The financial system is a broad term that includes various components such as Institutions, Instruments, Markets, Services, Intermediaries, and Regulators which facilitate the flow of money and exchange of financial assets between various sections of the economy. These components are integrated in such a manner that they collectively enhance the efficient allocation of financial resources and lead to economic stability. This is done by facilitating investments, savings, and the smooth flow of capital. Let us have a brief overview of these components:
- Financial Institutions: These are organizations that provide financial services. They can be divided into two major categories namely, Banking institutions and Non Banking Institutions. These institutions play a crucial role in the economy by connecting the borrowers and lenders by mobilizing savings, providing liquidity as and when needed, and allocating capital to productive investments which would lead to economic development.
- Financial Markets: These are contact points where financial assets such as stocks, bonds, and other financial instruments are bought and sold. Financial markets help in price discovery and provide a mechanism for asset dealing, thereby contributing to market efficiency. Broadly, they can be classified as Short term and Long term markets.
- Financial Instruments: These are products that are traded in the financial markets. They can be classified as equity-based instruments such as stocks, debt-based such as bonds, or derivatives such as futures, options, and swaps. Each of these instruments serves different investments and financing needs.
- Financial Services: These include a wide range of services provided by financial institutions, such as investment advice, asset management, fund transfer services, and financial planning. These act as the linkages that intermediaries create to provide linkages between the investors and the financial system so that they can access the markets more easily.
- Regulatory Bodies: These are governmental or independent bodies that oversee, regulate, and facilitate the smooth functioning of financial markets and institutions. Examples include the Reserve Bank of India which oversees the banking system, Securities Exchange Board of India which regulates the Capital Markets.
The primary function of a financial system is to efficiently allocate resources and manage risks in an economy. It helps in the accumulation of capital, production of goods and services, and supports economic growth and stability by providing a framework for payments, savings, investments, and obtaining credit. A robust financial system is vital for fostering economic development and improving living standards.
