Importance 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.

Importance of Financial System

Links savers and borrower

The financial system serves as an important source for bringing together the savers and borrowers. It bridges the gap in between the one who has excess of funds lying idle with them and one who are in need of them. The financial system enables in pooling of funds from one person to another person across the economy.

Provide payment mechanism

It enables people in successfully doing financial transactions by providing various convenient mode of payments. Financial system support payment mechanism which facilitates smooth flow of funds in economy. Buyers and sellers are easily able to complete transactions for sale and purchase of goods using payment methods like cheque, UPI, debit cards, credit cards etc.

Improve liquidity

Financial system plays an efficient role in enhancing overall liquidity in market. It serves as a mediator for facilitating the free movement of funds among people. Households are provided with different investment avenues for deploying their funds that have better liquidity rates i.e. can be easily converted into cash. It motivates the lenders in doing investments that ensure regular availability of appropriate funds in the market.

Risk allocation

Risk diversification is one of the important feature of financial system. Investors are provided with wide range of investment securities in financial market to choose from as per their choice. Financial system enables allocation of people’s funds among various sources due to which risk is minimized.     

Promote capital formation

Financial system accelerates the rate of capital formation in a country. It assists business in acquiring funds from banks, financial institutions and general public for financing their activities. Availability of funds at right time enables business in maintaining their continuity and attaining growth. Government also require funds for financing its different infrastructural development and social-welfare activities. Financial system by supplying right amount of funds support the capital formation in nation.

Employment growth

A efficient financial system of country is capable of generating large employment opportunities for people. It supplies the required amount of funds to business and large organizations for carrying out their activities and expanding their size. With the growth in business and industrial sector, it will consequently generate more employment opportunities for both organized as well as unorganized sector. 

Attracts foreign capital

Financial system enables in attracting sufficient amount of foreign capital in an economy. Capital market constitutes an important part of country’s financial system. If this market is properly developed and promoted, then it is capable of attracting funds not only form domestic market but also form foreign market. When there is sufficient capital available, investment will widen that will result in speeding up the economic development of nation.

Balanced regional development

It has a significant role in achieving balanced regional development in a country. Financial system enables in overall development of rural and backward areas by offering concessions and sops. Balance development mitigate political and several other dispute in nation. It also controls the migration of rural peoples toward urban areas.