Nature and Role of Financial System

Meaning of Financial System

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 all together facilitate the smooth transfer of funds. This system exists at the regional, national and international levels. It is an efficient tool that helps in economic development of a country by linking savings and investments thereby leading to wealth creation.

Financial system acquires money from people who are keeping it idle and distribute it among those who uses it for yielding income and generates wealth in country. It aims at efficient allocation of financial resources by channelizing funds between net savers and net spenders. Financial system has efficient role in minimizing the risk through diversification of funds among large number of people.

Nature of Financial System

Nature of Financial System
Nature of Financial System

Transfer Funds

Financial system helps in transferring of financial resources from one person to another person. This system includes financial markets, financial intermediaries, financial assets and services which facilitates fund movements in an economy.

Mobilizes Saving

It helps in allocating ideal lying resources with peoples into productive means. Financial system is the one which obtains funds from savers and provide it to those who are in need of it for various development purposes.

Risk Allocation

Diversification of risk in an economy is important feature of financial system. Financial system allocates people’s funds in various sources due to which risk is diversified. 

Facilitates Investment

Financial system encourages investment by peoples into different investment avenues. It provides various income-generating investment options to peoples for investing their savings.

Enhances liquidity

Financial system helps in maintaining optimum liquidity in an economy. It facilities free movement of funds from households (savers) to corporates (investors) which ensures sufficient availability of funds. 

Role of Financial System

Role of Financial System
Role of Financial System

Facilitates Payment Mechanism

Financial system provides a payment mechanisms for the smooth flow of funds among peoples in an economy. Buyers and sellers of goods or services are able to perform transactions with each other due to the presence of a financial system.

Reduces Risk

It aims at reducing the risk by diversifying it among a large number of individuals. Financial system distributes funds among a large number of peoples due to which risk is shared by many peoples.

Brings Savers and Investors Together

Financial system serves as a means of bridging the gap between savings and investment. It acquires money from those with whom it is lying idle and transfers it to those who need it for investing in productive ventures. 

Assist in Capital Formation

Financial system has an efficient role in the capital formation of the country. It enables big corporates and industries to acquire the required funds for performing or expanding their operations thereby leading to capital formation in the nation.

Improves Standard of living

It raises the standard of living of peoples by promoting regional and rural development of the country. The financial system promotes the development of a weaker sections of society through cooperative societies and rural development banks.

Facilitates Economic Development

Financial system influences the pace of economic growth or development of an economy. It aims at optimum utilization of all financial resources by investing all idle lying resources into useful means which leads to the creation of wealth.