A financial system performs key functions to facilitate the flow of funds between surplus and deficit agents. These functions include allocating financial resources, managing risks, and promoting economic growth.
A financial system plays a crucial role in coordinating the flow of funds between surplus and deficit agents. The key functions of a financial system with regards to surplus and deficit agents include:
- Allocation of Financial Resources: The financial system helps allocate financial resources by facilitating the transfer of funds from surplus agents (individuals, businesses, government) to deficit agents (borrowers). This is done through various financial intermediaries such as banks, credit unions, and financial markets.
- Risk Management: The financial system provides mechanisms for surplus agents to manage various types of risks. For example, surplus agents can invest in diverse portfolios to reduce the risk of loss. On the other hand, deficit agents can obtain insurance or use derivative contracts to hedge against risks.
Facilitation of Economic Growth: By efficiently channeling funds between surplus and deficit agents, the financial system stimulates economic growth. Surplus agents can earn returns on their savings, while deficit agents can access the capital needed for investment and expansion.