What is the financial system?
A financial system is a set of institutions, such as banks, insurance companies, and stock exchanges, that allow the exchange of money. Financial systems exist at corporate, regional and global levels. Borrowers, lenders, and investors exchange current money to finance projects, whether for consumption or for productive investments, seeking a return on their financial assets. The financial system also includes sets of rules and practices that borrowers and lenders use to determine which projects to fund, who finances projects, and the terms of financial deals.
Key Points
A financial system is a set of global, regional, or corporate institutions and practices and practices used to facilitate the exchange of money.
Financial systems can be regulated using market principles, central planning, or a combination of both.
Institutions within the financial system include everything from banks to stock exchanges and government treasuries.
Understanding the financial system
Like any other industry, the financial system can be regulated using markets, central planning, or a combination of both.
Financial markets include borrowers, lenders, and investors who negotiate loans and other transactions. In these markets, the economic good traded on both sides is usually some form of money: current money (cash), claims on future money (credit), or claims on potential future income or the value of real assets (equity). These also include derivative instruments. Derivatives, such as commodity futures or stock options, are financial instruments that depend on the performance of the underlying real or financial asset. In the financial markets, they are all traded between borrowers, lenders and investors according to the normal laws of supply and demand.
In a centrally planned financial system (for example, a single company or a command economy), the financing of consumption and investment plans is not determined by the counterparties to the transaction but directly by a central manager or planner. Which projects receive funds, whose projects receive funds, and who funds them are determined by the planner, whether that means a business manager or a party leader.
Most financial systems contain elements of give-and-take markets and top-down central planning. For example, a business firm is a centrally planned financial system with respect to its internal financial decisions; However, it usually operates in a broader market interacting with external lenders and investors to implement its long-term plans.
At the same time, all modern financial markets operate within some kind of government regulatory framework that places limits on the types of transactions allowed. Financial systems are often strictly regulated because they directly influence decisions about real assets, economic performance, and consumer protection.
Components of the financial market
Multiple components make up the financial system at different levels. The financial system of the company is the set of implemented procedures that follow the financial activities of the company. Within a company, the financial system includes all aspects of finances, including accounting measures, revenue and expense schedules, wages, and balance sheet checks.
At the regional level, the financial system is the system that enables lenders and borrowers to exchange money. Regional financial systems include banks and other institutions, such as stock exchanges and financial clearinghouses.
The global financial system is essentially a broader regional system that includes all financial institutions, borrowers and lenders within the global economy. From a global perspective, the financial systems include the International Monetary Fund, central banks, government treasuries, monetary authorities, the World Bank, and major international private banks.