A financial system is a system that allows the exchange of funds between financial market participants such as lenders,

investor An investor is a person who allocates financial capital with the expectation of a future Return on capital, return (profit) or to gain an advantage (interest). Through this allocated capital the investor usually purchases some species of pr ...

s, and borrowers. Financial systems operate at national and global levels. Financial institutions consist of complex, closely related services, markets, and institutions intended to provide an efficient and regular linkage between investors and borrowers. In other words, financial systems can be known wherever there exists the exchange of a financial medium (money) while there is a reallocation of funds into needy areas (financial markets, business firms, banks) to utilize the potential of ideal money and place it in use to get benefits out of it. This whole mechanism is known as a financial system.

Money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are: m ...

, credit, and

finance Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...

are used as media of exchange in financial systems. They serve as a medium of known value for which

goods In economics, goods are anything that is good, usually in the sense that it provides welfare or utility to someone. Alan V. Deardorff, 2006. ''Terms Of Trade: Glossary of International Economics'', World Scientific. Online version: Deardorffs ...

and services can be exchanged as an alternative to bartering. A modern financial system may include banks (public sector or private sector), financial markets, financial instruments, and

financial services Financial services are service (economics), economic services tied to finance provided by financial institutions. Financial services encompass a broad range of tertiary sector of the economy, service sector activities, especially as concerns finan ...

. Financial systems allow funds to be allocated, invested, or moved between economic sectors, and they enable individuals and companies to share the associated risks.

The components of a financial system

There are mainly four components of the financial system: # Financial markets - the market place where buyers and sellers interact with each other and participate in the trading of bonds, shares and other assets are called financial markets. # Financial instruments - the products which are traded in the financial markets are called financial instruments. Based on different requirements and credit seekers, the securities in the market also differ from each others. # Financial institutions - financial institutions are acting as a mediator between the investors and borrowers. They provide financial services for members and clients. It is also termed as financial intermediaries because they act as middlemen between the savers and borrowers. The investor's savings are mobilized either directly or indirectly via the financial markets. They offer services to organisations who want to raise funds from markets and take care of financial assets (deposits, securities, loan, etc). # Financial services - services provided by assets management and liabilities management companies. They help to get the required funds and also make sure that they are efficiently invested. (eg. banking services, insurance services and investment services)

Banks

Bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...

s are

financial intermediaries A financial intermediary is an institution or individual that serves as a "Intermediary, middleman" among diverse parties in order to facilitate financial transactions. Common types include commercial banks, investment banks, stockbrokers, insura ...

that lend money to borrowers to generate revenue and accept deposits . They are typically regulated heavily, as they provide market stability and

consumer protection Consumer protection is the practice of safeguarding buyers of goods and services, and the public, against unfair practices in the marketplace. Consumer protection measures are often established by law. Such laws are intended to prevent business ...

. Banks include: *Public banks * Commercial banks *

Central bank A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the mo ...

s *Cooperative banks *State-managed cooperative banks *State-managed land development banks

Non-bank financial system

Non-bank financial systems facilitate financial services like

investment Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

risk pool A risk pool is a form of risk management that is mostly practiced by insurance companies, which come together to form a pool to provide protection to insurance companies against catastrophic risks such as floods or earthquakes. The term is also u ...

ing, and market brokering. They generally do not have full banking licenses. Non-bank financial system include: * Finance and loan companies

Financial markets

Financial markets are markets in which

securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...

commodities In economics, a commodity is an economic good, usually a resource, that specifically has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. Th ...

, and fungible items are traded at prices representing

supply and demand In microeconomics, supply and demand is an economic model of price determination in a Market (economics), market. It postulates that, Ceteris_paribus#Applications, holding all else equal, the unit price for a particular Good (economics), good ...

. The term "market" typically means the institution of aggregate exchanges of possible buyers and sellers of such items.

Primary markets

The primary market (or initial market) generally refers to new issues of

stock Stocks (also capital stock, or sometimes interchangeably, shares) consist of all the Share (finance), shares by which ownership of a corporation or company is divided. A single share of the stock means fractional ownership of the corporatio ...

s, bonds, or other financial instruments. The primary market is divided in two segments, the money market and the capital market.

Secondary markets

The

secondary market The secondary market, also called the aftermarket and follow on public offering, is the financial market in which previously issued financial instruments such as stock, bonds, options, and futures are bought and sold. The initial sale of ...

refers to transactions in financial instruments that were previously issued.

Financial instruments

Financial instrument Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership, interest in an entity or a contractual right to receive or deliver in the form ...

s are tradable financial

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

s of any kind. They include money, evidence of ownership interest in an entity, and contracts.

Derivative instruments

A derivative instrument is a contract that derives its value from one or more underlying entities (including an asset, index, or

interest rate An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, ...

Financial services

Financial services Financial services are service (economics), economic services tied to finance provided by financial institutions. Financial services encompass a broad range of tertiary sector of the economy, service sector activities, especially as concerns finan ...

are offered by a large number of businesses that encompass the finance industry. These include

credit union A credit union is a member-owned nonprofit organization, nonprofit cooperative financial institution. They may offer financial services equivalent to those of commercial banks, such as share accounts (savings accounts), share draft accounts (che ...

bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...

s, credit card companies,

insurance Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect ...

companies, stock brokerages, and investment funds.

References

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