TheTaxHeaven Dictionary - Know the meaning of tax

Financial System

What is a financial system?

A financial system is made up of institutions like banks, insurance companies, and stock exchanges, which facilitate money transfers. It functions at various levels and is used by borrowers, lenders, and investors to fund projects and seek returns on their assets. It also has certain rules and practices which dictate the terms of financial transactions. 

Understanding Financial Systems

Due to limited economic resources, a financial system helps in allocating these efficiently. It assists the economy in growing and benefits its participants by: 

  • Facilitating payments

  • Offering interest to savers

  • Providing financial protection

  • Supplying financial information

  • Regulating the system

  • Ensuring liquidity and cash conversion

Financial institutions play a vital role in the financial system. They allow people to save and invest, creating more economic activities, jobs, and profits. Funds can flow from savers to borrowers in two ways: 

  • Market-Based

  • Centrally Planned

In a market-based financial system, securities are exchanged based on supply and demand. In a centrally planned system, a central authority decides on the investment of funds. Most economies have a mix of these systems.