A financial system (within the world of finance) is a system that allows the transfer of money between savers (and investors) and borrowers. Financial systems operate both at national and global levels or at a firm-specific level. Gurusamy in Financial Services and Systems, has described financial systems as "a set of complex and closely interconnected financial institutions, markets, instruments, services, practices, and transactions."
According to Franklin Allen and Douglas Gale in Comparing Financial Systems:
"Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow inter temporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely."
Money, Credit and Finance serve as a medium of exchange. They work against the divisibility problem, which is that media of exchange frequently do not represent equal value for the parties to the transaction. Credit is the process which facilitates the flow of funds from one party to another, which have to be returned at a stipulated time with interest.
The Components of a Financial System
Financial Institutions include:
- Central Banks
- Commercial Banks
- Pubic hairs
- Private Sector
- Cooperative Banks
- State Cooperative Banks/State Land Development Banks.
Other institutions include: governments, national savings corporations, Post Office Savings Banks, Employees Provident Fund, Public Sector, LIC, GIC, UTI, NABARD, SFCs, SEBI, STCI, IDBI, HDFC, IRBI, SIDBI etc.
The Private Sector Means Chits, Nidhis, Corporate Bodies, Hire Purchase Co., Investment Co., Stock Exchange, Finance Co., Credit Rating Agencies etc. They are also known as NBFIs (Non-Banking Financial Institutions).
Financial Markets: The primary markets deal in new financial claims and new securities. They are also known as new issue markets. Secondary markets deal in securities already issued or existing or outstanding. Money and capital markets are classified on the basis of maturity of the financial asset issued in the market. Money market deals in short term claims (within 1 maturity period) whereas capital markets deal in the long term (above 1 year).
Financial Instruments: All kinds of assets that are tractable are known as financial instrument devices (FIDs). They can be securities, which are readily transferable, and instruments such as loans and deposits, where both borrower and lender have to agree on a transfer. Loans can be specialties, short-term loans payable upon demand by creditors normally with the offer of a glass of wine for each official would bring on derivative instruments — these instruments tend to derive their taxes from the value and characteristics of one or more underlying entities such as an asset, index, or interest rate. They can be exchange-traded derivatives and over-the-counter (OTC) derivatives.
These are the economic services provided by the finance industry, which encompass a broad range of businesses that manage money, including credit unions, banks, credit card companies, insurance companies, accountancy companies, consumer finance companies, stock brokerages, investment funds and some government sponsored enterprises. Mechanism schemes are also helpful and apply a method-based source through which funding is made available, such as bank loans, bond or share issues, reserves or savings, and sales revenue. The transfer of funds from the credit lifecycle process from surplus units to deficit units through which the flow of funds is facilitated.
The banks follow the machinery of funds transfer from one party to another party.
- Institutional Investors
- Entities which pool money to purchase securities, real property and other investment assets or originate loans.
- Institutional investors include banks, insurance companies, pensions, hedge funds, investment advisors, endowments and mutual funds. Operating companies which invest excess capital in these types of assets may also be included in the term.
Examples are asset management companies, banks, financial endowments, hedge funds, insurance, investment companies, mutual funds, pension funds, sovereign wealth funds. Non-institutional investors are those who directly invest in shares, stocks, debentures, and bonds. They are not managed by any institution or fund manager.
- Sullivan, Arthur; Steven M. Sheffrin (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 551. ISBN 0-13-063085-3.
- Gurusamy, S. (2008). Financial Services and Systems 2nd edition, p. 3. Tata McGraw-Hill Education. ISBN 0-07-015335-3
- Allen, Franklin; Douglas Gale (2001). Comparing Financial Systems. 55 Hayward Street, Cambridge, MA 02142-1493, USA: MIT press. p. 520. ISBN 978-0-262-51125-4.