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What Is A Financial System?

A financial system is a set of institutions that facilitate the exchange of funds between borrowers, lenders, and investors. It can be organized through markets, central planning, or a hybrid. Financial systems exist on firm, regional, and global levels and include components like banks, stock exchanges, and government treasuries. They set rules for determining which projects receive funding and terms of financial deals.

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21 views

What Is A Financial System?

A financial system is a set of institutions that facilitate the exchange of funds between borrowers, lenders, and investors. It can be organized through markets, central planning, or a hybrid. Financial systems exist on firm, regional, and global levels and include components like banks, stock exchanges, and government treasuries. They set rules for determining which projects receive funding and terms of financial deals.

Uploaded by

David Shrsth
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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ECONOMY FISCAL POLICY

Financial System
By JIM CHAPPELOW | Reviewed By DANIEL ALPERT | Updated Dec 9, 2019

What Is a Financial System?


A financial system is a set of institutions, such as banks, insurance companies, and stock
exchanges, that permit the exchange of funds. Financial systems exist on firm, regional,
and global levels. Borrowers, lenders, and investors exchange current funds to finance
projects, either for consumption or productive investments, and to pursue a return on
their financial assets. The financial system also includes sets of rules and practices that
borrowers and lenders use to decide which projects get financed, who finances projects,
and terms of financial deals.

KEY TAKEAWAYS

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A financial system is the set of global, regional, or firm-specific institutions and
practices used to facilitate the exchange of funds.
Financial systems can be organized using market principles, central planning, or a
hybrid of both.
Institutions within a financial system include everything from banks to stock
exchanges and government treasuries.

Understanding the Financial System


Like any other industry, the financial system can be organized using markets, central
planning, or some mix of both.

Financial markets involve borrowers, lenders, and investors negotiating loans and other
transactions. In these markets, the economic good traded on both sides is usually some
form of money: current money (cash), claims on future money (credit), or claims on the
future income potential or value of real assets (equity). These also include derivative
instruments. Derivative instruments, such as commodity futures or stock options, are
financial instruments that are dependent on an underlying real or financial asset's
performance. In financial markets, these are all traded among borrowers, lenders, and
investors according to the normal laws of supply and demand.

In a centrally planned financial system (e.g., a single firm or a command economy), the
financing of consumption and investment plans is not decided by counterparties in a
transaction but directly by a manager or central planner. Which projects receive funds,

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whose projects receive funds, and who funds them is determined by the planner, whether
that means a business manager or a party boss.

Most financial systems contain elements of both give-and-take markets and top-down
central planning. For example, a business firm is a centrally planned financial system with
respect to its internal financial decisions; however, it typically operates within a broader
market interacting with external lenders and investors to carry out its long term plans.

At the same time, all modern financial markets operate within some kind of government
regulatory framework that sets limits on what types of transactions are allowed. Financial
systems are often strictly regulated because they directly influence decisions over real
assets, economic performance, and consumer protection.

Financial Market Components


Multiple components make up the financial system at different levels. The firm's financial
system is the set of implemented procedures that track the financial activities of the
company. Within a firm, the financial system encompasses all aspects of finances,
including accounting measures, revenue and expense schedules, wages, and balance
sheet verification.

On a regional scale, the financial system is the system that enables lenders and borrowers
to exchange funds. Regional financial systems include banks and other institutions, such
as securities exchanges and financial clearinghouses.

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The global financial system is basically a broader regional system that encompasses all
financial institutions, borrowers, and lenders within the global economy. In a global view,
financial systems include the International Monetary Fund, central banks, government
treasuries and monetary authorities, the World Bank, and major private international
banks.

Related Terms
Money Definition
Money is a medium of exchange that market participants use to engage in transactions for goods and services. more

What Was a Discount House?


Primarily operating in the United Kingdom, a discount house bought, sold, and negotiated bills of exchange or promissory notes. more

Bretton Woods Agreement and System: An Overview


The Bretton Woods Agreement and System created a collective international currency exchange regime based on the U.S. dollar and gold. more

Credit Money Definition


Credit money is value created from any future monetary claim against an individual that can be used to buy goods and services. more

Central Bank Definition


A central bank conducts a nation's monetary policy and oversees its money supply. more

Repurchase Agreement (Repo) Definition


A repurchase agreement is a form of short-term borrowing for dealers in government securities. more

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