Understanding the Financial System
Any system is incomplete without its rules, governance and network. The financial system provides the rules, network and institutions. These are for fund flow.
In general a financial system consists of several institutions. These institutions are banks, stock exchange and insurance companies. A financial system consists of several norms and practices. Individuals use it to finance better.
Impact of Financial System on Economy
The financial system definitely impacts economic development. It promotes economic growth and technological progress. It is important for saving rate, pooling of savings and capital inflow.
Countries with better financial systems grow faster. It reduces poverty across the country and reduces risk by reducing vulnerability.
Role of Central Bank in Financial System
The Central bank is a public institution. It manages monetary policy and flow of currency across the country.
Here are few key responsibilities that central banks have:
- Central banks set several goals for the stability of the economy. This includes setting interest rates to boost growth.
- Central banks can issue currency. They do this to inject liquidity and stable exchange rates.
- Central banks ensure that financial laws are respected. They also monitor payment systems to ensure it is working.
Risks in Financial System
Financial institutions face several risks including operational, legal, reputational and credit risks. The severity of the risk depends on several factors. These are the size of business, complexity and nature.
Here are few risks in financial system:
Market Risk:
It is the potential for an investment to fall over time due to market factors. Some of the market risks are commodity prices, exchange rates, indices etc.
Compliance Risk:
Compliance risk is the risk of not following the standards and policies. It is related to the risk of financial consequences due to non-compliance.
Legal Risk:
This risk is non-compliance to tax laws, contract acts, corporate laws etc.
Technology Impact on Financial System
Over the years technology has been impacting the financial system progressively. Technological evolution has changed the way transactions happen and how funds are managed.
1- Accessibility
Technology has evolved financial services. Now people can access banking and payments remotely.
2- Speed
With digital wallets, financial transactions are faster because of money transfer Companies like Tangopay. It eliminates all the delays of traditional banking. It’s faster and more manageable.
3- Inclusion
Technology has played a big role in extending financial services to the underserved population. It bridges the gap between the banked and unbanked population.
4- Data Analytics
Big data and analytics enables financial institutions to make data driven decisions. These decisions are crucial in risk assessment.
Financial Instruments in Financial System
Financial instruments can be used or traded as capital. Financial instruments make capital flow efficient.
Financial assets can be in any form including cash. They can also have the right to deliver or receive cash or any other financial instrument.
Types of Financial Instruments
There are two types of financial instruments. One is a cash instrument and the second is a derivative instrument.
Cash Instruments
- Value of cash instruments is affected by the market. This includes financial securities that can be traded. Some examples of cash instruments are stocks and bonds.
- Cash instruments also include loans and deposits offered by lenders and borrowers.
- One of the examples of cash instruments is checks.
Derivative Instruments
- Value of derivative instruments depends on the underlying. This includes interest rates, indices and assets.
- Derivative instruments also include call options. This derives the value of underlying shares and gives you the option to buy shares. You can buy these shares at a certain price and by a certain time.
- There are exchange-traded derivatives in the market too. This is a market where non-listed securities can be traded and priced.
Future of Financial System
The future of finance is heading towards a big change curve. Technology, especially blockchain, is driving this change. Our financial records are usually stored in one central place. Instead the concept of decentralised ledger is gaining momentum.
This means many copies of transaction records are stored in different computers globally. This makes the overall system more secure. This decentralisation brings transparency and keeps private information secure.
But moving from the current structure has its challenges. But there’s a need for change. The existing system has weaknesses especially on risk.
Conclusion
In summary, the financial system is a network of institutions. These institutions make money flow. It includes banks, markets and financial instruments like investments and loans.
But the financial system’s future is destined for change driven by technology. To lead this technological evolution tech companies and regulators must partner.
FAQs
What do you mean by financial system?
Ans. Financial system is a network of institutions, regulations and practices. It makes money flow in an economy.
What are the three main components of the financial system?
Ans. The three main components of financial system are:
- Financial Institutions
- Financial Markets
- Financial Instruments
What are examples of financial systems?
Ans. Some examples of financial systems are banking system, stock market, bond market, insurance market and regulatory bodies that oversee financial activities.
