How does the financial system function and why does a financial crisis occur ?

Financial system function

The main role of financial system is to allow funds to allocated, invested and moved between economic sectors. That is financial system that allows exchange of funds between financial market participants. The financial system includes banks, financial markets, financial instruments and financial services. The main functions of financial systems are;

Saving function: The savings to public for instruments issued in market and promise to give future cash flow. The funds hands to investment and increase standard of living.

Liquidity function: Financial market give opportunity to liquidate the investment. But, funds in the form of stock, bonds, debentures have higher level of risk and less liquidity.

Risk function: Financial market are protection against income risk ,life and health. The investors to hedge against possible risk in various instruments.

Payment function: It is very easy mode of payment of goods and service. The various payment methods like check , card are allowed.

Policy function: The government intervene to influence macroeconomic variables. Mainly macroeconomic variables are interest rate and inflation.

Financial Crisis

The financial crisis occurs the value of financial institutions drop rapidly. It often to stock market crashes, sovereign defaults, currency crises, banking panics and large withdrawals. Financial crisis affected to country or a segment of financial services and spread in globally.

Causes of financial crisis

• The excess leverage leads to banking crises. Bankers will squeal, profit will fall, transactions slow are the banking crises.
• The financial market failures also lead to financial crisis, That is irrational exuberance among agents and other matters.
• Structural changes in global economy.
• Failures of rating agency
• Interest rates too low rate
• Global imbalance and securitization
• Imprudent mortgage lending and housing bubble
• Loss of confidence to liquidity problem
• Rapid decrease in equity market prices
• Taxes and subsidies also affect the financial needs.