Dimension of well-functioning financial Systems
Financial sector development in developing countries and emerging markets is part of the private sector’s development plan for promoting economic growth and alleviating poverty. The financial sector consists of institutions, tools, and markets. It also covers the legal and regulatory framework that allows for credit-extension transactions. Fundamentally, financial sector growth is about overcoming “costs” incurred in the financial system. This process of lowering the costs of gathering information, enforcing contracts, and carrying out transactions leads to the establishment of financial contracts, intermediaries, and markets. Different kinds and combinations of information, transaction, and enforcement costs, together with varying regulatory, legal, and tax regimes, have inspired varied forms of contracts, intermediaries, and markets across countries at different periods.
A well-functioning financial system has complete markets with effective financial intermediaries and instruments, allowing investors to move money from the present to the future at a fair rate of return. Borrowers can easily obtain capital, hedges can offset risks, and traders can easily exchange currencies and commodities.
A country’s financial system serves five important purposes, including generating information about potential investments and allocating resources.
(ii) Monitoring investments and ensuring corporate governance after providing money.
(iii) Facilitates trading, diversification, and risk management.
(iv) Mobilizing and pooling savings.
(v) Enhancing the trade of commodities and services.
Financial sector growth occurs when financial instruments, markets, and intermediaries collaborate to lower the costs of information, enforcement, and transactions. A strong and well-functioning financial sector is a significant driver of economic development. It produces local savings, which result in constructive investments in local businesses. Furthermore, successful banks may route international private remittances. The financial sector therefore provides the foundation for income growth and employment development.
Well-functioning financial systems are distinguished by financial instruments that assist people in solving financial problems, liquid markets with low trading costs (operationally efficient), timely financial disclosures resulting in market prices that reflect available information (informationally efficient), and prices that move primarily in response to changes in fundamental value rather than liquidity demands. Well-functioning markets eventually lead to efficient allocations, which place resources where they are most useful.