A network that facilitates the practice of exchanging funds between one entity to another
What is a Financial System?
A financial system is a network of financial institutions – such as insurance companies, stock exchanges, and investment banks – that work together to exchange and transfer capital from one place to another. Through the financial system, investors receive capital to fund projects and receive a return on their investments.
Summary
- A financial system can be perceived on a company, regional, or global scale, which facilitates the practice of exchanging funds between one entity to another.
- It involves various players such as insurance companies, stock exchanges, investment banks, and more.
- Financial systems are regulated, as their processes influence and contribute to the growth of many assets.
Understanding Financial Systems
Financial markets involve various players, including borrowers, lenders, and investors that negotiate loans for investment purposes. The borrowers and lenders tend to trade money in exchange for a return on the investment at some future date. Derivative instruments are also traded in the financial markets as well, which are contracts that are determined based on an underlying asset’s performance.
When determining the guidelines of raising capital within a financial system, the project being funded and who funds them are decided upon by the planner, who can be a business manager. Thus, the financial system is typically organized through central planning, a market economy, or a combination of both.
A centrally planned economy is structured around a central authority, such as a government, which makes economic decisions regarding the manufacturing and distribution of products for a specific country. A market economy is when the pricing of goods and services is dictated by the aggregated decision of citizens and business owners, often resulting in the effects of supply and demand.
Financial markets operate within a government regulatory framework that filters the sort of transactions that can be conducted. Financial systems are heavily regulated due to their influence and facilitation capabilities to contribute to the growth of real assets.
Financial System Components
The financial system is composed of many components depending on the level. From a company’s perspective, its financial system includes procedures that follow its financial activities. It would include aspects such as finances, accounting, revenue, expenses, wages, and more.
From a regional standpoint, the financial system, as mentioned above, facilitates the exchange of funds between borrowers and lenders. Players on a regional level would include banks and other financial institutions such as clearinghouses.
On a global scale, the financial system includes the interactions between financial institutions, investors, central banks, government authorities, the World Bank, and more.
Example
An example of one player within the financial system is the Bank of Canada (BoC). The BoC promotes economic and financial welfare for Canadians by cultivating a financial system whereby banks, credit unions, financial markets, and other factors interact to ensure the economic landscape continues to operate effectively for its citizens. The BoC achieves its objectives through the following:
- Providing central bank services such as liquidity and credit facilities: The Bank of Canada sources liquid funds to the financial system and is often known as the lender of last resort.
- Developing and implementing national policy: The federal government introduces legislation to implement a new retail payments framework. The BoC would oversee the service with operational and financial requirements, ensuring regulations are maintained.
- Oversees financial market infrastructures: The Canadian central bank conducts regulatory oversight and acts as the resolution authority for financial market infrastructures. They include payments systems and clearing and settlement systems.
List of Financial System Banks
Banks
- Public banks
- Commercial banks
- Central banks
- Cooperative banks
- State-managed cooperative banks
- State-managed land development banks
Non-Bank Financial Institutions
More Resources
CFI offers the Capital Markets & Securities Analyst (CMSA)®certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:
FAQs
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.
What are the four 4 functions of the financial system? ›
The financial system serves four main functions: providing a payment system, matching borrowers and lenders, enabling individuals to manage their finances across lifetimes and generations, and sharing and managing risk.
What are the 6 elements of financial system? ›
This course serves as an introduction to the financial system. It breaks down the financial system into its six elements: lenders & borrowers, financial intermediaries, financial instruments, financial markets, money creation and price discovery.
Why are financial systems important? ›
The financial system plays a critical role in the economy. It enables the financial intermediation process which facilitates the flow of funds between savers and borrowers, thus ensuring that financial resources are allocated efficiently towards promoting economic growth and development.
What is a good financial system? ›
A well-functioning financial system has complete markets with effective financial intermediaries and financial instruments, allowing: Investors to move money from the present to the future at a fair rate of return. Borrowers to easily obtain capital. Hedgers to offset risks.
What are the 4 primary components of a financial system? ›
The main financial system components include financial institutions, financial services, financial markets, and financial instruments.
What are the five key roles of the financial system? ›
The five key functions of a financial system are: (i) producing information ex ante about possible investments and allocate capital; (ii) monitoring investments and exerting corporate governance after providing finance; (iii) facilitating the trading, diversification, and management of risk; (iv) mobilizing and pooling ...
What are the three parts of the financial system? ›
The three components of the financial system are: a monetary system, financial institutions, and financial markets.
What are the basics of financial system? ›
Within a company, the financial system covers all facets of finance, including accounting procedures, revenue and expenditure schedules, salaries, and verification of balance sheets. On a regional level, the financial system is the system that allows the exchange of funds between lenders and borrowers.
Who is a financially stable person? ›
A simple definition of financial stability is being able to comfortably live every month without worrying about money. You don't overspend but you still enjoy doing things you love to do. You pay your bills on time and you have an emergency fund in place.
Governments and intergovernmental bodies act as purveyors of international trade, economic development, and crisis management. Regulatory bodies establish financial regulations and legal procedures, while independent bodies facilitate industry supervision.
How to be financially stable with low income? ›
How To Become Financially Stable: Eight Achievable Steps
- Set A Budget And Stick To It. ...
- Save, Save, Save. ...
- Live Within (Or Below) Your Means. ...
- Establish An Emergency Fund. ...
- Pay Down Your Debt. ...
- Invest In Yourself And Your Retirement. ...
- Monitor Your Credit Score. ...
- Don't Be Afraid To Enjoy Life.
Financial systems play a pivotal role in facilitating economic transactions and allocating resources efficiently. At its core, a financial system encompasses various institutions, markets, and mechanisms that facilitate the flow of funds between savers and borrowers.
What is a good financial structure? ›
An optimal capital structure is the best mix of debt and equity financing that maximizes a company's market value while minimizing its cost of capital. Minimizing the weighted average cost of capital (WACC) is one way to optimize for the lowest cost mix of financing.
What is considered a financial system? ›
A financial system is a set of institutions and practices that facilitate and allow for the exchange of funds between borrowers, lenders and investors. Financial systems exist on firm-specific, regional and global levels. They include institutions like: Banks. Government treasuries.
What are the 4 main functions of finance? ›
Finance functions cover Investment (allocating funds to assets for growth), Dividend (deciding on profit distribution to shareholders), Financing (raising capital through equity or debt), and Liquidity (ensuring sufficient cash flow for operations).
What are the four 4 functions of money explain? ›
whatever serves society in four functions: as a medium of exchange, a store of value, a unit of account, and a standard of deferred payment.
What are the 4 major functions of accounting explain each? ›
The primary functions of an accounting system are to track, report, execute, and predict financial transactions. The basic function of financial accounting is to also prepare financial statements that help company leaders and investors to make informed business decisions.
What are the 4 functions of the economic system? ›
The four functions of an economic system is what to produce, how much to produce, how to produce, and to whom to distribute.
