The main task of the financial system: to channel financing from savers to investors
The financial system performs the essential economic function of channelling funds from those who are net savers (ie who spend less than their income) to those who are net spenders (ie who wish to spend or invest more than their income). In other words, the financial system allows net savers to lend funds to net spenders.
The most important lenders are normally households, but firms, the government and non-residents may also lend out excess funds. The principal borrowers are typically firms and the government, but households and non-residents also sometimes borrow to finance their purchases.
Funds flow from lenders to borrowers via two routes. In direct or market-based finance, debtors borrow funds directly from lenders in financial markets by selling them financial instruments, also called securities (such as debt securities and shares), which are claims on the borrower’s future income or assets. If financial intermediaries play an additional role in the channelling of funds, one refers to indirect finance. Financial intermediaries can be classified into credit institutions, other monetary financial institutions and other financial intermediaries, and they are part of the financial system.
One of the key features of a well-functioning financial system is that it fosters an allocation of capital that is most beneficial to economic growth. The infrastructure of the financial system refers to payment and settlement systems through which financial market operations are concretely carried out. A smooth and reliable functioning of payment and settlement systems promotes effective capital movements in the economy and thereby supports financial stability.
