of loan for production purpose, personal nature and industrial form.

Allocation of Funds:

Helps in choosing the right project and earmarking the funds in the right way for the right amount. It reviews such projects from time to time so that it can be ascertained whether this fund is being used for the right purpose and in the right way. For example, a company approaches a bank and needs a loan for its plant and new machinery, then the bank officer will assess its proposal with the help of technical know-how.

They will give money only when they see the work type and production of the project as well as the expectation of profit in the coming time. Even after disbursing the funds, it will be ensured by the bank from time to time that the funds are being used by the customer for the right and proposed reason.

Mode of payment for exchange of goods and services:

Various securities are used to provide this as well as electronic payment methods are also used. For example, if the company is based in Mumbai and it takes the services of a company based in Kochi, then Bugattan is possible through direct electronic transfer. Along with this, it also helps to take the sources to different places like the company is in Mumbai but the company serving it is in Kochi.

Risk Management System:

In this, savings are disseminated and this money is disseminated in the right way along with distribution. Risk management ensures that the money invested by investors is safe. Going by the above example, the bank ensures that efficiently and effectively. And it checks that the money invested by the public is safe.

Extensive and accurate information

Transparency is an essential element for decision making and it is used throughout the facilitation provided by the financial system. Regulators, especially small investors, are given more attention.

Components of the financial system:

Financial Institutions: Financial institutions provide financial services for members and clients. It is also called as financial intermediaries as they act as middlemen between the savers and the borrowers.

Banks: Banks are financial intermediaries that lend money to borrowers to generate revenue and accept deposits. They are usually heavily regulated, as they provide market stability and consumer protection. Banks include:-

  1. Public bank
  2. Commercial Bank
  3. Central bank
  4. Cooperative bank
  5. State-Managed Co-operative Banks
  6. State-Managed Land Development Bank

Non-bank financial institutions: Non-bank financial institutions facilitate financial services such as investment, risk pooling and market brokerage. They generally do not have full banking licenses. Non-bank financial institutions include:-

  1. Finance and loan companies
  2. Insurance companies
  3. Mutual funds
  4. Commodity traders

Financial Markets: Financial markets are markets in which securities, commodities and fungible commodities are traded at prices representing the supply and demand. The term "market" generally refers to the institution of overall exchange of potential buyers and sellers of such goods.

Primary Market: The primary market (or initial market) generally refers to new issues of stocks, bonds or other financial instruments. The primary market is divided into two segments, the money market and the capital market.

Secondary Market: Secondary market refers to transactions in financial instruments that were issued earlier.

Financial Instruments: Financial instruments are any type of traditional financial asset. They include money, evidence of ownership interest in an entity, and contracts.

Cash Instrument: A cash instrument's value is determined directly by the markets. These can include securities, loans and deposits.

Derivative Instrument: A derivative instrument is a contract that derives its value from one or more underlying entities (including an asset, index, or interest rate).

Financial Services: Financial services are offered by a large number of businesses that comprise the finance industry. These include credit unions, banks, credit card companies, insurance companies, stock brokerages and investment funds.

Financial Regulators in India:

  • Reserve Bank of India
  • Securities and Exchange Board of India
  • Forward Market Commission (FMC)
  • Insurance Regulatory and Development Authority (IRDA)
  • Deposit Insurance and Credit Guarantee Corporation
  • Enforcement Directorate

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  Last update :  Tue 11 Oct 2022
  Post Views :  16361
  Post Category :  Indian Economics