# Financial System: Definition, Types, and Market Components

![Financial System](https://www.investopedia.com/thmb/OeLowLgNROyIZoQ_7oU6M23EsOc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/financial-system_final-a9f735f765244e84829563e8a147abf2.jpg)

*— Investopedia / Katie Kerpel*

> **Definition**
>
> A financial system is a network of institutions that facilitates lending, investment, and other financial activities.

## What Is a Financial System?

A financial system is a set of institutions, such as banks, insurance companies, and stock exchanges, that permit the exchange of funds and credit. Financial systems exist on firm, regional, and global levels.

Borrowers, lenders, and investors use the financial system to raise money for consumption or productive investments. The financial system also includes the rules and practices that determine which projects get financed, who finances them, and the terms of financial deals.

### Key Takeaways

*   A financial system is a set of global, regional, or firm-specific institutions and practices used to facilitate the movement of funds and credit.
*   Financial systems can be organized using market principles, central planning, or a hybrid of both.
*   Institutions within a financial system include everything from banks to stock exchanges and government treasuries.

## How a Financial System Works

Like any other industry, the financial system can be organized using [markets](https://www.investopedia.com/terms/m/marketeconomy.asp), [central planning](https://www.investopedia.com/terms/c/centrally-planned-economy.asp), or some mix of both.

Financial markets involve borrowers, lenders, and investors negotiating loans and other transactions. In these markets, the economic goods traded on both sides are usually some form of money: current money (cash), claims on future money (credit), or claims on the future income potential or value of real assets (equity).

These also include derivative instruments. [Derivative](https://www.investopedia.com/terms/d/derivative.asp) instruments, such as commodity futures or stock options, are financial instruments that depend on an underlying financial asset's performance. In financial markets, these are all traded among borrowers, lenders, and investors according to the normal [laws of supply and demand](https://www.investopedia.com/terms/l/law-of-supply-demand.asp).

### $62 Trillion

The approximate total market capitalization of the U.S. stock market at the start of 2025.

In a centrally planned financial system (e.g., a single firm or a [command economy](https://www.investopedia.com/terms/c/command-economy.asp)), the decision to allocate funds for consumption and investment plans is made directly by a manager or central planner, rather than by counterparties in a transaction. The planning body or manager decides which projects to fund, who will manage them, and how to spend the proceeds.

Most financial systems contain elements of both give-and-take markets and top-down central planning. For example, a single business resembles a centrally planned financial system with respect to its internal decisions. However, it typically operates within a broader market, interacting with external lenders and investors to carry out its long-term plans.

At the same time, all modern financial markets operate within a regulatory framework that limits the types of transactions and investments allowed. Financial systems are strictly regulated because they directly influence decisions over real assets, economic performance, and consumer protection.

## Financial Market Components

The financial system has multiple components at different levels. At the level of a single firm, it can refer to the set of procedures that track finances within the company, including accounting measures, revenue and expense schedules, wages, and balance sheet verification.

On a regional scale, the financial system enables lenders and borrowers to exchange funds. Regional financial systems include banks and [other institutions](https://www.investopedia.com/terms/d/discount-house.asp), such as securities exchanges and financial clearinghouses.

The global financial system is a broader system that encompasses all [financial institutions](https://www.investopedia.com/terms/f/financialinstitution.asp), borrowers, and lenders within the global economy. In a global view, financial systems include the International Monetary Fund, central banks, government treasuries and monetary authorities, the World Bank, and major private international banks.

## How Will I Use This in Real Life?

If you ever plan to apply for a credit card, save money in the bank, or even cash a check, you will interact with the financial system. This is the web of businesses that facilitates the movement of money.

Today, the financial system affects almost all economic actors. Businesses interact with the financial system when they need to sell shares or borrow money. Individual consumers also interact with the financial system when they save money in the bank or borrow money through a credit card.  

## Who Runs the U.S. Financial System?

There's no single institution or individual that runs the U.S. financial system. One of the most powerful agencies overseeing the financial system is the U.S. Federal Reserve, which sets monetary policy to promote the health of the economy and general stability. Other notable agencies involved in overseeing the financial system include the Federal Deposit Insurance Corporation (FDIC), which insures deposits at banking institutions, and the [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp), which regulates the stock market.

## What Are the Factors Affecting the Stability of the Financial System?

Stable financial systems are ideal because such conditions permit the most efficient allocations of resources, steady unemployment, and predictable assessment and management of risk. The stability of financial systems depends on a diverse range of factors and can be disturbed by events like political turmoil, trade imbalances, natural disasters, health emergencies, and rapid inflation, among others.

## Why Is the Financial System Important?

Financial systems are critical as they are a foundation for most economic activity. Individuals and businesses rely on financial systems to borrow and lend money, buy and sell assets, and make profitable investments. Financial systems link all the bodies, participants, and practices that make such interactions possible.

## The Bottom Line

A financial system refers to all the institutions that facilitate the exchange of funds throughout an economy. This includes lenders like banks and credit unions, marketplaces like the stock exchange, government agencies like the Federal Reserve, and even international institutions like the World Bank. It is within the financial system that all interactions—borrowing, lending, investing, financing—can be conducted.

> **Article Sources**
>
> 1.  Siblis Research. "[Total Market Value of the U.S. Stock Market](https://siblisresearch.com/data/us-stock-market-value/)."