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Role of Financial System in Economic Development Research Team | Posted On Wednesday, May 01,2019, 11:37 AM

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Role of Financial System in Economic Development



The financial system plays a crucial role in the economic development of a country. Businesses and industries are financed by the financial systems which lead to growth in employment and in turn increase economic activity and domestic trade. Financial intermediaries help improve investment efficiency, leading to higher economic growth.

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Role of Financial System in Economic Development

Given below are the roles of the financial system in the growth of the country:

Savings-Investment Relationship:

The Financial system helps efficiently direct the flow of savings and investments in the economy. Here financial institutions like banks play a major role. They allow depositors invest money in various deposits like FDs and RDs by offering attractive rates of interest. These savings are then channelized by the banks to provide credit to different business entities, which are involved in production and distribution. Banks help in the allocation of resources across different sectors of the economy.

Growth of Capital Markets:

Business entities require capital for funding business activities and production. Businesses require two kinds of capital: Working capital and Fixed capital. Therefore, various business entities use the financial system to raise funds for both short term and long term money requirements.

Foreign Exchange Markets:

The foreign exchange market helps exporters and importers raise and receive funds for settling transactions. It also enables banks borrow money and provides funds to different types of customers in various foreign currencies like Dollars or the Euro. The market also provides opportunities for banks to invest short term idle funds and earn profits. Even governments have benefited as they can meet their foreign exchange requirements through this market.

Government Securities:

The financial system enables the government raise funds, helping them borrow at a lower rate of interest. The state and the central government can raise short term and long term funds from the government securities market, to finance capital requirements by issuing bills and bonds. The government can also borrow funds from the money market by issuing treasury bills. These instruments offer attractive rates of interest. Therefore, the money market, the capital market and the foreign exchange market help in the development of trade, industry and commerce within and outside India, ensuring the development of the economy.

SEE ALSO: Basics of Financial Planning

Infrastructure and Growth:

The financial infrastructure has a strong financial bearing on economic growth. The financial infrastructure signifies the financial assets, the financial market and the financial intermediaries which are the three main pillars of the economy.

Financial Services play a crucial role by providing funds for the growth of infrastructure and industry. The financial market provides the mechanism for trade in financial assets through financial intermediaries, by serving as a link between savers and investors and also facilitating the transfer of resources between them.

Trade Development:

The financial system helps in the development of both domestic as well as foreign trade and also industry and commerce. The financial institutions provide funds to traders through the financial market, which issue financial instruments like treasury bills and commercial papers. Pre-shipment and post-shipment finance by commercial banks helps foreign trade. Letter of credit (LCs) is issued in favor of importers.

The financial system facilitates the exchange of documents between sellers and buyers through banks. The buyer does not need to meet the seller to complete negotiations. These transactions help the economy grow faster.

Employment growth:

A properly functioning financial system helps generate more employment opportunities within the economy. The financial system helps provide funds to the growing business houses and industries, which results in an increase in production. Consequently, it generates more employment opportunity for both the organized sector as well as the unorganised sector. Increase in business and industrial activity leads to various employment opportunities like sales, marketing, advertisement and so on. Funding availed by startups helps create additional employment opportunities.

SEE ALSO: Importance of Financial Planning

Venture Capital:

Startups have grown big time in India. However, securing funds for growth is one of the major challenges faced by startups. The main reason is lack of sufficient venture capital in India. The economic development of the country will be faster when more business ventures are funded and promoted. This capital deficit can be solved when more financial institutions contribute a part of their funds for the promotion of new ventures. In this way the financial system allows the creation of venture capital.

Balances Economic Growth

Economic development needs balanced growth which can be attained by propelling growth in all sectors, simultaneously. The financial system helps allocate savings into investment channels. It helps in mobilizing savings and make better use of these funds by allowing investments in various sectors of the economy. The financial system helps channelize available funds, thus leading to productive use of money by distributing it across sectors in such a manner, that there is balanced growth in industries, agriculture and service sector.

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