A financial system is composed of financial institutions and financial markets. When you talk of
the financial systems role in an economy you are indirectly addressing the role that financial
institutions and financial markets play in an economy.
I. Transmission of monetary policy
Because deposits are a significant component of the money supply, which in turn impacts on the
rate of inflation, depository institutions particularly commercial banks play a key role in the
transmission of monetary policy from the central bank. This may be through variation of the
reserve ratio (in order to increase or lower money supply)
II. Credit Allocation
A financial system offers the economy with a unique service as a major conduit of credit to
sectors of the economy that need special financing such as farming and real estate (Residential
specifically). Authorities in such cases may require that a significant portion of FIs assets be in
the areas identified.
III. Time intermediation intergenerational wealth transfer
Most countries offer relief and subsidies to encourage investments by savers in life insurance and
pension funds to enable the older generation to transfer wealth to the younger one.
IV. Payment services
Depository institutions and thrifts are special in that the efficiency in which they provide
payment services directly benefits the economy. Any breakdown in the payment systems (check
clearing of wire transfers) would result in harmful effects to the economy
NatalieR answered the question on February 9, 2022 at 09:00
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