Financial System

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In economics, the financial system is the system that allows the transfer of money between savers and borrowers.

Eight Basic Facts about Financial Systems

1. Stocks are not the most important source of external financing for businesses.

2. Issuing marketable debt and equity securities are not the primary ways in which businesses finance their operations.

3. Indirect finance is much more important than direct finance.

4. Financial intermediaries are the most important source of external funds.

5. The financial system is among the most regulated sectors of the economy.

6. Only large, well-established corporations have easy access to securities markets to finance their activities.

7. Collateral is a prevalent feature of debt contracts.

8. Debt contracts are extremely complicated legal documents that place substantial restrictive covenants on borrowers.

Financial Crises

Definition

Financial crises occur because a sharp increase in adverse selection and moral hazard problem. As a result, financial intermediaries are unable to channel funds to investors.

Characteristics of financial crises

  • Sharp declines in asset prices
  • Failures of many financial and non-financial firms.