Friday, 30 December 2016

Various Functions Performed By Financial System

The functions performed by a financial system are: 

The Savings Function:

The public savings find  their way  into  the hands of  those  in production  through  the financial system. Financial  claims  are  issued  in  the money  and  capital markets which promise  future income flows. The funds in the hands of the producers result in production of better goods and services,  increasing  society's  living  standards.  When  savings  flows decline,  however,  the growth of investment and living standard begins to fall. 

Liquidity Function:

Money in the form of deposits offers the least risk, of all financial instruments. But its value is most  eroded  by  inflation.  That  is  why  one  always  prefers  to  store  the  funds  in  financial instruments  like  stocks,  bonds,  debentures,  etc.  The  compromise  one  makes  in  such investments is (1) that the risk involved is more, and (2) the degree of liquidity, i.e. conversion of  the  claims  into  money  is  less.  The  financial  markets  provides  the  investor  with  the opportunity to liquidate the investments. 

Payment Function:

The  financial system offers a very convenient mode of payment  for goods and services. The 
cheque system, credit card system et al are  the easiest methods of payments  in  the economy. The  cost  and  time  of  transactions  are  drastically  reduced.  In  India,  the  cheque  system  of payment  is  widely  practiced.  The  credit  card  system  has  entered  only  urban  India  and  is widely used in these areas for payments of consumption expenditure. 

Risk Function:

The  financial  markets  provide  protection  against  life,  health  and  income  risks.  These are accomplished  through  the  sale  of  life  and  health  insurance  and  property  insurance policies. The financial markets provide immense opportunities for the investor to hedge himself against or reduce the possible risks involved in various investments. 

Policy Function:

India  is  a mixed  economy.  The  government  intervenes  in  the  financial  system  to influence macroeconomic variables like interest rates or inflation. In 1996-97, by bringing about several cuts in the CRR from 12% to 10% the government, the RBI has tried to force the interest rates down and increase the availability of credit to the corporates at cheaper rates. 

Modern  day  economies  require  huge  sums  of money  for  investment  in  capital  assets (land, equipment,  factory,  etc.) which  are  then  used  for  providing  goods  and  services. The  funds required  are  so  huge  that  it  is  not  possible  for  a  single  government/firm  to provide  for  the requirement.  By  selling  financial  claims  like  stocks,  bonds,  etc.  the required  funds  can  be quickly  raised  from  a  variety  of  investors.  The  business firm/government  issuing  such  a financial claim then hopes to return the borrowed funds from expected future inflows. Indeed, we see that the financial markets within the financial system have made possible the exchange of  current  income  for  future  income  and transformation of  savings  into  investments,  so  that production and income grow. 

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