The Financial System's Role in Economic Growth

The Savings-Investment Relationship

The financial system helps efficiently direct the flow of savings and investments within the economy. Here, financial institutions like banks play a major role. They allow depositors to invest money in various deposits, such as Fixed Deposits (FDs) and Recurring Deposits (RDs), by offering attractive rates of interest. These savings are then channeled by the banks to provide credit to different business entities involved in production and distribution.

Fostering the Growth of Capital Markets

Business entities require capital for funding business activities and production. Businesses require two kinds of capital:

• Working capital
• Fixed capital

Therefore, various business entities use the financial system to raise funds for both short-term and long-term monetary requirements.

Facilitating Foreign Exchange Markets

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

Supporting Infrastructure and Economic Growth

The financial infrastructure has a strong bearing on economic growth. The financial infrastructure signifies the three main pillars of the economy:

• Financial assets
• The financial market
• Financial intermediaries

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, serving as a link between savers and investors and also facilitating the transfer of resources between them.

Driving Trade Development

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