Financial System

Reviewed by Komal | Updated on Aug 27, 2020

What is a Financial System?

A financial system is a collection of institutions which allow the exchange of funds, such as banks, insurance companies, and stock exchanges. The financial system exists in the corporate, national, and global level.

Borrowers, lenders, and creditors are exchanging current funds to finance ventures, either for consumption or productive investment and seeking returns on their financial assets. Furthermore, the financial system includes sets of laws and policies used by creditors and lenders to determine which projects are funded, who fund the projects, and scope of financial deal.

Understanding the Financial System

Financial markets include arranging loans and other deals with creditors, lenders, and investors. The economic good traded on both sides in these markets is usually some form of money: current money (cash), claims on future money (credit), or claims on the potential for future income or real asset value (equity). These include derivative instruments as well.

Derivative contracts, such as commodity futures or stock options, are financial products that depend on the performance of an underlying real or financial asset. These are all exchanged in financial markets among borrowers, lenders, and investors according to the standard supply and demand rules.

In a centrally planned financial system (such as a single company or a command economy), the funding of business and investment plans is determined not by counterparties but directly by a manager or central planner.

What projects receive funding, whose projects receive funding, and who finances it is determined by the planner, whether that means a business manager or a group leader.

Components of a Financial System

Multiple elements make up a different level of the financial system. The financial system of the firm is the collection of executed procedures which track the company's financial activities. 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. National financial systems include banks and other institutions, including exchanges of shares and financial clearinghouses.