Advantages and disadvantages of the financial system

  • Mar 30 2022
  • by
  • Analyst AZA
Advantages and disadvantages of the financial system

Advantages and disadvantages of the financial system

This article will provide the reader with a basic understanding of the financial system, its advantages, and its disadvantages. First, financial markets have both positive and negative effects on the real/mainstream economy. Before discussing the implications, we will first explain the operation of the financial system and its functions. The main function of the system is to transfer capital from depositors of funds to users of funds. It is made up of different economic units that perform different tasks to ensure the efficient distribution of funds. Households are a critical sector of the system, as they accumulate most of the capital. For example, suppose consumer deposits $100 for a 10-year deposit, the money will be transferred to a unit borrowing money for the same term. Households are not donators of money all the time.

As they go through life cycles, they turn from participants into users of capital and vice versa. For example, when a human student takes out a loan from a bank to pay for tuition, at that point in time he is a scarce unit, but when he spends more money than he earns, he becomes a surplus unit. But overall, the household sector is a net provider of capital to the financial system. The business sector is considered a user of capital because it uses the money received from the system to generate profits for business owners. The public sector can be either in deficit or in surplus. In the United States, at the municipal level, they are known to be savers, by contrast, at the federal government level, they are deficit players. There are many financial instruments that contribute to the system's ability to move the capital to the right places.

Tools allow participants to adjust their positions. We have debt and equity instruments. Equity instruments are instruments in which an investor owns part of a company and his/her profitability will be determined by the performance of the firm, if the firm performs poorly it will also experience erosion of their positions. Debt instruments provide the holder with a fixed regular payment from profits, such instruments are mainly owned by large institutional investors. We have a bond market that makes it easy to trade bonds of different maturities and different companies or countries. We also have a money market that facilitates the trading of bonds with maturities of less than a year. We have a mortgage market that gives an idea of ​​the housing market. We have the stock markets that were explained earlier.

We also have systematically important financial institutions whose activities are sensitive to the system. When one of the SIFIs experiences a shock in its business, it will spread to the entire system, this was proven during the 2008 crisis by the fall of the Lemans brothers. Commercial banks play an important role in ensuring the smooth operation of the system. They are an intermediary between the financial system and the real economy. Monetary policy is carried out through commercial banks. Financialization is a term that refers to the transition of a country from an industrially oriented to a financially oriented one. Financialization is the reason for the lack of innovation and development in the mainstream economy. These innovations create employment opportunities and narrow the gap between the rich and the poor. This lack of development is largely due to the reduction in lending to small businesses.
The financial system serves itself, not the local economy. The largest corporations borrow money from the system to engage in speculative activities rather than innovative, job-creating investments. In emerging economies, the adoption of a financial system based on economics can be detrimental to a country's development. Most companies in developing countries are in the 3rd industrial phase. Most of the developed countries are 4 industrial economies that are very technically advanced and mostly service-based. Technology can have both positive and negative effects on a nation. First, in emerging economies, unemployment is still at a higher level, and as technology will introduce machines, people will lose their jobs. Policies that encourage floating investment rather than fixed investment also contribute to the negative effects caused by the system.

When companies and institutional banks invest in the economy with fixed capital investments that create jobs, innovate, and improve the national infrastructure. This will be a step towards narrowing the gap between the haves and have-nots. Skill development is also a critical factor for an effective transition. If developing countries invested in the education and development of FinTech, this would solve the problem of unemployment. Professions that can implement technologies such as digital marketing coding, research, etc. are in demand. Even if the opportunities are limited in their country, they can export their services to other countries. The financial crisis of 2008, which was caused by the financial system, had a strong impact on the real economy. Financial institutions were rescued, but the impact on the real economy was lasting.

Financial institutions are posting record growth, while credit to businesses and households has declined. After the crisis, one would expect regulators to introduce rules limiting the amount of risky trading that takes place in the shadow banking system (the shadow banking system is the unregulated investment part of institutions). Although this was not the case, after the crisis, investment in risky assets increased by a significant amount, including with institutions that are involved in risky projects such as hedge funds. The philosophy created by Karl Marx asserts that the rise of capitalism will be the fall of the system. This prophecy almost came true during the 2008 financial crisis. The solution applied to this crisis was the introduction of rules like Dodd-Frank, but in order to effectively get rid of the fear of such terrible crises, we need to put in place systems that make financial market participants think in the long term.

And change some of the ingredients that make short-term investments more costly than long-term ones. We can increase the tax on short-term instruments, which will reduce short-term speculation and encourage institutions to get involved in projects that support small businesses and create jobs for the poor. We must pursue policies that limit the culture of amplifying lobbying efforts, which forces political parties to act in the interests of the party and take actions that do not benefit the people on the ground. Decisions like this will make many countries' economies more sustainable and their populations happier, which I think leaders should be aiming for, not just looking out for their pockets. 

Financial institutions are posting record growth, while credit to businesses and households has declined. After the crisis, one would expect regulators to introduce rules limiting the amount of risky trading that takes place in the shadow banking system


imgaza youtube

Profitable trading recommendations, forex analytics for beginners traders

Subscribe our channel

top authors

Fundamental analyst

Stan Zabar
Fundamental analyst

Head of Analysis Department

Michael Wallenberg
Head of Analysis Department

Economic Observer

Alan Dofine
Economic Observer

Call US Feedback
en de nl fr pt es it uk zh ko ja ar ru pl tr