What Is the Financial Sector?
The financial sector is a section of the economymade up offirms and institutions that provide financial services to commercial and retail customers. Thissector comprises a broad range of industries including banks, investment companies, insurance companies, and real estate firms.
Key Takeaways
- The financial sector is a section of the economymade up offirms and institutions that provide financial services to commercial and retail customers.
- A strong financial sector is a sign of a healthy economy.
- The financial sector generates a good portion of its revenue from loans and mortgages and thrives in a low-interest-rate environment.
- The sector is comprised of many different industries including banks, investment companies, insurance companies, and real estate firms.
Understanding the Financial Sector
A large portion of this sector generates revenue from mortgages and loans, which gain value as interest rates drop. The health of the economy depends, in large part, on the strength of its financial sector. The stronger it is, the healthier the economy. A weak financial sector typically means the economy is weakening.
Many people equate the financial sector with Wall Street and the exchanges that operate on it. But there's much more to it than that. The financial sector is one of the most important parts of many developed economies. It is made up of brokers, financial institutions, and money markets—all of which provide the services needed to help keep Main Street functioning every day.
In order for an economy to remain stable, it needs to have a healthy financial sector. This sector advances loans for businesses so they can expand, grants mortgages to homeowners, and issues insurance policies to protect people, companies, and their assets. It also helps build up savings for retirement and employs millions of people.
The financial sector generates a good portion of its revenue from loans and mortgages. These gain value in an environment where interest rates drop. When rates are low, the economic conditions open up the doors for more capital projects and investment. When this happens, the financial sector benefits, meaning more economic growth.
Financial Sector Makeup
As mentioned above, the financial sector is made up of many different industries ranging from banks, investment houses, insurance companies, real estate brokers, consumer finance companies, mortgage lenders, and real estate investment trusts (REITs).
The financial sector is one of the largest portions of the . The largest companies within the financial sector are some of the most recognizable banking institutions in the world, including the following:
- JPMorgan Chase (JPM)
- Wells Fargo (WFC)
- Bank of America (BAC)
- Citigroup (C)
While these large companies dominate the sector, there are other, smaller companies that participate in the sector as well. Insurers are also a major industry within the financial sector, being made up of such companies as American International Group (AIG) and Chubb (CB).
Investing in the Financial Sector
Economists often tie the overall health of the economy with the health of the financial sector. If financial companies are weak, this is a detriment to the average consumer. Financial companies provide loans for businesses, mortgages to homeowners, and insurance to consumers. If these activities are restricted, it stunts growth in both small businesses and real estate.
Financial stocks are very popular investments to own within a portfolio. Most companies within the sector issue dividends and are judged on the overall strength of their financial health. During the financial crisis of 2007-2008, the financial sector was one of the hardest hit, with companies like Lehman Brothers filing for bankruptcy. After an influx of government regulation and restructuring, the financial sector is considerably stronger.
Financial ETFs, such as the Financial Select Sector SPDR Fund (XLF)—the largest financial ETF—can provide investors with broad exposure to the sector.
As of the close of trading on Sept. 29, 2020, the financial sector had a combined market capitalization of $5.59 trillion. The sector has underperformed the S&P 500 index in the trailing 12 months (TTM), where the S&P 500 is up 14.3% while the S&P 500 Financials Sector has fallen 13.7%.
Special Considerations
Some of the positive factors that affect the financial sector include:
- Moderately rising interest rates. As rates rise, financial services companies can earn more on the money they have and on credit they issue to their customers.
- Reducing regulation. Whenever the government decides to cut back on red tape, members of the financial sector will benefit. This means it could lessen the burden while increasing profits.
- Lower consumer debt levels. as consumers decrease their debt loads, they lessen the risk of defaults. This lighter load also means they may have a tolerance for more debt, further increasing profitability.
Conversely, investors should consider some of the negative factors that affect this sector as well:
- Rapid interest rate increases. If rates rise too quickly, demand for credit such as mortgages could drop, which could negatively affect certain parts of the financial sector.
- Yield curve flattening. If the spread between long- and short-term interest rates drop too far, the financial sector could start to struggle.
- More legislation. Government regulation can have a big impact on the financial sector. While it may help protect consumers, more red tape can bog down a business that operates in financial services.
FAQs
The financial sector is a section of the economy made up of firms and institutions that provide financial services to commercial and retail customers. This sector comprises a broad range of industries including banks, investment companies, insurance companies, and real estate firms.
Why are financial markets so important to the economy? ›
Financial markets provide liquidity, capital, and participation that are essential for economic growth and stability. Without financial markets, capital could not be allocated efficiently, and economic activity such as commerce and trade, investments, and growth opportunities would be greatly diminished.
What is the financial sector share of the economy? ›
U.S. share of value added to GDP 2023, by industry
In 2023, the finance, insurance, real estate, rental, and leasing industry contributed the highest amount of value to the GDP of the U.S. at 20.7 percent.
Why are finance jobs important to the economy? ›
The finance industry is critical to the functioning of any economy. It provides the necessary capital to businesses, individuals, and governments to invest in new projects and expand their operations. The finance industry also offers financial services that enable economic growth and development.
What is finance with an example? ›
What is Finance? Finance is defined as the management of money and includes activities such as investing, borrowing, lending, budgeting, saving, and forecasting. There are three main types of finance: (1) personal, (2) corporate, and (3) public/government.
What is the primary goal of financial management? ›
Typically, the primary goal of financial management is profit maximization. Profit maximization is the process of assessing and utilizing available resources to their fullest potential to maximize profits. This has the greatest benefit for company shareholders hoping for the highest possible return on their investment.
What is the main purpose of financial markets quizlet? ›
The primary role of financial markets is to facilitate the flows of funds from individuals and businesses that have surplus funds to individuals, businesses, and governments that have needs for funds in excess of their income.
Why are financial markets essential for a healthy economy and economic growth? ›
Financial markets facilitate the interaction between those who need capital with those who have capital to invest. In addition to making it possible to raise capital, financial markets allow participants to transfer risk (generally through derivatives) and promote commerce.
Is economics in the financial sector? ›
Economics and finance are disciplines that are interrelated but are not the same. They are both concerned with the world of money, markets, and transactions but are very different in how they approach them.
Why the financial sector? ›
The financial services sector is the primary driver of a nation's economy. It provides the free flow of capital and liquidity in the marketplace. When the sector is strong, the economy grows, and companies in this industry are better able to manage risk.
In the U.S., the positive impact of finance multiplies and helps generate much more in terms of growth and jobs than the financial sector accounts for directly. For every job in the financial services industry, 3.6 jobs are created in the rest of the economy.
Why is finance important to society? ›
From taxes to government spending, budgeting, and debt issuance policies, government finance affects every level of society. In the federal government, public finance can also include economic stability measures and efforts used to prevent market failure, shore up the economy, etc.
What is an important part of financial economics? ›
There are two basic aspects of financial economics, namely present value and risk management diversification.
Why is finance important? ›
Without finance, people would not be able to afford to buy homes (entirely in cash), and companies would not be able to grow and expand as they can today. Finance, therefore, allows for the more efficient allocation of capital resources.
What does finance mean in economics? ›
Finance is a specialized branch of economics concerned with the origination and management of money, credit, banking and investment. Typical areas of study within finance are corporate finance, investments, financial institutions, and risk management.
Why is financial decision important? ›
Financial decision is important to make wise decisions about when, where and how should a business acquire fund. Because a firm tends to profit most when the market estimation of an organization's share expands and this is not only a sign of development for the firm but also it boosts investor's wealth.
How does the financial market impact the economy in Everfi? ›
How does the financial market impact the economy? The financial market helps the economy grow. The financial market determines how the economy is doing. The financial market gives individuals, companies, and the government access to money they need.
How do markets contribute to the improved functioning of the economy? ›
In a well-functioning market, firms can thrive, and consumers can readily access the desired goods and services. Conversely, when markets fail to function well due to frictions or distortions, they may disincentivise production and/or consumption, leading to economic stagnation or decline.
Why is the stock market so important? ›
Raising Capital: Most importantly, the stock market offers a platform where companies raise funds by issuing stocks. This capital is essential for business expansion, research and development, and other corporate initiatives. By selling shares to the public, companies gain access to these funds without incurring debt.
What are financial market advantages and disadvantages? ›
While financial markets provide numerous benefits, such as liquidity and investment opportunities, they also come with certain disadvantages, including: Volatility and market fluctuations: Financial markets are subject to volatility and fluctuations in asset prices, which can lead to potential losses for investors.
