The first post in this series emphasized the significance of transfer of money from the savers (investors) to the borrowers and the second one talked about various instruments (financial assets) available for such transfer. Now let us look at the system that facilitates the interaction between the two groups. An economy is divided into three sectors: (a) household sector, comprising of individuals; (b) business sector, comprising of various business enterprises and (c) the government. Each of these sectors constitute entities who save as well as borrow. For example some individuals save whereas some others borrow. Same is the case with business units and the government. So lending (same as saving) and borrowing happens among the three sectors as well as within the three sectors. However, household sector is almost always net saver (with savings exceeding the borrowing) and the government almost always net borrower.
In order to have smooth interaction between the lenders and the borrowers, the following becomes necessary:
(a) proper instruments to facilitate the interaction
(b) a platform for them to interact, and
(c) well-defined rules and regulations
We have already discussed about the instruments (financial assets). Financial markets and various financial institutions provide the platform for interaction among the lenders and borrowers. Financial markets can be divided into primary market and secondary market. Financial institutions take various forms like commercial banks, insurance firms, mutual funds etc. Various regulators like RBI, SEBI, FMC, IRDA etc. are involved in framing rules and regulations and ensuring their implementation. Thus the system comprising of financial markets, financial institutions and regulators is known as 'The Financial System'. Every country has its own financial system, even though the level of development of these systems differ from country to country. In the absence of a well-developed financial system, the basic economic process of capital formation becomes constrained.
In order to have smooth interaction between the lenders and the borrowers, the following becomes necessary:
(a) proper instruments to facilitate the interaction
(b) a platform for them to interact, and
(c) well-defined rules and regulations
We have already discussed about the instruments (financial assets). Financial markets and various financial institutions provide the platform for interaction among the lenders and borrowers. Financial markets can be divided into primary market and secondary market. Financial institutions take various forms like commercial banks, insurance firms, mutual funds etc. Various regulators like RBI, SEBI, FMC, IRDA etc. are involved in framing rules and regulations and ensuring their implementation. Thus the system comprising of financial markets, financial institutions and regulators is known as 'The Financial System'. Every country has its own financial system, even though the level of development of these systems differ from country to country. In the absence of a well-developed financial system, the basic economic process of capital formation becomes constrained.
I liked the macro level approach of an economy you have explained, I would love to here some more on this Sir. In particular I would be happy to hear about the incentives for the householders who save that is Interest, and how interest is used by the RBI to control inflation (recently I see that RBI is increasing the interest rate a lot, which I think is a tool to cut down the inflation in the economy if I am not wrong) and the effects of the interest rate movements on stock price and Indian currency (I have been seeing Indian currency depreciating from past three months, one reason being the US$ appreciating due to European crisis. But I am not sure how RBI can control the depreciation of Indian currency? does Interest rates play any role in stopping the depreciating?).
ReplyDeleteSushma...Thank you very much for your comments. You have raised questions on some very important and fundamental concepts. It deserves detailed explanation and I will post a new blog on the same. Meanwhile, I suggest you read the chapter on 'Managing International Risk' in 'Principles of Corporate Finance' by Richard Brealy & Stewart Myers. I have not come across any other book, which explains these relationships better.
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