Key Roles Performed by Financial System in the Economy Essay

Key Roles Performed by Financial System in the Economy - Essay Example In simple terms, financial system can be called as the system that keeps the flow of money between people and institutions. It is the mechanism through which money flow from the individual investors to the borrowers in the system. Financial system is an inevitable factor for the very existence of the economy itself. The term financial system is an all-encompassing term consisting of various types and components within it. â€Å"A financial system can be defined at the global, regional or firm specific level.† (Investopedia, 2011) A firm level financial system refers to the financial system followed by companies in order to track their financial performance. Most companies will have similar kind of financial system. Regional level refers to the system where money is exchanged between lenders and borrowers. It is not necessarily between lenders and borrowers but also between lenders and investors or investors and borrowers. The third one is global level. It refers to the exchange or movement of finance between big corporate and government institutions at the global level. Though each of these levels is important in the economy, global level is the most important level. Before looking into the each level of the financial system and their importance, it is important to have a detailed look into the various components of financial system. The components of financial system will include all the three levels which are mentioned in the previous paragraph. The main components of a financial system are as follows: 1. Financial Intermediaries 2. Financial Markets 3. Regulators 4. Financial Instruments Components of Financial System & their Roles Financial Intermediaries Financial intermediaries are the first component of financial system. As the name signifies, financial intermediaries act as an intermediary or channel between two parties. The two parties are namely investors and the firms that are raising fund or savers and borrowers. â€Å"The difficulty that lenders (savers) and borrowers (spenders) encounter when confronted with finding and dealing directly with each other has provoked the appearance of financial intermediaries† (Morawski, 2007) All kinds of financial institutions fall under the category of financial intermediaries. Some of the most common financial intermediaries are banks, insurance companies, investment brokers, mutual fund houses, wealth management co mpanies, pension funds, etc. Financial intermediaries are the component that facilitates the flow of money in the economy. It helps to convert one form of fund the other. As such it becomes an inevitable factor for the development of an economy. The major roles played by financial intermediaries in the economy are as follows: 1. Channel of Transfer 2. Avoid the difficulties in direct dealing 3. Safe keeping of assets 4. Mobilisation of funds 5. Creation of financial instruments 6. Investment Services 7. Quicker development Channel of transfer: The basic function of a financial intermediary is to act as a channel. Financial intermediaries channelize funds from one person to the other based on each other’s need. This can simply be explained with the case of commercial banks. Commercial bank’s take deposits from the investors and distribute is as loans to other parties. Thus, a link is established between investors and borrowers. Such an efficient system of exchange is no t possible without the existence of financial intermediaries. Avoid the difficulties in direct dealing: If there were no financial intermediaries at all, it would have resulted in several unorganised lending and receiving activities in the market. It would be difficult for the investors to find borrowers and vice versa. Such a situation would also cause chaos in the whole system. But financial intermediaries help to identify the investors and borrowers and provide them the required services. Safe keeping of assets: Financial intermediaries help the people with surplus funds by aiding them to keep it safe. Due