Components of Financial System

Meaning of Financial System

The financial system is a system that facilitates the movement of funds among people in an economy. It is simply a means through which funds are exchanged between investors, lenders, and borrowers. A financial system is composed of various elements like financial institutions, financial intermediaries, financial markets, and financial instruments which altogether facilitate the smooth transfer of funds.

Components of Financial System

Financial Institutions

The financial institution is the first component of the financial system. These institutions serve as a mediator in between the borrower and investors that arranges their meeting. It brings together the one who have surplus funds and one who is in need of funds. They are government or private entities that provides distinct services for management of services to businesses and general public. Financial institutions perform the role of mobilizing investors’ savings either directly or indirectly through financial markets using distinct financial instruments as well as in process using various financial services. 

Financial institutions can be categorized into: Banking and Non-Banking institutions. Banking institutions are one that accepts deposits as well as provide credit to individuals. Whereas, non-banking institutions do not accept deposits from public but offer them various types of financial products and services. 

Financial Markets

Financial market is place where financial assets are created and transferred among public. It is market in which buyer and sellers interact with one another for entering into transactions related to trading of assets like shares, debentures, bonds etc. These markets facilitate borrowers in finding lender for raising funds. Businesses are able to finance their operations and achieve growth by attracting different investors with the help of financial markets. These financial markets are classified into 4 categories that are: –

Money Market

Money market is wholesale debt market for high liquidity, low risk and short-term instruments. It is a marketplace where securities with a maturity period ranging from single day to one year are bought and sold. Banks, Government and large financial institutions have full control over the money market. 

Capital Market

It is financial market where long-term securities having maturity period of more than one year are traded. Capital market are meant for financing the long-term investments. Various securities traded in capital market are bonds, stocks, debentures etc. New York stock exchange, National stock exchange and Bombay stock exchange are some of the capital market. This market is further classified into three categories like primary market, secondary market and derivative market.

Commodity Market

This market is one in which commodities such as gold, silver, crude oils etc. are traded.

Forex Market

Forex market deals in foreign currencies exchanges and also determines their rate of exchange. 

Financial Instruments

Financial instruments are key component of financial system. These are the products which are traded in financial market be it primary market, capital market and derivative market. There are wide range of securities available in market as the needs of credit seekers and investors vary from each other. Financial instruments are classified into three categories that are primary market instruments, capital market instruments and derivative instruments. 

Financial Services

These are services offered by large financial institutions for management, borrowing, lending and investment of funds. Financial institutions are Asset management and Liability management company which facilitate appropriate acquisition and investment of money. These institutions assist in buying and selling of securities, borrowing, lending and investing, making and settling payments and monitoring risk exposures in financial markets. Financial services are generally classified into four categories: General banking services, Investment services, Insurance services and Foreign exchange services.


This is the last component and most important component of Financial system. Money is anything that is served as a medium of exchange and store of a value. It can be defined as anything that is accepted by seller as a means of payment for goods and services. Money has eased the whole exchange process as it is widely accepted by parties for settling transactions.