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The financial system is devised of many markets, banks and businesses, all in the market for borrowing, lending and to supply services, in order to maximise there own, and clients utility from financial transactions. Primarily, the financial system is made up of five sectors that all interact; households (personal), firms (commercial), public (government), financial (banks) and overseas. When all five interact with the assistance of intermediaries, brokers, dealers and regulators, the central part of the financial system is made. In order for an effective financial system to exist, three main features must exist; firstly, monetary systems are vital in order to provide an efficient medium for exchange goods and services, secondly, efficient and complete financial markets which provide the transfer of financial assets, and finally, the ability to facilitate capital formation, whereby excess capital provided by savers can be made available to borrowers (investors). A crucial aspect to the financial system that allows efficient allocation of resources within the economy is the number of financial inter-relationships between the five sectors that make up the economy. Carter described the financial system as a ‘set of inter-related financial institutions, markets and exchanges, all of which are in competition with each other to provide services’ (Carter, p.9). Additionally, it could also be said that the financial system consists of a network of financial links between economic units- it is a web of debt and shares. It is a superstructure erected on the basis of real wealth in the community. ‘The form of social accounting statement which exposes the basic structure of the financial system is the national balance sheet’ (Revell, p3) as it summarises the position which organisation has reached as a result of past activity and is concerned with the stocks of assets and liabilities. With all these financial inter-relationships existing within the economy, competition for savings is fierce with investors and other financial institutions all taking on riskier projects in order to maximise returns to savers. Financial institutions within the economy play a pivotal role, which capsulate the mechanisms by which facilitation of payments are made. The term used to describe these financial institutions is intermediary. Financial intermediaries refers to institutions such as banks, insurance companies, pension funds, mutual funds, finance companies and investment banks, who all borrow from consumers, companies and governments that have deficits in order to invest with those resources. Within each of the listed examples come products and services aimed at certain types of people and firms, with only major banks having the facility to service government debt liabilities, but the principle of financial intermediation applies to them all. But before I go into specific examples of intermediaries and how they work, ill take a closer look at a couple of general methods adopted that helps aide the efficient allocation of resources within the economy, these are, firstly maturity transformation, followed by risk transformation; Within the economy, lenders (savers) desire the ability to recoup their resources at short notice, while on the other hand, borrowers generally look to the long term in order to make good the original loan as well as additional profits expected from the venture. The job of the intermediary is to bridge this problem through allowing lenders to invest in the short run, with the pooled together short term deposits, larger and long term loans are made available to borrowers.
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