The formal financial system consists of the following components:
Financial Institutions: Their role is to allocate the funds effectively and act as intermediaries that facilitate and mobilize savings. Financial institutions can either be banking or non-banking.
Financial Markets: These financial markets are a mechanism that enables the participants to deal in financial claims. In these markets demands and requirements interact and then set a price for such claims. Financial markets are of 2 types i.e. primary and secondary markets.
Financial Instruments: It a claim against an institution or any person for payment at a future date of a sum of money or a periodic payment in the form of interest and dividend. Among financial instruments, financial securities are the ones that are negotiable and tradable.
Financial Services: These services are related to the borrowing and funding, lending and investing, selling and buying securities etc. Liquidity is an essential factor to smoothen the financial working system.
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The financial system of the country should also keep in mind the concept of optimum allocation of risk bearing. It limits and trades the risks involved in mobilizing savings and allocating credit. Risk reduction is achieved by holding diversified portfolios and proper screening of borrowers. Thus a financial system is a vertical management of a well-integrated chain of financial markets and institutions that provide the required financial facilities.
Article by Anisha Dutta
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