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Savings and the Financial System

Savings and the Financial System

When you go to a bank and deposit money in a savings account, it is an efficient financial system that ensures your money is kept safe. On top of that, it is an efficient economic system that gives you a savings return. This is not only for your savings account but everyone's savings in the economy. So what is the relationship between savings and the financial system? What do both mean, and how do they affect our economy? You'll find the answer to this and much more by getting to the bottom of this article!

Savings and the Financial System Summary

Here, we will provide a summary of how savings and the financial system operate, by breaking down everything into manageable chunks, so keep reading! For a nation's economy to keep growing, it has to generate capital, which consists of the many instruments, tools, and machines utilized in production. All of this production is conditional on the money available for investment. Savings and the financial system are essential in providing businesses and individuals the necessary funds to produce capital.

The term savings refers to the dollars made available due to individuals foregoing some of their consumption

The structure of our financial system is constantly being improved to better accommodate both savings and investors.

Individuals need to learn specific aspects of investment and the financial system, especially if they are considering saving money from now.

We have made an entire article on some of the basic Investment Considerations one must keep in mind. Check it out!

And if you're a beginner in investing, look no further than our article - Investing.

Today's financial system provides access to many different alternatives to invest your savings in.

A financial system refers to a set of institutions such as banks, insurance companies, etc., that enable the efficient channeling of funds from savers to investors.

Savings and the financial system are intrinsically connected. The financial system provides you with the bridge you need to be connected to individuals willing to borrow your money and pay you for having used your money. The household's savings are channeled to investors who are in demand of funds to expand their businesses or open a new startup through the financial system.

Savings and the Financial System Savings and the Financial System StudySmarterSavings and the Financial System, pixabay

There are many different methods for individuals to save money. They can open a savings account, purchase a bond, or buy a certificate of deposit, which is a document proving that an investor has made a loan with interest to a financial institution. Savers always get a receipt for their money in their savings accounts.

These types of investment options are referred to as financial assets by economists.

Financial assets are non-physical assets that gain value from a contract you make with the other party.

They represent claims on the borrower's property and income. The papers are considered assets since they constitute property that may be sold for a profit. They indicate the amount borrowed and the conditions under which the loan was made. Therefore, they reflect claims that may be brought against the borrower.

Components of Financial System

The main components of the financial system include financial institutions, financial markets, financial instruments, and financial services.

Financial institutions

Financial institutions bring investors and borrowers together, contributing to the efficient operation of the financial system. They do this by using a variety of financial instruments and, in the course of doing so, the services of multiple suppliers of financial services.

This may be done either directly or indirectly via the financial markets. They play an important role by contributing to the production of credit and the distribution of liquid assets. Additionally, they act as mediators in saving money and investing it.

Financial markets

A financial market is where new financial assets are generated, and existing ones are traded. The financial markets simplify buying and selling financial assets for buyers and sellers. The financial markets provide securities products that offer a return to those who have extra cash (investors or lenders) and make these monies accessible to those who need more funds (borrowers).

Financial Services

The field of financial services encompasses a wide variety of professional services, including credit rating, funding for venture capital, mutual funds, merchant banking, depository services, book building, and many more.

Through the use of various financial instruments, the functioning of the financial system is aided by the activities of financial institutions and financial markets. They need many financial services to be able to do the tasks that have been assigned to them. Consequently, financial services are regarded as one of the most important components of the financial system.

Financial Instruments

This is a significant part of the overall monetary and financial system. Products such as stocks, securities, and other financial instruments may be bought and sold in a financial market. Because the requirements of investors and those looking for credit are distinct, the markets include a diverse array of securities.

They represent a claim that will be made on the settlement of principle at a later time or on the payment of a regular amount by way of interest or dividends. Equity shares, debentures, bonds, etc., are some examples.

Financial Intermediaries in Financial System

Financial intermediaries in the financial system are a source of growth for any country's economy.

Financial intermediaries are financial institutions such as banks that help transfer funds from lenders to borrowers.

Financial intermediaries are crucial for the financial system as they make savings possible. Depository institutions, such as banks and credit unions, life insurance companies, pension funds, and other organizations that route savings to borrowers, are examples of financial intermediaries.

We have an excellent article covering Financial Intermediaries in depth. We suggest you check it out!

Small savers, who often have fewer assets available for investment, benefit tremendously from the assistance provided by these institutions.

Imagine if you didn't have institution channeling funds from savers to borrowers. It would be tough to find people borrowing from you or give them money in a good trust that they will deliver them back on time. Financial intermediaries make this process much more efficient.

Financial institutions like banks, credit unions, and savings associations can accumulate cash when customers make consistent deposits. However, other financial intermediaries don't take deposits from their customers and are known as non-bank financial institutions.

Non-bank financial institutions, also known as non-depository institutions since they do not hold deposits, are an additional significant type of financial intermediaries that also transfer savings to borrowers.

Non-bank financial institutions include organizations such as finance businesses, life insurance companies, and pension funds, amongst others.

The Role of Savings in the Financial System

The role of savings in the financial system is instrumental.

An economic system would not be able to function if it wasn't for savings.

Savings refer to the part of the income individuals choose not to consume

To better understand the role of savings in the financial system, let's consider the case of an entrepreneur like Elon Musk when he came up with the idea of Tesla cars. Elon Musk might be extremely rich now, but at that time, it was not like he had all the money to afford to hire a great team of engineers, build factories, and get the production of the Tesla cars going.

He instead had to seek money from other sources. He went to banks or gave out corporate bonds, which helped him get the funds he needed to get the production of Tesla going. Now Tesla is one of the most valuable car manufacturers in the world.

To better understand the role of savings in the financial system, check out our article - The Loanable Funds Market.

Now, there might have been an efficient financial system in place already. But if it wasn't for individuals who save money, Elon Musk and everybody else would have difficulty getting funds for investment. You can think of the savings like the fuel or electricity a car needs to move.

Savings play a vital role in the further development of the economy. All these new or existing companies can expand and provide jobs to other people because they can use savers' funds to do so. Of course, it is also a win for those who save as they get a return on their money and, therefore, receive income over time.

The Financial System, Saving and Investment Relationship

Saving and investment have a positive relationship in the financial system.

It's easy to become confused between the concepts of saving and investing. Most individuals use both of these phrases interchangeably. However, in economics, they are not always the same thing.

Let's consider Anna for a moment, who has a surplus of income over her expenses and decides to invest it by putting the money in the bank or purchasing some stocks or bonds from a company. Because Anna's income is higher than her expenditures, she contributes to the country's overall savings.

Anna could consider what she is doing with her money an "investment." Still, an economist might consider what she is doing to be saving rather than an investment.

The term investment comes from the field of macroeconomics and refers to the act of purchasing new forms of capital, such as machinery or real estate.

When Moe takes out a loan from the bank to pay for the construction of his new home, he contributes to the nation's overall investment. It is important to remember that purchasing a new home is the only household expenditure considered an investment rather than consumption.

Likewise, it contributes to the nation's investment when a company sells some stock and uses the revenues to create a new factory.

As both saving and investment are equal in an economy, they have a positive relationship with one another. If the amount of savings was to increase, it would also lead to an increase in investment.

Savings and the Financial System - Key takeaways

  • The term savings refers to the dollars made available due to individuals foregoing some of their consumption
  • A financial system refers to a set of institutions such as banks, insurance companies, etc., that enable the efficient channeling of funds from savers to investors.
  • Financial assets are non-physical assets that gain value from a contract you make with the other party.
  • Financial intermediaries are financial institutions such as banks that help transfer funds from lenders to borrowers.
  • The term investment comes from the field of macroeconomics and refers to the act of purchasing new forms of capital, such as machinery or real estate.

Frequently Asked Questions about Savings and the Financial System

The financial system provides you with the bridge you need to be connected to individuals willing to borrow your money and pay you for having used your money. 

The role of savings in the financial system is instrumental. An economic system would not be able to work if it wasn't for savings. 

Saving is part of the income an individual chooses to not consume.

Investment refers to the act of purchasing new forms of capital, such as machinery or real estate.

A financial system refers to a set of institutions such as banks, insurance companies, etc., that enable the efficient channeling of funds from savers to investors. 

Yes as they provide the main source of funding.

Savings play a vital role in the further development of the economy. All these new or existing companies can expand and provide jobs to other people because they can use savers' funds to do so.

Final Savings and the Financial System Quiz

Question

What are investment considerations?

Show answer

Answer

Investment considerations are basic investment guidelines that help someone choose their best option when investing.

Show question

Question

What are some of the basic investment considerations?

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Answer

Basic investment considerations include consistency, simplicity, and risk-return relationship.

Show question

Question

Explain consistency in investing.

Show answer

Answer

Consistency is perhaps one of the most important investment considerations you should be aware of. Some of the most successful investors invest consistently over a long period. 


Show question

Question

Explain simplicity in investing.

Show answer

Answer

Simplicity is another significant investment consideration. It would be best if one is stuck with what you are familiar with. There are thousands of different investments available, many of which are relatively difficult to understand. 

Show question

Question

Explain risk-return relationship.

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Answer

There is always a direct relationship between risk (chance of loss) and return (profit), meaning that pursuing a greater rate of return (profit per dollar invested) requires accepting a greater chance of loss. 


Show question

Question

What are some zero-risk investments?

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Answer

Checking accounts, savings accounts, and CDs.

Show question

Question

Why checking accounts, savings accounts, and CDs have zero risk?


Show answer

Answer

Because they are insured by the federal government. 

Show question

Question

What are some of the key investment considerations?

Show answer

Answer

  • Simplicity
  • Risk-Return Relationship
  • Liquidity
  • Investment Goal

Show question

Question

What is liquidity?

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Answer

Liquidity refers to the ease of accessing the cash value of the investment.


Show question

Question

What is one of the most liquid investment assets?

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Answer

The most liquid investment would be an interest-bearing (pays you interest) checking account, from which you can spend directly. 

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Question

What are some less liquid assets?

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Answer

Stocks

Show question

Question

What does investing for growth mean?

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Answer

Investing for growth means not pursuing dividend or interest payments in the short term and expecting a larger payout when the investment term finishes. 

Show question

Question

What is the meaning of ESG?

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Answer

ESG means "environmental, social, and governance." 

Show question

Question

What is the use of ESG in investing?

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Answer

ESG factors are used by financial analysts when analyzing companies in terms of sustainability.

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Question

What are some non-financial investment considerations?

Show answer

Answer

Non-financial investment considerations include:
ESG factors, demand-side factors like positive public reputation, supply-side factors like a track record of innovation (creativity and flexibility).

Show question

Question

What does 'savings' mean?

Show answer

Answer

The term 'savings' refers to the dollars made available due to individuals foregoing consumption, which the economist defines as "the absence of expenditure."

Show question

Question

What is a financial system?

Show answer

Answer

A financial system refers to a set of institutions such as banks, insurance companies, etc., that enable the efficient channeling of funds from savers to investors.

Show question

Question

Explain the relationship between savings and the financial system.

Show answer

Answer

Savings and the financial system are intrinsically connected. The financial system provides you with the bridge you need to be connected to individuals willing to borrow your money and pay you for having used your money. 

Show question

Question

What are some of the methods one can use to save money?

Show answer

Answer

There are many different methods for individuals to save money. They can open a savings account, purchase a bond, or buy a certificate of deposit, which is a document proving that an investor has made a loan with interest to a financial institution. Savers always get a receipt for their money in their savings accounts.

Show question

Question

What are financial assets?

Show answer

Answer

Financial assets are non-physical assets that gain value from a contract you make with the other party.

Show question

Question

What is the role of savings in the financial system?

Show answer

Answer

The role of savings in the financial system is instrumental. An economic system would not be able to work if it wasn't for savings as they provide the main source of funding for further economic development.

Show question

Question

What is investment?

Show answer

Answer

Investment refers to the act of purchasing new forms of capital, such as machinery or real estate.

Show question

Question

What are the main components of the financial system?

Show answer

Answer

The main components of the financial system include financial institutions, financial markets, financial instruments, and financial services.

Show question

Question

Explain financial institutions.

Show answer

Answer

Financial institutions bring investors and borrowers together, contributing to the efficient operation of the financial system.

Show question

Question

Explain financial markets.

Show answer

Answer

A financial market is where new financial assets are generated, and existing ones are traded.

Show question

Question

Explain financial services.

Show answer

Answer

The field of financial services encompasses a wide variety of professional services, including credit rating, funding for venture capital, mutual funds, merchant banking, depository services, book building, and many more. 

Show question

Question

What are financial intermediaries?

Show answer

Answer

Financial intermediaries are financial institutions such as banks that help transfer funds from lenders to borrowers. 


Show question

Question

Are savings important with regards to the financial system?

Show answer

Answer

Yes as they provide the main source of funding.

Show question

Question

How does saving money affect the economy?

Show answer

Answer

Savings play a vital role in the further development of the economy. All these new or existing companies can expand and provide jobs to other people because they can use savers' funds to do so.

Show question

Question

Why are financial intermediaries important?

Show answer

Answer

Financial intermediaries are crucial for the financial system as they make savings possible.

Show question

Question

Define the circular flow of money

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Answer

The circular flow of money describes the looped flow of money in the network of consumers and producers in an economy.

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Question

The network of the circular flow of money includes savers.

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Answer

True

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Question

The network of the circular flow of money includes labor, land, and capital.

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Answer

False

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Question

Why is the circular flow of money is important?

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Answer

The circular flow of money enables consumers and producers to transact with each other in an economy.

Show question

Question

Schools are a type of financial intermediary.

Show answer

Answer

False

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Question

Banks are not a type of financial intermediary.

Show answer

Answer

False

Show question

Question

Banks find borrowers for the money savers deposit.

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Answer

True

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Question

Investors are the borrowers.

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Answer

True

Show question

Question

A strong financial system does not really need the circular flow of money.

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Answer

False

Show question

Question

Financial intermediaries come before savers in the circular flow of money.

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Answer

False

Show question

Question

The first phase of the circular flow of money involves the transfer of funds by savers.

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Answer

True

Show question

Question

Financial intermediaries link surplus funds with the financial assets.

Show answer

Answer

True

Show question

Question

Financial assets certify the loans in the third phase of the circular flow of money.

Show answer

Answer

False

Show question

Question

Businesses appear on both sides of the circular flow diagram.

Show answer

Answer

True

Show question

Question

The government appears on both sides of the circular flow diagram.

Show answer

Answer

False

Show question

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