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Chapter Two
Overview of the Financial System
Introduction
2.1 As noted in Chapter 1, FSIs are calculated and disseminated for the purpose of
assisting in the assessment and monitoring of the strengths and vulnerabilities of financial
systems. Such assessments need to take account of country specific factors, not least the
structure of the financial system. Simply stated, whether an economy has a few or many
banks, has diverse financial intermediaries or not, has deep and liquid securities market or
not, and whether the financial intermediaries have international operations or not, matters to
any assessment. This chapter identifies and defines the main types of players and markets
that typically constitute a financial system.
What is a financial system?
2.2 A financial system consists of institutional units10 and markets that interact, typically
in a complex manner, for the purpose of mobilizing funds for investment, and providing
facilities, including payment systems, for the financing of commercial activity. The role of
financial institutions within the system is primarily to intermediate between those that
provide funds and those that need funds, and typically involves transforming and managing
risk. Particularly for a deposit-taker, this risk arises from its role in maturity transformation,
where liabilities are typically short term, (e.g., demand deposits), while its assets have a
longer maturity and are often illiquid (e.g., loans). Financial markets provide a forum within
which financial claims can be traded under established rules of conduct, and can facilitate the
management and transformation of risk. They also play an important role in identifying
market prices (“price discovery”).
2.3 Within a financial system, the role of deposit-takers is central. They often provide a
convenient location for the placement and borrowing of funds and, as such, are a source of
liquid assets and funds to the rest of the economy. They also provide payments servic