The financial system consists of:
- financial actors such as banks and insurance companies
- financial markets such as the capital and foreign exchange markets
- financial infrastructure in the form of technical systems and the regulations and routines required to make payments and exchange securities
- financial regulatory frameworks in the form of legislation, regulations and other standards.
The financial system has three basic functions:
- mediating payments
- converting savings into funding
- managing risks
The financial system helps households and companies when they need to pay for goods and services. The banks are primarily those who mediate payments. The mediation of payments can only work if the technical systems, that is the financial infrastructure, are functioning.
Converting savings into funding
Converting savings into funding means that the financial system receives savings from households and companies. These savings can in turn be loaned to fund consumption and investments. Households can, for example, save by making deposits at a bank or by buying securities on a market, and they can take bank loans to fund the purchase of a house or flat.
The financial system helps households and companies to spread and redistribute risks to those financial actors that are interested in bearing these risks in return for payment. Risk management has become increasingly important as the financial markets have developed. If risk management did not work, many transactions would become more difficult or perhaps impossible to carry out at all.
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