Logo letter

The Role of Financial Systems in our Economy


There are major functions provided by the financial sector that are important at the level of the firm and at the level of the economy as a whole.


The first function is to provide payment services. For people to carry around large amounts of cash to pay for purchased goods and services is inconvenient, inefficient, and risky. An efficient alternative is provided by financial institutions. Obvious examples are personal and commercial checking and check clearing and credit and debit card services. These are growing in importance in the modern sector, and even of low income countries. You can go visit this 100k factory revolution review page.


The second function is to match savers and investors. There are a lot of people who save. They save money for retirement. And some have investment projects such as a factory building or expanding the inventory of a family micro enterprise. Thus, it is important that savers and investors somehow meet and agree on terms for loans or other forms of finance. This can occur without financial institutions because even in highly developed markets, new entrepreneurs obtain a significant fraction of their funds from family and friends. But the presence of banks, venture capitalists and the stock market can facilitate matching in an efficient manner. Small savers merely deposit their savings and let the bank decide where to invest them.


The third function is to generate and distribute information. This is one of the most important functions of the financial system. Stock and bond prices in the daily newspapers of developing courtiers is one example. The prices represent the average judgment of thousands or millions of investors based on the information they have available about these and all other investments. Banks also collect information about the firms that borrow from them. The information derived from these firms is an important component of the capital of a bank but it is unrecognized as such.  Thus, financial markets are said to represent the brain of the economic system.


They also allocate credit efficiently. The key to the wealth of nations is to channel investment funds to uses yielding the right rate of return, and it allows increases in specialization and the division of labor.


And, they do pricing, pooling, and trading risks. Protection against risk is provided by the insurance market but it is also possible through diversification in stock markets or in banks' loan syndications.


They also increase asset liquidity. There are long lived investments like hydroelectric plants and such investments may last a century or more. And investors will soon want to sell them. Sometimes it is difficult to find a buyer at a time when one wishes to sell. Financial development increases liquidity by making it easier to sell. Visit the 100k factory 2017 page for example.