Financial system is a set of institutions that allows the exchange of funds. The system covers various financial institutions such as banks, pension funds, financial markets, and insurance companies.
The function of the financial system
The financial system functions to connect savers and spenders. Savers or spenders can come from companies, governments, or even individuals (households).
Savers have money and invest in several financial instruments. For example, individuals invest by buying company stock or putting it on time deposits.
Meanwhile, borrowers need money for various purposes. Companies need money to buy capital goods and build factories. The government needs funds to finance infrastructure projects. And individuals borrow money from banks to buy houses or cars.
Components of the financial system?
The three main parts of this system are:
- Savers who hold money to invest
- Financial intermediaries that offer a variety of financial services and products
- Fund users or spenders who need money
Savers invest money in various assets, for example, in the corporate debt securities. They buy bonds through securities companies. Money then moves from savers to users of funds, the company. With this money, companies can spend it for various purposes, such as buying new equipment.
Why is it important?
The financial system has a significant impact on the economy. It facilitates the flow of funds between savers and borrowers. A system that works well ensures efficient allocation of financial resources, which can ultimately promote economic growth and development.
A functioning system helps solve financial problems. The two characteristics of a functioning financial market are:
- Liquid, thereby reducing the cost of trading. Spenders can raise money at a low cost, for example bearing a low coupon.
- Market information, including financial statement disclosures, is available correctly and in a timely manner. It is crucial to produce a fair market price and low information costs.
