4.5.2 The role of the financial sector

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    Financial sector – the part pf the economy that provides financial services to commercial                             (businesses) and personal (individual) customers

     

    Generally, retail banks will lend to everyday consumers and small businesses. Investment banks will lead to larger companies and take larger risks. Insurance companies, the stock market, retail and investment banks are all part of the financial sector.

     

    It has many functions within society, which are summarised below:

    • To mobilise savings for lending to firms and individuals – financial markets aid the transfer of funds between economic agents. Saver’s money is used for loans with the belief it is ‘safe’ and they are rewarded with interest payments. Loans can be used for investment and consumption.
    • To lend to businesses for investment in working capital – this is usually in the form of an overdraft which firms can use to cover wages or trade credit whilst waiting for payments to come in.
    • To lend to individuals – consumers have access to larger amounts that they would not otherwise have e.g. credit cards. Another example of the financial sector and lending to individuals is mortgages.
    • To facilitate the exchange of goods and services – banks offer safe ways to pay for goods and services (credit/debit cards). Also, international fund transfers are simpler and bank transactions are immediate.
    • To assess creditor risk – banks use credit ratings to gain information on their consumers to assess the risk of lending. This can be used to determine an individual’s reliability, probability of repayment and potential losses.
    • To provide forward markets in currencies and commodities – banks can organise advance currency payments at a price decided in advance, one form of this may be direct debit payments (on a smaller scale). The currency market is also part of the financial sector.
    • To provide a market for equities – this is the trade of shares which occurs on the stock market. Equity markets provide access to capital for firms and allows investors to own one part of the part.

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