What Is the Role of the Financial System in Economic Development?

Economic development is partially dependent on the financial system to help mediate the transfer of money to areas of the economy that need it most. The financial system has a number of key functions, which help facilitate these shifts in money that are important for sustainable economic growth.

Savings

The financial system allows you to place your excess money into a savings account in a bank of your choice. Keeping your money in a bank safeguards your savings, and the bank pays you interest based on the amount you keep in your account.

Loans

Money in deposit accounts, like savings accounts, is used to provide loans for a wide range of projects to people and businesses. Mortgages, car loans and student loans are financed largely by deposits in banks, savings institutions and credit unions.

Investments

The financial system also facilitates the transfer of money from investors to businesses. When businesses raise capital, they sell stock to investors. Investors give their money to the company in exchange for ownership in the company.

Business Growth

Businesses may expand their operations or finance growth by issuing debt instruments called bonds. Bonds are bought and sold through the financial system. Bond markets allow businesses to access investor capital to finance their growth, while bond investors have an opportunity to profit from helping finance business expansion.

Government Expenditure

Governments may finance programs or deficit spending through the financial system by issuing bonds to raise money. Investors may buy government bonds to own a part of government debt, and collect interest payments from the government. In turn, the government has the money it needs to continue to function.

References

• European Central Bank Chief speech on the role of financial systems in economic development
• "Principles of Finance;" Scott Besley, Ph.D.;1999
• "Financial Markets and Institutions;" Jeff Madura, Ph.D.;2009