Class Reflection: 30th January, 2022

A financial system is a set of interdependent components that work together to facilitate

exchange of funds between the surplus unit (lenders/investors) and deficit unit (borrowers). The
major functions of a financial system include:
 Fund mobilization and optimum utilization of resources
 Bridging the gap between savings and investment
 Managing risk and liquidity
The system basically consists of 3 components:
1. Instruments: A financial instrument is basically a contract between the lender and
borrower. It provides security to the lender by guaranteeing repayment of the loan. For
example, if a company intends to raise capital, it has to deliver a financial to another
party instrument for the transaction to be completed. That is, one company is obligated to
provide cash, while the other is obligated to provide the instrument. For example- bond,
share certificates, T-bills, repo, certificate of deposit, securities etc.
2. Financial Intermediaries: A financial intermediary is the connecting link between
lenders and borrowers. To elaborate, financial intermediaries facilitate the transfer of
funds from individuals or businesses with excess capital to persons or businesses who
require cash to conduct specific economic activity. For example – banks, pension funds,
mutual funds, non-banking financial institutions etc.
In Direct Finance, borrowers gather funds directly from investors by selling them
financial instruments (for example, shares and bonds). On the other hand, if financial
intermediaries play an additional role in the transfer of funds, it is referred to as Indirect
Finance.
We also discussed the subsidiaries of IDLC to have a better understanding of financial
intermediaries. For instance, IDLC Securities only performs information intermediation;
IDLC Asset Management handles long-term investment of clients while IDLC Finance is
similar to a bank conducting Indirect Finance.
3. Financial Market: A financial market is a marketplace that brings together lenders and
borrowers for the sale and purchase of assets. They provide individuals, companies, and
even government with access to capital. Financial markets can be classified as stock
market, bond market etc.
The Global Financial Crisis of 2008 is the striking example of how the mismanagement of these
components devastated the whole financial system, leading to recession.