Understanding Components Of Financial System – assets liabilities

The financial sector is responsible for the creation and exchange of financial assets and the liabilities as well as providing various forms of financial services. In the introduction of basic components of financial system, modern economics is said to consist of two inter related and mutually dependent economic sectors – the real sector and the financial sector.

The financial sector consists of all the financial intermediaries (agents) involved in the rendering of financial services by facilitating the flow of funds from savers (fund suppliers) to users (fund raisers). While the real sector is concerned with the flow of goods and non financial services.

Components Of Financial System

Although both sectors complement each other, the real sector is generally the first to develop its activities to a certain level. It can indeed operate without the financial sector as was the case in the barter economies of primitive society.

Without the financial sector, however, economic exchange would be time consuming and cumbersome. In the absence of a financial sector, exchange would require double, multiple or even higher order coincidence of wants. These short comings accounted for the early demise of the barter economy.

Conceptual Issues

Is the financial sector synonymous with the financial system? In considering the components of financial system, there is a considerable disagreement over this issue. For some people, both terms could be used inter changeably. Though related, the terms are distinct.
The financial sector refers mainly to the financial intermediaries and the facilitating institutions utilized by them in the task of promoting financial flow.

This function is carried out by the constraint of laws, rules and regulations. Such rules defines norms of behaviour for the participants and also determine their duties, rights and obligations. They constitute the legal and normative framework which encompasses the financial sector as well as the legal and normative environment for its operations constitutes the financial system.
By the components of financial system therefore, this means the generality of the financial agents or intermediaries that operate in the financial sector, the institutional facilities utilized by them as well as the network of regulation, rules and norms of behaviour which govern financial transactions and regular financial flows through the macro economy.

The system provides

facilities for direct and indirect interaction between savings surplus economic units and savings deficit economics units.
The saving surplus units of the economic are the units with more funds than they require for current consumption. Savings surplus units are therefore the ultimate savers and fund suppliers to the system.
Savings deficit units on the other hand, are those units that intend to invest or to spend more funds than currently accrues to them. Saving deficit are the ultimate fund users.

They are fund raisers who utilize the financial system to source for funds that will meet their capital requirements.
Interaction between both groups enables fund raisers to make up for shortfalls in funding by issuing various forms of financial claims on themselves in exchange for immediate supply of funds from others. Similarly, it creates opportunities for funds suppliers to acquire income yielding financial assets in exchange for idle cash balance.
Thus the system of interaction leads to the simultaneous creation of financial assets and financial liabilities. It gives rise to constant changes in claims and counter claims to financial assets. These changes represent financial flows which lubricate the wheels of modern trade and industry.

Structure And Functions Of The Components Of Financial System

Like similar systems, the world over the American financial system approximately a self perpetuating flow of funds of various maturities. Funds originate from saving surplus economic units, which are the fund suppliers and flow to ultimate fund raisers either directly or through various levels of intervening financial agents.
The fund raisers (users of fund) invest funds sourced from the system in various types of income earning assets. But they are obliged to compensate fund suppliers with the appropriate returns in form of interest or dividend income. Moreover, fund users have the additional obligation of final settlement of the initial sums raised.

Such compensating backwards flows to fund suppliers ensures a self perpetuating system because they constitute the primary source for the further outward flows to fund raisers.
They may however, be leakages out of the financial system as well as non autonomous injections into the system. Leakages occur when part of the backward flow of funds to fund supplier is ejected out of the system as happened when the foreigners repatriates dividends or interest income. Injections on the other hand, occur when the funds either earned or sourced abroad is brought into the system and made available to local fund raisers.

The (Five) 5 Components Of Financial System

The 5 components of financial system are as follows;

  1. The primary system participant
  2. Secondly, financial markets
  3. Thirdly, financial intermediaries
  4. Financial instruments and
  5. Lastly, financial system regulators.

Each of the above components of financial system is not one but rather a group of institutions. Thus each constituent represents a sub system of institutions, facilities and regulations. The financial system is crucial for the growth and development of modern economies, its primary functions includes the following;

Primary Functions Of Financial System

  • Firstly, to provide a forum, in essence, a market mechanism for the interaction of fund raisers and suppliers on mutually beneficial terms.
  • Secondly, to provide facilities for the creation custody, distribution and marketing of financial assets and liabilities.
  • To provide regulation, rules and operating procedures to guide such interactions.
  • To create an orderly transfer and delivery system for the exchange of financial instruments.
  • Lastly, to moderate the price structure of securities as well as the cost of raising funds.

Primary Operators

the primary operators in the financial system are the fund suppliers (fund savers) and the fund raisers. The Fund suppliers are those savings surplus economic units with more financial resources than they need for their current consumption. Also, Fund raisers, on the other hand, are the savings deficit economic units.
Fund raisers in the financial sector perform services that are similar to those of production units in the real goods sector. They draw funds from suppliers to promote various forms of direct investment activities.
To draw funds, the fund raisers issues various types of instruments which represents financial claims on themselves such as equity shares, bonds, commercial papers etc.

Fund suppliers are compensated in various forms of dividends, interest, capital gains etc.
Without the primary operators, there would be no financial flow and therefore no financial system in the strict sense of the word.

It is also necessary to note that in the components of financial system; No economic unit is permanently a fund supplier or permanently a raiser of funds. Positions keep shifting. But there are net suppliers and net raisers of funds;
Financial operators are usually not confined to one role. Some financial intermediaries often double as primary participants when they raise or supply funds in their individual capacities.

Suppliers of Funds

There are three major suppliers of funds, they includes the following groups;

  1. Individual and household units which account for the bulk of savings in modern society.
  2. Institutional investors like insurance companies, super annuation and pension schemes unit and investment trusts, isusu groups etc
    Banks of various types
  3. Primary mortgage institutions and
    Specialized government agencies that provide credit on ad hoc basis.

Fund Raisers

The components of financial system comprises of different actors, of which fund raisers are part of, the fund raisers use various instruments to attract funds. While small fund raisers rely on direct (personal) approach, the bigger fund raisers use securitized media. Securitized offers a lot of flexibility, a lot of impersonality and confidentiality. The major fund raisers are;

  • Business enterprises of various forms
  • Public corporations
  • Government (local, state and federal).

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