The Structure of Financial System


The financial system is the backbone of an economy. Every economic activity in the country is dependent upon its financial system. The constituents of the financial system of a country are:

  • Financial institutions (specialized and non specialized) ;
  • Financial markets (organized and unorganized);
  • Financial instruments and financial services;
  • Procedures and practices adopted in the markets; and
  • Financial interrelationships

The financial system of a country is concerned with three basic things – Money, Credit, and Finance. ‘Money’ refers to the prevalent medium of exchange or the means of payment. ‘Credit’ implies the sum of money that is to be returned along with it the interest accrued. ‘Finance’ includes the monetary resources comprising debt and ownership funds of government, company, or a person.

Financial Institutions

These are the organizations which mobilize and deposit the savings, and supply credit or finance. These also provide various types of financial services.

Classification of financial institutions:

  1. Banking and non-banking financial institutions: Banking institutions are active participants in the economy’s payment system; their deposits constitute of a major part of the national money supply; and they can create money through deposits and credit. These features are not present in non-banking financial institutions.
  2. Intermediaries and non-intermediaries: Intermediaries act between savers and investors; they lend money and mobilize savings; their liabilities are towards the savers. On the other hand, their assets arise when they lend money.

Financial Markets

These are the centers or arrangements where buying and selling of financial claims and services takes place. Companies, financial institutions, individuals, and governments are the participants in these markets either directly or indirectly through brokers and dealers.

Classification of financial markets:

  1. Primary and secondary markets: In the primary market, the purchase and sale of a particular security is done for the first time. It is also known as the new issue market. Secondary markets deal in the securities that have been issued in the primary market before they enter the secondary market.
  2. Money and capital markets: Money markets deal in instruments which have short term maturity (up to one year). On the other hand, capital markets deal in securities which have maturity of over one year.

Financial Instruments

Financial instruments are the assets that have a monetary value and act as an evidence of the ownership of the underlying asset. They may also serve as contractual rights to accept or deliver the cash or any other financial instrument.

Classification of financial instruments

  1. Primary or direct:Investors issue the primary securities directly to the savers in the form of shares and debentures.
  2. Secondary or indirect:These securities are issued by the financial intermediaries to the ultimate savers as bank deposits, units, insurance policies, etc.