Financial System

BASIC ELEMENTS OF FINANCIAL SYSTEM
1. What is 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.
2. Functions of Financial System
 Payment System – An efficient payment system allows businesses and merchants to
collect money in exchange for their products or services. Payments can be made with
cash, checks, credit cards, and even cryptocurrency in certain instances.
 Savings – Public savings allow individuals and businesses to invest in a range of

investments and see them grow over time. Borrowers can use them to fund new
projects and increase future cash flow, and investors get a return on investment in
return.
 Liquidity – The financial markets give investors the ability to reduce the systemic risk
by providing liquidity thus allows for easy buying and selling of assets when needed.
 Risk Management – It protects investors from various financial risks through

insurances and other types of contracts.
 Government Policy – Governments attempt to stabilize or regulate an economy by

implementing specific policies to deal with inflation, unemployment, and interest rates
3. Financial Intermediation
A financial intermediary is an entity that facilitates a financial transaction between two parties.
Such an intermediary or a mediator could be a firm or an institution. Some examples of
financial intermediaries are banks, insurance companies, pension funds, investment banks,
and more.
Advantages of Financial Intermediaries

 They help in lowering the risk of an individual with surplus cash by spreading the risk via
lending to several people. Also, they thoroughly screen the borrower, thus, lowering the
default risk.
 They help in saving time and cost. Since these intermediaries deal with a large number
of customers, they enjoy economies of scale.
 Since they offer a large number of services, it helps them customize services for their
client. For instance, banks can customize the loans for small and long-term borrowers
or as per their specific needs. Similarly, insurance companies customize plans for all
age groups.
 They accumulate and process information, thus lowering the problem of asymmetric
information.
4. Kinds of Financial Intermediaries
Bank
These intermediaries are licensed to accept deposits, give loans, and offer many other
financial services to the public. They play a major role in the economic stability of a country
and thus, face heavy regulations.
Mutual Funds
Mutual funds help pool savings of individual investors into financial markets. A fund manager
oversees a mutual fund and allocates the funds to different investment products.
Financial Advisors
Such intermediaries may or may not offer a financial product but advise investors to help them
achieve their financial objectives. These financial advisors usually undergo special training.
Credit Union
It is also a type of bank that works to serve its members and not the public. They may or may
not operate for-profit purposes.
5. Regulation of Financial System
Financial regulation refers to the rules and laws firms operating in the financial industry, such
as banks, credit unions, insurance companies, financial brokers and asset managers must
follow. However financial regulation is more than just having rules in place - it's also about the
ongoing oversight and enforcement of these rules.
The Central Bank regulates and supervises financial service providers operating in the country.
Why is financial regulation important?

All of us depend on the financial system in one way or another. For example, savers rely on
banks to have their money available when they need it. Businesses need to be able to borrow
to maintain and develop their business. Consumers taking out a mortgage or insurance may
need to get advice on the best product for them. In the case of insurance companies,
policyholders rely on getting claims paid when something goes wrong.
Poorly regulated financial institutions have the potential to undermine the stability of the
financial system, harm consumers and can damage the prospects for the economy. That's why
strong financial regulation is important - to put rules in place to stop things from going
wrong, and to safeguard the wider financial system and protect consumers if they do go
wrong.
How does financial regulation work?
Ensuring firms have the funding to trade safely, have the appropriate risk controls in
place and are appropriately governed is known as "prudential regulation".
An important part of prudential regulation is authorization. We call this our "gatekeeper
role" and means we only allow firms to operate in the financial system once they have fulfilled
a number of criteria, including governance and risk control.
Ensuring firms treat customers fairly from the sales process to how complaints are
managed, is known as "consumer protection".
Consumer protection rules are also in place. These spell out how firms must treat their
customers when selling them financial products. So for example, a regulated firm must ensure
that it "acts honestly, fairly and professionally in the best interests of its customers and the
integrity of the market".

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BASIC ELEMENTS OF FINANCIAL SYSTEM

1. What is Financial System

 Savings – Public savings allow individuals and businesses to invest in a range of

 Risk Management – It protects investors from various financial risks through

 Government Policy – Governments attempt to stabilize or regulate an economy by

Advantages of Financial Intermediaries

4. Kinds of Financial Intermediaries

5. Regulation of Financial System

Why is financial regulation important?

How does financial regulation work?

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