The Financial system is one of the most important inventories of modern society.

The phenomenon of
imbalance in the distribution of capital or funds exists in every economic system. There are areas or
people with surplus funds, while other areas or people are facing a deficit. A financial system functions
as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. It is
a composition of various institutions, markets, regulations and laws, practices, money managers,
analysts, transactions, and claims & liabilities.

The financial system helps determine both the cost and the volume of credit. This system can affect a
rise in the cost of funds, thus adversely affecting the consumption, production, employment, and growth
of the economy. Vice-versa, lowering the cost of credit can have a positive effect and enhance all the
above factors. Clearly, a financial system has an impact on the basic existence of an economy and its
citizens.

1. The Savings Function:

As already stated, public savings find their way into the hands of those in production through the
financial system. Financial claims are issued in the money and capital markets, which promise future
income flows. The funds, in the hands of the producers, resulting in the production of better goods and
services and an increase in society's living standards. When savings flow decline, however, the growth of
investment and living standards begins to fall.

2. Liquidity Function:

Money in the form of deposits offers the least risk of all financial instruments. But its value mostly
eroded by inflation. That is why one always prefers to store funds in financial instruments like stocks,
bonds, debentures, etc. However, in such investments (i) a greater level of risk is involved, (ii) and the
degree of liquidity (i.e., conversion of the claims into money) is less. The financial markets provide the
investor with the opportunity to liquidate the investments.

3. Payment Function:
The financial systems offer a very convenient mode of payment for goods and services. The check
system, credit card systems et al are the easiest methods of payment in the economy; they also
drastically reduce the cost and rime of transactions.

4. Risk Function:

The financial markets provide protection against life, health, and income risks. These are accomplished
through the sale of life, health, and property insurance policies. Overall, they provide immense
opportunities for the investor to hedge himself/herself against or reduce the possible risk involved in
various instruments.

5. Policy Function:

Most governments intervene in the financial system to influence macroeconomic variables like interest
rates or inflation. For example, the federal bank or a central bank does indulge in several cuts in CRR and
try to force the interest rates down and increase the availability of credit-at cheaper rates to the
corporates.

Conclusion:

Modern-day economies require huge sums of money for investment in capital assets (land, types of
equipment, factory, etc.), which are then used for providing goods and services. The funds required are
so huge that it's not possible for a single government/firm to meet the requirement. By selling financial
claims like stocks, bonds, etc., the required funds can be quickly raised from a variety of investors. The
business firm/government issuing such a financial claim then hopes to return the borrowed funds from
expected future inflows. Indeed, we see that the financial markets within the financial system have
made possible the exchange of current income for future income and transformation of savings into
investments so that production and income keep growing.