Financial system and economic development:

The financial system is a critical element in a well-functioning economy. Financial sector and financial markets perform the essential function of channelling funds from people who have saved surplus funds by spending less than their income to people who have a shortage of investible funds because their plans to spend exceed their income.

The people who have surplus savings are called the lender-savers and those who borrow funds to finance their spending are referred to as the borrower-spenders. The most important source of surplus funds in an economy tends to be the households, but sometimes business enterprises, governments (central, state or local) as well as foreigners also sometimes have excess funds and so they also lend them out. The most important borrower-spenders are various businesses and governments at different levels; however, at times the households and foreigners may also borrow to finance their spending. 

One may ask why it is important to channelise the funds from savers to borrowers. The answer is as follows: the people who have surplus funds are generally not the people who have the idea about the profitable investment opportunities. The entrepreneurs who have these ideas tend to lack the funds to initiate the projects to make their ideas to take shape. In the absence of financial markets the savers and borrowers would find it very hard to transfer funds from a person who has surplus funds but does not have the profitable opportunities to invest  to one who and lacks adequate funds. The result would be that both would be stuck and both will be worse off the same will be true for the economy/society. Financial markets, thus, are essential in promoting  economic efficiency in any economy.

The existence of financial markets is also beneficial for someone who wants to borrow for a purpose other than starting a  business such as for buying a house. Overtime one may not have problem in saving enough for a house of one's dream but by  that time the person would have got too old to enjoy it fully. Without the financial markets, one will be stuck and would not be able to buy a house and therefore must continue to stay in the rented accommodation. If the financial market were to be set up in this situation then it will create an avenue for the persons with surplus to charge certain interest and make these funds available to the individual who wishes to buy the house and is ready to pay interest on the amount borrowed. Without the financial market the savers would have got no or very low rate of interest, the borrower on the other side, would not been able to buy the house as funds would not have been available to him. From this simple example we can understand the important function played by the
financial markets in an economy. So we can see that the financial markets contribute to higher level of production and efficiency in the overall economy. They also directly improve the well being of consumers by allowing them to time their purchases better.

Therefore it becomes very important that they operate to their best potential for realizing their full benefit for the economic  welfare of the society.