FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT

FINANCIAL SYSTEM AND ECONOMIC DEVELOPMENT 

Financial sector acts as a mediator between those who have surplus funds and those who are in needs of funds. It is a very critical element in an economy. There are people who spend less than their income and others who spend more than their incomes. Banks intermediate between them. Households are main savers however firms, government and foreigners may also save to some extent. Similarly, firms and government act as borrower but sometimes households and foreigners also borrow. There can be two types of finance:

(a) Direct Finance: 

When lender and borrower are in direct contact with each other without any mediocre and lender gives loan to borrower in lieu of a commitment on its assets or income in future, it is called direct finance. For example, when companies sell their securities, it takes form of direct finance. 

(b) Indirect Finance: 

When lender and borrower are not in direct contact of each other and lending and borrowing happens through a financial intermediary which may be a bank or non bank institution, it is called indirect finance. 

    Being a student of accountancy, you are aware that what is asset for one becomes liability for the other. Same is applicable for securities which are assets for lender and liabilities for borrower. It is necessary to shift funds from savers to investors because those who have additional funds are gifted with the ideas or ability to utilize these funds in a productive way and those who have such ability may not have funds. Therefore, they actually complement each other. If there is no financial market, savers and borrowers will be in a difficult situation. Both will be losers if there are no financial markets: borrowers and lenders. It will decrease overall utility and aggregate benefit. 

    Financial markets are also important for consumers. Those who want to buy goods and services on credit also seek help of financial markets. On saves throughout life and takes a house when he is 75, is it useful? The better option is there with financial markets that buy a house at age of 25 and keep paying installments for 40 years and in this way he could enjoy the house throughout his life. 

    Financial markets are equally beneficial for savers who will get zero or low interest in absence of financial markets. Financial intermediaries give safety to their funds along with interest. 

    Therefore, availability of finance increases overall productivity in the economy. It leads to greater efficiency. They improve overall well-being of consumers. They enhance overall utility and welfare in the economy. 

    Hence a well developed financial is extremely important in the efficient working of an economy.