Meaning, Definition, Services, and Functions of Financial System

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A financial system is a network of financial institutions, financial markets, financial instruments, and financial services that facilitate money transfer. This system includes end users of saver, arbitrator, device, and money. The level of economic development depends largely on the basis and it facilitates the economy of the prevailing financial system. Proper circulation of funds is necessary for the economic development of the country. Do you study to learn: If Yes? Then read the lot. Let’s Study Meaning, Definition, Services, and Functions of Financial System. Read this in the Hindi language: वित्तीय प्रणाली का अर्थ, परिभाषा, सेवाएं, और कार्य। 

The concept of Financial System Discussing the topic: Meaning, Definition, Services, and Functions of Financial System.

Use of effective circulation and wealth promotes industrial development of the country, which supports economic development. If money is not transmitted effectively in the economy, money will be seized, which will negatively affect economic development, in which the establishment and development of industries can be blocked.

Effective circulation, effective use of money is equally important. Economic development cannot be possible if the circulated wealth is not used properly in the producing areas. The financial system helps in spreading the wealth in the economy.

#Meaning of Financial System:

The financial system refers to set of complex and interconnected components consisting specialized and non-specialized financial institutions, organized and unorganized financial markets, financial instruments and financial services. The aim of the financial system is to facilitate the circulation of funds in an economy.

It is concerned about money, credit, and finance. Money refers to the medium of exchange or mode of payment. Credit refers to the amount of debt which is returned along with the interest. And the finance refers to the monetary resources comprising the own funds and debts of the state, company or a person.

The efficient financial system and sustainable economic growth are corollaries. The financial system mobilizes the savings and channelizes them into productive activity and thus influences the pace of economic development. Economic growth is hampered for want of an effective financial system. Broadly speaking, financial system deals with three inter-related and interdependent variables, i.e., money, credit, and finance.

#Definition of Financial System:

According to Amit Chaudhary,

“Financial system is the integrated form of financial institutions, financial markets, financial securities, and financial services which aim is to circulate the funds in an economy for economic growth.”

According to Dhanilal,

“Financial system is the set of interrelated and interconnected components consisting of financial institutions, markets, and securities.”

The financial system provides channels to transfer funds from individuals and groups who have saved money to individuals and group who want to borrow money. Saver (refer to the lender) are suppliers of funds to borrowers in return with promises of repayment of even more funds in the future.

Borrowers are demanders of funds for consumer durables, house, or business plant and equipment, promising to repay borrower funds based on their expectation of having higher incomes in the future. These promises are financial liabilities for the borrower-that is, both a source of funds and a claim against the borrower’s future income.

#Services Provided by the Financial System:

The following Services from Financial System is given below:

Risk Sharing:

The Financial system provides risk sharing by allowing savers to hold many assets. It also means the financial system enables individuals to transfer risk.

Financial markets can create instruments to transfer risk from savers to borrowers who do not like uncertainty in returns or payments to savers or investors who are willing to bear the risk.

The ability of the financial system to provide risk-sharing makes savers more willing to buy borrowers’ IOUs. This willingness, in turn, increases borrowers’ ability to raise funds in the financial system.


The second service that financial system provides for savers and borrowers is liquidity, which is the ease with which an asset can be exchanged for money to purchase other assets or exchanges for goods and services. Most of the savers view the liquidity as a benefit.

If an individual needs their assets for their own consumption and investment, they can just exchange it. Liquid assets allow an individual or firm to respond quickly to new opportunities or unexpected events. Bonds, stocks, or checking accounts are created by financial assets, which have more liquid than cars, machinery, and real estate.


The third service of the financial system is the collection and communication of information or we can say that it is the facts about borrowers an expectation about returns on financial assets. The first informational role the financial system plays is to gather information. That includes finding out about prospective borrowers and what they will do with borrowed funds.

Another problem that exists in most transactions is asymmetric information. This means that borrowers possess information about their opportunities or activities that they don’t disclose to lenders or creditors and can take advantage of this information. The second informational role that financial system plays is communication of information.

Financial markets do that job by incorporating information into the prices of stocks, bonds, and other financial assets. Savers and borrowers receive the benefits of information from the financial system by looking at asset returns. As long as financial market participants are informed, the information works its way into asset returns and prices.

#Functions of Financial System:

Functions and Role of the financial system, market are given below.

  • Pooling of Funds.
  • Capital Formation.
  • Facilitates Payment.
  • Provides Liquidity.
  • Short and Long-Term Needs.
  • Risk Function.
  • Better Decisions.
  • Finances Government Needs, and.
  • Economic Development.

Now each one Functions of the financial system are discussing on brief:

Pooling of Funds:

In a financial system, the Savings of people are transferred from households to business organizations. With these production increases and better goods are manufactured, which increases the standard of living of people.

Capital Formation:

Business requires finance. These are made available through banks, households and different financial institutions. They mobilize savings which leads to Capital Formation.

Facilitates Payment:

The financial system offers convenient modes of payment for goods and services. New methods of payments like credit cards, debit cards, cheques, etc. facilitate quick and easy transactions.

Provides Liquidity:

In the financial system, liquidity means the ability to convert into cash. The financial market provides the investors the opportunity to liquidate their investments, which are in instruments like shares, debentures, bonds, etc. Price is determined on the daily basis according to the operations of the market forces of demand and supply.

Short and Long-Term Needs:

The financial market takes into account the various needs of different individuals and organizations. This facilitates optimum use of finances for productive purposes.

Risk Function:

The financial markets provide protection against life, health, and income risks. Risk Management is an essential component of a growing economy.

Better Decisions:

Financial Markets provide information about the market and various financial assets. This helps the investors to compare different investment options and choose the best one. It helps in decision making in choosing portfolio allocations of their wealth.

Finances Government Needs:

The government needs a huge amount of money for the development of defense infrastructure. It also requires finance for social welfare activities, public health, education, etc. This is supplied to them by financial markets.

Economic Development:

India is a mixed economy. The Government intervenes in the financial system to influence macroeconomic variables like interest rate or inflation. Thus, credits can be made available to corporate at a cheaper rate. This leads to the economic development of the nation.

#Main Functions of Financial System:

The functions of the financial system can be enumerated as follows:

  • The financial system acts as an effective conduit for optimal allocation of financial resources in an economy.
  • It helps in establishing a link between savers and investors.
  • The financial system allows ‘asset-liability change’. When they accept deposits from customers, banks make claims against themselves, but they also make assets when providing loans to customers.
  • Economic resources (i.e., money) are transferred from one party to another through the financial system.
  • The financial system ensures the efficient functioning of the payment mechanism in the economy. All transactions between buyers and sellers of goods and services are easily affected due to the financial system.
  • In the case of mutual funds, the financial system helps in risk change by diversification.
  • The financial system increases the liquidity of financial claims.
  • The financial system helps in finding the prices of financial assets from the
  • contact of buyers and sellers. For example, the value of the securities is determined by capital market demand and supply forces.
  • The financial system helps reduce the cost of transactions.

As discussed above, financial markets play an important role in economic development through the role of capital allocation capital, supervising managers, saving savings and promoting technological change among others. Economists had thought that the development of the financial sector is an important element to encourage financial growth.

Financial development can be defined as the ability to obtain information effectively in the financial sector, implement contracts, facilitate transactions, and promote special types of financial contracts, markets, and arbitrators. Should be at a lower cost.

Financial development occurs when financial tools, markets, and intermediaries improve on the basis of information, enforcement and transaction costs, and therefore provide better financial services. Financial work or services can affect the economy’s savings and investment decisions through capital accumulation and technical innovation and therefore economic growth.

Capital accumulation can be modeled either through capital peripherals or capital goods, which are produced using constant returns, but without the use of any reproduction factors to stabilize static per-state growth.

Through capital accumulation, the steady growth rate in the work done by the financial system affects the rate of capital formation. The financial system affects capital accumulation either by either changing the savings rate or by reallocating the savings between capital production levels. Through technological innovation, focus on innovation of new production processes and inventions.

Because friction of the market and laws, rules and policies are quite different with the economies and the times, the impact of financial development on development can have different effects for the economy allocation and welfare in the economy. Read this in the Hindi language: वित्तीय प्रणाली का अर्थ, परिभाषा, सेवाएं, और कार्य। 

Meaning, Definition, Services, and Functions of Financial System.

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  • Appreciate it for all your efforts that you have put in this. very interesting info .

Nageshwar Das

Nageshwar Das, BBA graduation with Finance and Marketing specialization, and CEO, Web Developer, & Admin in