Definition and Functions of the Financial Sector

The financial sector is the interaction of markets and all therein, within a regulatory framework. This interaction usually entails lending and borrowing both long and short term. This is accomplished through financial intermediaries (banks and other financial institutions) providing a link between households, firms and governments in transferring funds from savers to borrowers, for consumption and investment purposes. The main functions of the financial sector are: Mobilisation of savings: Financial intermediaries allow individuals to save money in a secure place, which when accumulated is lent to firms and individuals. Risk management: Financial Intermediaries manage risk by lending to a large number of borrowers. They are able to cover risk and absorb the defaults through interest earned on other loans. Expert advice: Financial Intermediaries are able to acquire information about competing investment opportunities and relay the information to individuals, reducing their information cost. This also aids in ensuring capital are allocated efficiently and to the right projects. Monitoring borrowers: Financial intermediaries monitor the performance of firms, individuals and other borrowers. Facilitating the exchange of goods and services: This is accomplished via the ability of financial intermediaries to reduce information and transaction costs, which spurs an increase in transactions.

The functions of the financial sector are to reduce risk in economic life by providing insurance protection, to assist the government in stabilising the economy, to create mechanisms for payments for goods and services. The informal sector includes economic activity which takes place outside the stipulations of markets. That is, they are not officially regulated.
Role of the financial sector What distinguished financial institutions from other firms is the relatively small share of real assets on their balance sheets. Thus, the direct impact of financial institutions on the real economy is relatively minor. The indirect impact of financial markets and institutions on economic performance is extraordinarily important. The financial sector mobilizes savings and allocates credit across space and time. It provides not only payment services, but also enables firms and households to cope with

economic uncertainties by hedging, pooling, sharing and pricing risks. An efficient financial sector reduces the cost and risk of producing and trading goods and services and thus makes an important contribution to raising the standard of living.