Functions of the Financial System:

From the above brief description it is easy to understand that the existence of a sound financial system is a pre-requisite for rapid economic development. A well- developed financial system can contribute significantly to the acceleration of economic development through three routs.

One, technical progress is endogenous; human and physical capital are its important sources; and the increase in them require higher saving and investment, which the financial system helps to achieve.

Two, the financial system contributes to economic development not only via technical progress but also in its own right.  The economic development greatly depends upon the rate of capital formation.  The relationship between capital and output is strong, direct and monotonic.  Capital formation depends on whether finance is made available in time, in adequate quantity, and on favourable terms - all of which a good financial system could achieve.

Three, it also enlarges the market over space and time; it enhances the efficiency of the function of exchange and thereby helps in economic development. In order to play such a crucial role in economic development, a financial system performs following  functions:

i) An important function of a financial system to link the savers and investors and thereby help in mobilising and allocating the savings efficiently and effectively.

By acting as an efficient conduct for allocation of resources, it permits continuous upgradation of technologies for promoting growth on a sustained basis.

ii) A financial system not only helps is selecting projects to be funded but also inspires the operators to monitor the performance of the investment.  It provides a payment mechanism for the exchange of goods and services and transfers economic resources through time and across geographic regions and industries.

iii) One of the important functions of a financial system is to achieve optimum allocation of risk bearing.  It limits, pools and trades  the risk involved in mobilising savings and allocating credit.  An efficient financial system aims at containing risk within acceptable limits and reducing the cost of gathering and analysing information to assist operators in taking decisions carefully.

iv) It makes available price-related information which is a valuable assistance to those who need to take economic and financial  decisions.

v) A financial system minimises situations where the information is asymmetric and likely to affect motivations among operators or when one party has the information and the other party does not.

vi) A financial system provides financial services such as insurance and pension and offers portfolio adjustment facilities.

vii) A financial system helps in the creation of a financial structure that lowers the cost of transactions.  This has a beneficial  influence on the rate of return to savers.  It also reduces the cost of borrowing.  Thus the system generates an impulse among the people to save more.

viii) A well-functioning financial system helps in promoting the process of financial deepening and broadening.  Financial deepening refers to an  increase of financial assets as percentage of the gross domestic product.  Financial broadening refers to building an increasing number and a variety of participants and instruments.