What Is a Financial System?
A financial system is a set of institutions, such as banks, insurance companies, and stock exchanges, that permit the exchange of funds. Financial systems exist on firm, regional, and global levels. Borrowers, lenders, and investors exchange current funds to finance projects, either for consumption or productive investments, and to pursue a return on their financial assets. The financial system also includes sets of rules and practices that borrowers and lenders use to decide which projects get financed, who finances projects, and terms of financial deals.
Key Takeaways
- A financial system is the set of global, regional, or firm-specific institutions and practices used to facilitate the exchange of funds.
- Financial systems can be organized using market principles, central planning, or a hybrid of both.
- Institutions within a financial system include everything from banks to stock exchanges and government treasuries.
Understanding the Financial System
Like any other industry, the financial system can be organized using markets, central planning, or some mix of both.
Financial markets involve borrowers, lenders, and investors negotiating loans and other transactions. In these markets, the economic good traded on both sides is usually some form of money: current money (cash), claims on future money (credit), or claims on the future income potential or value of real assets (equity). These also include derivative instruments. Derivative instruments, such as commodity futures or stock options, are financial instruments that are dependent on an underlying real or financial asset's performance. In financial markets, these are all traded among borrowers, lenders, and investors according to the normal laws of supply and demand.
In a centrally planned financial system (e.g., a single firm or a command economy), the financing of consumption and investment plans is not decided by counterparties in a transaction but directly by a manager or central planner. Which projects receive funds, whose projects receive funds, and who funds them is determined by the planner, whether that means a business manager or a party boss.
Most financial systems contain elements of both give-and-take markets and top-down central planning. For example, a business firm is a centrally planned financial system with respect to its internal financial decisions; however, it typically operates within a broader market interacting with external lenders and investors to carry out its long term plans.
At the same time, all modern financial markets operate within some kind of government regulatory framework that sets limits on what types of transactions are allowed. Financial systems are often strictly regulated because they directly influence decisions over real assets, economic performance, and consumer protection.
Financial Market Components
Multiple components make up the financial system at different levels. The firm's financial system is the set of implemented procedures that track the financial activities of the company. Within a firm, the financial system encompasses all aspects of finances, including accounting measures, revenue and expense schedules, wages, and balance sheet verification.
On a regional scale, the financial system is the system that enables lenders and borrowers to exchange funds. Regional financial systems include banks and other institutions, such as securities exchanges and financial clearinghouses.
The global financial system is basically a broader regional system that encompasses all financial institutions, borrowers, and lenders within the global economy. In a global view, financial systems include the International Monetary Fund, central banks, government treasuries and monetary authorities, the World Bank, and major private international banks.
FAQs
A financial system is a set of institutions, such as banks, insurance companies, and stock exchanges, that permit the exchange of funds. Financial systems exist on firm, regional, and global levels.
What is the meaning and components of financial market? ›
Meaning of Financial Markets
A Financial Market is referred to space, where selling and buying of financial assets and securities take place. It allocates limited resources in the nation's economy. It serves as an agent between the investors and collector by mobilising capital between them.
What is financial market and system? ›
Financial Markets include any place or system that provides buyers and sellers the means to trade financial instruments, including bonds, equities, the various international currencies, and derivatives. Financial markets facilitate the interaction between those who need capital with those who have capital to invest.
What is a financial system Quizlet? ›
What is the financial system? The financial system is the process by which funds are transferred between those having excess funds(savers) and those needing additional funds(users).
What is the best definition of the financial system? ›
A financial system is a set of institutions and practices that facilitate and allow for the exchange of funds between borrowers, lenders and investors. Financial systems exist on firm-specific, regional and global levels. They include institutions like: Banks. Government treasuries.
What are the main functions of the financial system? ›
The five key functions of a financial system are: (i) producing information ex ante about possible investments and allocate capital; (ii) monitoring investments and exerting corporate governance after providing finance; (iii) facilitating the trading, diversification, and management of risk; (iv) mobilizing and pooling ...
What are the five key components of financial markets? ›
THE STRUCTURE OF FINANCIAL MARKETS. Financial markets comprise five key components: the debt market, the equity market, the foreign-exchange market, the mortgage market, and the derivative market.
What are the four types of financial markets? ›
The 4 types of financial markets are currency markets, money markets, derivative markets, and capital markets. Capital markets are used to sell equities (stocks), debt securities.
What is the market structure of the financial system? ›
Broadly, a financial market structure refers to a system that allows for the issuance and exchange of financial assets. It hinges on a variety of factors, reliant on the nature of the assets, the principles of demand and supply, and the fluctuations of the economy.
What is a market system in simple terms? ›
A market system is the network of buyers, sellers and other actors that come together to trade in a given product or service. The participants in a market system include: Direct market players such as producers, buyers, and consumers who drive economic activity in the market.
Financial markets may seem confusing, but essentially they exist to bring people together, so money flows where it is needed the most. Markets provide finance for companies so they can hire, invest and grow. They provide money for the government to help it pay for new roads, schools and hospitals.
What are the six of the financial system? ›
The financial system can be broken down into six main parts: money, financial instruments, financial markets, financial institutions, regulatory agencies, and central banks.
What is the main function of the financial system Quizlet? ›
The financial system performs the essential economic function of channelling funds from those with a surplus of funds (i.e., net savers who spend less than their income) to those who wish to borrow (i.e., net spenders who wish to spend more than their income).
What is the main purpose of the financial system quizlet? ›
The role of the financial system is to gather money from businesses and individuals who have surplus funds and channel funds to those who need them. The financial system consists of financial markets and financial institutions.
What is the meaning of financial system? ›
A financial system is a system that allows the exchange of funds between financial market participants such as lenders, investors, and borrowers. Financial systems operate at national and global levels.
What is a financial system in simple terms? ›
A financial system is a collection of institutions which allow the exchange of funds, such as banks, insurance companies, and stock exchanges. The financial system exists in the corporate, national, and global level.
What are the segments of the financial system? ›
Two segments of financial market are: Primary Market:The transactions in primary markets exist between issuers and investors. It is the market for newly issued securities i.e securities which are issued for the first time. Secondary Market:Secondary markets allow investors to buy and sell existing securities.
