77. An Introduction to the Financial System
A financial system has the primary function of channeling funds from
people who spend less than their income, and therefore have surplus funds,
to people who spend more than their income, and therefore have a shortage
of funds. Funds can be channeled directly with the help of financial
markets and instruments, or indirectly with the help of financial
intermediaries.
Financial instruments are claims on some future income or assets.
Financial markets are arrangements which permit financial instruments to
be traded. Some financial markets may involve only short-term
instruments, in which case they are called the money markets. The most
common instruments traded in the money markets are treasury bills,
negotiable certificate of deposits, and commercial papers. All of these
instruments have a maturity of less than one year. Longer-term instruments
are traded in the capital markets, which include stocks, corporate bonds,
and government bonds.
Unlike financial markets which provide places where borrowers and
lenders can meet directly, financial intermediaries stand between the
borrowers and the lenders. They do so by borrowing funds from the lenders
and then making loans to the borrowers. Examples of financial
intermediaries are commercial banks, insurance companies, mutual funds,
etc.
As directing flows of funds from savers to borrowers, the financial
system also transfers risks from one investor to another, and monitors uses
of funds. A well-functioning financial systeir^ therefore, can foster
economic growth not only by making more funds available for investment,
but more importantly by allocating fluids efficiently and hence improving
the economy's productivity.
